Global equity markets have been through volatile times and we noticed some rebound since been affected by the US subprime mortgage market collapse. What started of in the subprime sector enveloped the prime home loan as well as the securitized debt markets as a spillover effect. Yet, the Fed and the Central banks were quick enough to buffer the market crisis with the former cutting interest rates and the later pumping huge money, around $550 billion till now, into the markets. The cumulative effort saw the markets react with some bull rallies before turning volatile again. The CME volatility index has been around 21-23 last month against 37 in August, the highest since last year. Some banking consolidation has taken place since the subprime with major investment banks re-pricing risks on MBS bonds. Hedge funds also have reported some big losses exposed to the MBS bonds.
The other prime market mover is the crude oil, which have in fact quite rude on the markets. Oil price shock with Nymex touching nearly $100, have had enough stress on the economy. The OPEC is expecting some oil price moderation and the oil is expected to settle in the range of $ 70-$ 85 per barrel in 2008. The depreciating US $ have been implicated to be one of the cause of rising crude oil price, apart from supply constraint and gulf events. Sustained oil price rise could prove detrimental for the already struggling US economy, as it might further accentuate the chance of an US economic slowdown, fearing a faltering in Asian exports, according to Bloomberg.
We have also noticed some risk de-leveraging in the alternative investment sectors, but that would be a temporary effect, according to global economists, which they expect to pass off in recent times as investors, now being more risk averse, will tend to diversify their asset holdings in the emerging markets. Liquidity crunch within the interbank system have been somewhat contained with prompt central bank interventions, but credit conditions beyond the banking sector remain much stressed. Global investors certainly look forward for a better 2008 as macro-economic fundamentals have started to improve since the last quarter.
One of the prime agenda of the Bush administration and the Fed is targeted to rescuing distressed mortgage lenders and sheltering subprime borrowers. These measures have indeed upgraded the investor sentiments while they await to see more aid from the Fed, if it likely be so needed to cut interest rates further. Fed Fund rate outlook for the next session hovers around 4.0% or even 3.5%-3.75%, industry analysts expect.
Market Pulse-Asia-Pacific- Feeling the stability!
With stabilization of global assets, equity markets might see some rebounds as indices in the emerging markets have been in their best rallies in recent times. The BSE crossed a big milestone when it touched the 20k mark around October. The Hang Seng did cross the 30k mark too. It has been implicated that the opening up of investment opportunities for Chinese investors to invest outside China for the first time have been met with success, with more investors investing in H-shares traded in Hang Seng as an alternative to the A-shares trading at Shanghai’s SCI 300. This has also created an arbitrage opportunity for the same share being traded both in Hang Seng and SCI 300.
The Asia-Pacific market pulse indicates some positive trends in the coming, partly because of some recovery in the global equity markets, except Nikkie-225 that lost around 11% for the first time in last five years, and partly by the inflow of some good information about the US labor markets, consumer sentiments and about the festive season. With C/A surpluses of Asian economies and better industrial production rates in China, India, these countries have the least minimum exposures to US subprime and a likely US or Chinese slowdown, however, enjoys substantial freedom from a sudden capital outflow or a rapid currency devaluation as it happened during the last Asian Financial Crisis in 1997, according to some analyst.
Emerging markets are awash with abundant liquidity to propel their growth engines toward sustaining this economic boom in a healthy pulse, even in the event of an impending US slowdown. It should however be noted that the Dow Jones P/E ratios are far lower than their Asian counterparts which awaits some corrections likely, of the Chinese SCI 300, as the economy have become overheated , according to Bloomberg and other economists. On a sector-wise outlook, three sectors seems to have caught the fire in the markets; i.e, the cement, steel and the Oil. Prevailing infrastructure boom in many emerging economies like China, India, Vietnam and others, correlate between the sector performances with the infrastructure and real estate growth in these countries. The mineral stocks like copper, silicon are likely favored long term stocks as well as the diamond sector and the gold stocks and the utilities, that is expected to do well even in a bad market.
Global Liquidity-Is there enough out there?
Global markets now have more liquidity and assets than any other time in history. With buoyant credit markets funding LBO deals on high leverages along with the participation of Private Equity players, there is no dearth in liquidity in the market. If the developed markets are supplying liquidity, the Emerging markets are contributing to this sustaining the economic growth, like China that contributed to the highest global growth last year-15.6% compared to 15.4% from the US. In private capital investments, US and the Japan are the major sources of liquidity in the markets, with a bulk of it from the US. As such, any major US downturn would generally hit the credit markets hard and the Asian exports would be hit due to a low consumption in the US. India, being on the forefront with major infrastructure programs being financed, which would otherwise be delayed if hit by a credit halt.
Remittances from NRI’s (Non Resident Indians) form a substantial source of forex reserve in India as like Philippines, and as such, any events effecting demands for foreign workers in US and the gulf could have an effect on inward remittances. Analysts have a view that the Central Banks now should be more active in smoothing out any volatility, credit problems or other factors that might have some adverse effects on the markets.
India Outlook
With an ever increasing India’s middle class (100-200 million), along with the consumer boom that has started to take shape lately, India is flying high in the global capital markets like a dove. More FDI and FII are flowing into the markets, targeting hot sectors like IT, real estate and the infrastructure. Annual FDI flow close to US $30 billion are expected to hit the markets and will be canalized to the fund crunched much needed infrastructure sector. India is wooing Japan to invest in India’s infra-techs, one such example being the successful completion of the Delhi metro rail project. The ambitious plan drawn up to create DMIC, -Delhi-Mumbai Industrial Corridors of 1500 km long, at a projected cost of around US$90 billion is under consideration by the central planning commission. The government wants to create SPV (special purpose vehicles) to fund the project. And with multiple SEZs on the pipeline, it seems India has entered the same construction boom that prevailed during Deng Xiaoping’s era in China, early 1980’s. Recent visit by the Japanese Prime Minister Shinzo Abe to India and Indonesia did boost up Indo-Japan tie. Japan might be hedging against the dependency on China—an event that could be related to his more inclined visit to India.
However, Japan would be reluctant to deteriorate any ties with China, as India-Japan-China has more become like economic allies rather than pure competitor to say. India, would also like to take the opportunity to improve bilateral ties with
China, since India and China constitute the two largest and fastest growing economies in the world. Neither India nor Japan would like to jeopardize each other’s ties with China in the meantime. Though it is obvious that China and India would at some point of time in future will become chief competitors of Japan.
Thus, it throws some light that how India has positioned itself within the Asia-Pacific region demanding more attention in the regional economic cooperation and multilateral free trade ties with the ASEAN nations. Along with the US Nuke deal, India is also counting to tap on the Japan’s and France’s civilian nuclear technology for its energy demands. What could give a real boost to the FTA in the Asia-Pacific region if India lowers or removes some tariff on component businesses from Japan, the same Indonesia did remove tariffs on auto-components from Japan, and Japan responded with removing tariffs on agricultural imports from Indonesia. In Fact, Indonesia is still a bigger trade partner of Japan than India, and India needs to look into this prospect.
Bilateral trade between Japan and India stands around $8.5 billion and is projected to reach $14-20 billion by 2010-2012. Even though, due to widening of investment options for Indians, there might be a continued upside potential for the BSE Sensex, since some analysts have a view that BSE could reach well beyond 23k next year, and with continued upswing, there might be more overseas investors queuing up the lane, if all goes well.
See JETRO for more on Japan’s International Trade.
Forex Markets: Exchange Rate Swings
Major traded currencies like $ and the Yen have been highly volatile, and in-fact, the dollar has lost around 10% against global currency majors. The Indian rupee has appreciated further on account of FII inflows, and some analysts expect the rupee to tighten further till 36-37/$ mark as against 39.41/$ at present. But the Rupee along with other Asian currencies is also vulnerable to risk of devaluation against a sudden reversal in capital flow dynamics, i.e., capital flight. Though it may not likely to happen in the near term as long as the dollar remains week and the emerging market growth story remains firm. The Yen appreciation to 113/$ saw the unwinding of carry trade, a tool where one borrows cheap and invests in higher yielding assets. The low interest scenario of Japan-0.50% and the continued deflation has put the Japanese yen under pressure, which saw resumption in carry trade. There was a short term bounce in GBP/JPY (219/£) against the Yen (¥) trading at 248/£ in August this year and the present range have been somewhere around a low ¥111-119/$, according to Bloomberg and ET.
The Philippine Peso has also appreciated by 10% and thus risks depreciation if the US economy slows down. Since about 10% of Philippines are overseas workers that contribute remittances from abroad which constitute 10% of their GDP, a slowdown in Gulf or the US might affect the inward remittances in Philippines, thus hurting their consumer boom. There has been much pressure from the G7 nations to revalue the Chinese yen, as it has maintained an artificial low since it got un-pegged from the US $. The Chinese Yuan is devalued around 12% against the US$ that is causing much un-pleasure since it has resulted in a huge trade imbalance between the US and the China. This is in part good for the Chinese exporters who enjoy marginal competition among the Asian exporters.
Since consumption constitutes around 70% of US GDP, credit squeeze in the US could hurt the corporate sector that might bring down consumer sentiment heavily. According to analysts, real GDP in US is growing by around 2.3% y-o-y, and some analysts forecast it around 3.2% at best. The US still remains the largest economy followed by Japan, and with an increased possibility of the US slowdown, the growth story of the emerging markets might sing on the wrong tune. An equity outflow from the Asian markets could also trigger forex weakness, since emerging markets have increased their foreign ownership in stock market capitalization. As the US still remains the major investor in global economy, a redemption pressure in the US could also jeopardize the ambitious plans in the emerging nations. Considering all these risk factors on currencies, it might be said that the financial markets in Asia are in better shape than what they were in 1997-98, during the Asian financial crisis and it likely to buffer to some extent if a full fledge global economic slowdown comes around.
