'Contagion effect' could spell 'mayhem' for markets

Disclaimer: This write-up is not meant to scare investors, but enable them to understand ground realities and prepare them to take informed decisions on their investments.

 

Us equity indices are trading at all time highs and you thought that the global economy is in 'pink of health': you are mistaken. Bullion prices have smartly recovered from their recent lows and you thought genuine demand is back: you are sadly mistaken. Real estate prices have started firming up after stagnating for 2 quarters and all is 'hunky dory': you may be far away from reality. The month of May 2013 could lead to busting of many such myths and bring the world closer to reality. May may lead to 'mayhem' in the markets!

 

Let us understand the meaning of 'Contagion effect': According to Wikipedia Financial contagion refers to a scenario in which small shocks, which initially affect only a few financial institutions or a particular region of an economy, spread to the rest of financial sectors and other countries whose economies were previously healthy, in a manner similar to the transmission of a medical disease. Financial contagion happens at both the international level and the domestic level. To put it in simple words it can be explained as: 'When 'Uncle Sam' sneezes the 'Dragon' catches cold. Let us analyse the reasons that could pull all markets down in tandem.

 

Quantitative easing (QE): There have been three rounds of QE leading to pumping of liquidity into the markets to overcome the spectre of a recession. There was a consensus on the positive impact of QE1, whereas the opinion of economists was divided over QE2. But the consensus has been strong on the negative impact of QE3. Most economists believe that QE3 was responsible for excessive dose of liquidity in the markets which fuelled the prices of risk assets (Equity, bullion, real estate) to unsustainable levels. Now the markets are in a mood to correct these imbalances. The crash in Bullion prices is only the tip of the iceberg. Gold was traded at Rs.19500 per gram in 2011, so a correction to these levels should not come as a surprise to investors, after a temporary rebound. US equity markets have rallied to new highs despite serious questions on its growth prospects: a 10-15% slide cannot be ruled out. Real estate prices in Asia (more particularly India) are still quoting at unaffordable levels in most tier-I cities: a decent correction cannot be ruled out.

 

The trigger for a correction is most likely to come from Euro zone, which is on the brink of a major full-blown crisis. Indian markets would also have to contend with an uncertain political situation leading to the non-functioning of parliament/ dissolution of the Lok Sabha. Where would the money flow in such a scenario: The excess liquidity would definitely move into US treasuries leading to a strength in US dollar, which would weaken the commodity and equity markets. Gold & equity markets havs a potential to correct at least 20% from current levels: So don't be surprised to see Gold at Rs22000 per gram in Indian market, and front line Nifty at sub 5000 levels in this 'mayhem'. Realty markets could also stagnate for a few more quarters with tier-I cities bearing the brunt of the carnage.

 

The best investment strategy in such a scenario would be to sit on cash/ bank deposits, which can be profitably re-deployed once the downturn has played out. A real/ meaningful global recovery is still at least 2 quarters away. It may not be a bad idea to sell in the markets at current levels and go for a holiday in May 2013.

A 'Golden myth' shattered: Real Estate crash may follow!

The inevitable has happened: Gold & Silver prices have recorded their biggest single day crash in world markets today. Interestingly, media has got something new on its platter as compared to the boring debates on Narendra Modi vs Rahul Gandhi, none of whom is capable enough to become a worthy PM candidate of world's largest democracy.

 

The events of the past 2-3 days have shattered one of the most common myths cherished by many investors: "Gold prices can never fall''. Many such investors who put forth an argument in favour of investment in gold at ridiculously high prices was its 'safe haven' appeal and the limited supply, suddenly have developed cold feet and are quitting their gold investment in a hurry. The entire metal sector is witnessing a free fall due to escalation of the Euro zone crisis to alarming proportions. Indian economy is also in the grip of a massive slowdown, even as liquidity becomes tighter. The events of the past few days have started the exodus from physical assets which are held by investors till a panic situation is created.

 

Is this a precursor to the larger crash to follow? I am pointing towards a real estate market meltdown. If history is to be believed there are enough reasons for creation of a bleak scenario for the real estate crash in the near future. In a panic situation investors liquidate the most liquid assets first and illiquid assets are retained till the last. Real estate being the most illiquid asset, investors are still holding on to it, on the belief that they still have not lost money on their investment. This illogical belief is based on the artificial prices created by the builder lobby. The recent entrants to the real estate market will be the first to panic once they are faced with a liquidity crunch. The reasons for this to happen are very strong as the new real estate stock sold recently is almost entirely owned by speculators. End users have been left far behind in the race for owning their 'dream home'. The liquidity crunch coupled with an unstable political scenario is a perfect situation to create a crisis in the real estate market. In such a scenario first time home owners are advised to wait a while to get better bargains to suit their budget. It may not be a bad idea to strike a bargain to rent a property of your choice as rentals are on a southward journey. Commercial rental market is also showing signs of a massive slowdown. Those in need for owning a house may opt for 'ready to move in' properties rather than new projects which are being launched at unrealistic premiums during the festive season. Resale properties are available at 10-12% lower price point.

An economic recovery will not be sustainable without a real estate crash, as economic growth depends upon an orderly real estate market: both for individual home owners and corporate sector. Real estate must be available at reasonable prices to the end users. The asset class that will revive the risk appetite will be 'Equity'. Investors are advised to enter equity markets on declines as they drift lower in sympathy with commodity and real estate markets.

 

 

 

Extreme pessimism may push markets down: Investors advised caution

There is extreme pessimism in the markets, despite US equity indices making new highs. In my last post, four weeks back, I had anticipated the markets to correct to the level of around 5600 on the Nifty. The market has decisively breached the 5600 mark recently and is not showing any signs of a recovery soon. The underlying pessimism in the markets is a result of the following factors:

• India's economic recovery is still illusive. In fact fresh data is suggesting a further slowdown in growth momentum. Inflation is not coming down to reasonable levels and the Current account deficit (CAD) has blown to 6.7% of the GDP. Despite a falling rupee our exports continue to stagnate. There are serious supply side bottlenecks in core sector growth. Policy paralysis is making a heavy negative impact on the Infrastructure, Power & Mining sectors. New investors are shying away from investments in Indian projects. Even the FII flows are slowly turning negative.
• Political Uncertainty is likely to intensify in the days to come. This may lead to postponement of important economic decisions. The announcement of early General elections could dampen the market sentiment further.
• The news flow from Euro zone continues to caste its shadow on risky assets. The Cyprus issue could escalate  to a full blown crises for the Euro zone. There are other concerns too. North Korea continues to be 'Joker in the pack'. It has the capability to disturb the global equation, and may lead to military tensions with the west.

In the above scenario, the short term outlook for all risk assets (Equity, Bonds & Real estate) does not seem to be promising. We could soon see a panic situation in real estate markets as the liquidity is becoming tight. We could also  see a substantial fall in equity indices from the current levels. Equity markets could fall another 10% from the current levels and could stabilise around 5000-5200 on Nifty and 16500-17000 on the Sensex. A sudden declaration of war (by North Korea) or dissolution of Lok Sabha could have a knee jerk reaction on the equity indices which could take the Nifty to sub 5000 levels for a short while. If this happens it would be a really opportune time for investors to buy, as the indices would recover from their lows quickly. Investors are advised not to panic in the volatile environment and keep investing in front line  equity stocks on declines. Any short term bounce from the current levels towards 5750 on Nifty will be a good opportunity to book some profits & trim short term losses. An early election will be positive for the long term revival of the Bull market in India. If that happens we could see a sharp turnaround in equity markets in the 2nd half of FY 13-14.