Time for a correction?

Everything seems to be doing well right now.  The economy (in India) is very much back on track, job markets are again buoyant,  companies are talking of giving two-digit increments and retention bonuses, the stock markets are up at 18k levels which is not far from the peak and they have stayed there for some time, real estate prices have gone up in the last six months, the rupee has stopped gyrating wildly and is at 46-47 levels, oil at $75 seems to be neither underpriced nor overpriced… and the list goes on.

 

So life is good.  It's a grand party. Things will go on like this for the next ten years. Or so we think. 

 

Therefore, it's time to worry.  Things don't look as great and rosy as they did in end-2007, but they still look too good to be true.  Most economies of the world are not out of the woods yet, and there are certain macro-economic factors at play that seem eerily similar to the situation prevailing in end-2007.

 

The US Economy is not back on track. The meltdown caused by the subprime crisis has not gone away. The interest rates are at a record low still, i.e. close to zero, and the Fed is still pumping cheap money into the economy.  The Fed really has no more tools left in its armory than to wait it out and hope the economy recovers before something implodes. After a lot of talk of the Greek  crisis, there seems to be silence on that front.  The banks and governments have got together and "refinanced" the debt, and are now silent on how it will be ultimately repaid.  The PIIGS countries are all facing structural problems caused by huge debt; they are currently on the hospital beds with their eyes closed hoping that when they open them the disease would have miraculously gone away.

 

The Indian Economy was never affected too much by the 2008 crisis in the first place.  When the party was on, it benefited from inflows of money that pushed up asset prices, and when the time for reckoning came, the money rushed out leaving tumbling asset prices in its wake.  However, the real economy was not too much affected. Most of the swings we saw were due to money flows.

 

Right now we seem to be in a steady state.  Which is not to say that the economy is fine and things are looking rosy. The old structural problems remain and are reasserting themselves. Inflation is very high over the last couple of years, especially in the areas where it hurts the common man the most i.e. food.  RBI is slowly raising interest rates once again, but not as fast as it would like to, since the Government is not keen on too much monetary tightening. 

 

The world over, retail investors are not participating in the stock markets in a big way right now.  Liquidity is being artificially propped up with cheap money from the US  Fed.  The markets are being held up by the exuberance of institutional players.  Past experience tells us that if the feeling reverses, they will all rush for the exits together. The Dow is up, but how much of it is due to structural reasons and how much due to reasons to do with liquidity? In India, the rise in real estate prices witnessed in the last six months is not really backed by real demand. The stock market seems to be sustaining itself at reasonably high levels not based on solid corporate performances but more on expectations. 

 

So where does that leave us? We should be wondering whether the US markets will sustain. Will there be a correction (not a crash this time, let's use the word "correction") in the near future? Will there be any fallout of the crisis in the European markets which has not really gone away? If that happens, we know what the pattern is. People will start pulling out money from all emerging markets including India.  The Indian stock market for all its size lacks too much depth. A few billion dollars in or out due to FII flows, and the market reacts disproportionately.    The rupee, if this happens, could again depreciate to 50 or more levels.  In sympathy will stock prices, real estate and other assets could also tumble. In case of real estate there is the additional factor of too much supply about to enter the market. There will be some amount of stability provided by the real economy, but short term price movements are dictated more by liquidity flows.

 

Will it happen?  I don't know.  But there is a good chance of there being some kind of correction.  If it happens, asset prices will drop,  at least for a while.  If it does not happen, asset prices do not seem likely to go up substantially from current levels in the near future.  Balance of probability and expected gain would suggest that it is time to consider booking some profits.  It's also a time to think twice before committing to fresh investments.