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.
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