Decoupling theory-A comeback?
by Ishan Bakshi on 21 Jun 2009 0 Comment

The stunning upward trajectory of benchmark indices has left people gasping for breath. With an eighty percent rise over a span of two odd months, many experts have proclaimed - “The worst is over”. While some euphoric observers have described it as the commencement of the next Bull Run, others have adopted a more cautious approach, dubbing the present rally as a cyclical bull run in a structural bear market. With better than expected Q4 GDP numbers, is it possible the decoupling theory is making a comeback? Can emerging markets embark on a bull run while the west limps on?


Changing scenarios


At the peak of the crisis, fear prompted a retreat from ‘risky’ to ‘safe’ assets namely the US dollar and treasuries. These were considered ‘safe’ havens as assets classes across all economies were plunging. However, the US policy response to the crisis in the form of monetary and quantitative easing and stimulus packages, has led many to question the long term viability of staying invested these ‘safe’ assets.


With the US still in a very precarious situation, the probability of the Fed raising rates anytime soon is very low. Also, the fragile state of the economy further casts aspersions on the ability of the largest borrower in the world to pay back its creditors; a point which has been highlighted by the head of the Chinese central bank (the largest buyer of US treasuries).


Fear leading to paranoia which prompted a move away from ‘risky’ emerging markets was misplaced, with various statistics pointing out the same. Emerging economies are faring much better than the pessimistic forecasts, and their reliance on the US consumer is gradually decreasing. This realization has prompted a global re-routing of portfolios in their favour. Inflows into emerging economies, especially BRIC economies, have suddenly increased sharply, leading to ‘suspicious’ stock market rallies.


FII net purchases (India), which were negative for 2008, stood at 7000 crores in April; climbing to an astonishing 20,000 crores in May. While some may argue that election results may have impacted the inflows, they were evenly distributed in May. Ironically, such an interest was shown only in September-October 2007, before the last lap of the Bull Run.


 

 

FII Net Purchase

Mutual Fund Net Purchases

2005

 

45825.60

13295.16

2006

 

31281.08

14484.59

2007

Jan-June

25508.65

72.88

 

July

18132.80

-900.80

 

Sept

18948.50

-761.20

 

Oct

15577.60

-1715.40

 

Nov-Dec

299.30

5370.60

2008

 

-53051.70

11728.00

2009

Jan-March

-5536.40

-884.10

 

April-May

27991.10

2329.90


 Figures in Rs Crores; source moneycontrol.com 


A huge quantum of investable funds was lying on the sidelines because of uncertainty about the direction of the market. Having missed the rally and underperforming the markets, there is a tendency to buy on pullbacks, which is taking the market higher.


Great Expectations


The uncertainty in the political arena had complicated matters further. It was widely believed that the formation of government at the centre would be possible only with the help of ‘difficult and demanding’ regional parties. Given the inability of the Congress to undertake reforms during the last five years, due to coalition compulsions, the unexpected result was given two thumps up by the market. It is widely believed and expressed that the current government with a strong mandate will fast track reforms. With more stress expected on infrastructure, exports and measures to revive the economy, GDP growth forecasts have been revised upwards.


Economists’ forecasts for India’s GDP

 

Before Elections

After Elections

Macquarie Securities

5.5

7.0

Barclays

5.5

7.0

Bank of America- Merrill Lynch

5.3

6.3

Goldman Sachs

5.8

5.8

Source: research reports


The only exception being Goldman Sachs, architect of the BRIC theory. Before the election results, Goldman Sachs proclaimed that a BJP-led government would be more pro-business than a Congress government. Congress has been seen by many as undertaking populist measures and changing policies to suit a few business houses. Though India has a long history of governments disappointing on reform agendas, with the Left not in the picture, there is widespread optimism that history will not repeat itself.


A secular Bull Run?


Liquidity created post the collpase of the dotcom buble was largely responsible for the massive flows directed towards emerging economies till 2007. Now again, a low interest rate regime in most countries around the world coupled with quantitative easing being carried out on a massive scale, is largely going to benefit emerging economies, in particular BRIC nations.

 

 

Short-term Interest Rates

Region/Country

March

March

June

Sept

Dec

March

 

2007

2008

2008

2008

2008

2009

US

5.23

2.26

2.29

2.04

0.44

0.5

UK

5.55

6.01

5.93

6.25

2.73

1.7

Japan

0.57

0.75

0.75

0.75

0.62

0.54

Euro Area

3.91

4.72

4.96

5.07

2.97

1.5

India

7.98

7.23

8.73

8.56

5.04

4.95

China

2.86

4.5

4.48

4.31

1.86

1.22

Singapore

3

1.38

1.25

1.75

0.91

0.56

Hong Kong

4.17

1.83

2.33

3.66

1

0.9

 

 

 

 

 

 

(Per cent)

Data for India refer to 91-day Treasury Bills rate and for other countries 3-month money market rates.

Source : The Economist

 

 

 

 

 




Their relatively less painful escape from the crisis has brightened their future growth prospects. By reducing their dependency on the US consumer and focusing on their burgeoning domestic demand, they provide a viable alternative to the highly fragile western world. However, like before, the possibilty of massive inflows leading to asset bubbles is very high.


The author is a financial analyst

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