FIIs’ rave party in India; Economic indicators are at loggerheads

From bleak to bright – the markets suddenly turned positive ending its successive falls, thanks to strong FIIs inflows and short covering. In a swift movement, the bellwether Sensex added over 1300 points in a span of nine working days ending all the bearish sentiments which had been prevalent across the punters. The favorable factors emanating were from Greece whose parliament approved stark austerity measures; thus, paved the way for international financial aid and it would bail out the country. In India, FIIs joined in the rave party after a brief lull with a total inflow of Rs. 5,084 crore in the last week of June. Markets across the world moved up.

What the other indicators say?

While the equity moved up on favorable news emanating from European sub-region, the manufacturing has slackened across the world. In the latest Purchasing Managers’ Index (PMI) by HSBC and Markit Economics, the figures dropped across the countries. As per the latest figures, the manufacturing growth is slowing from China to Europe, thus, sending the dilemma to all central bankers whether to increase the interest rates to combat inflation despite high prices. While China’s factory index fell to its lowest level since Feb 2009, Europe’s index dropped to 18-month low. Across Europe i.e. Italy, Ireland, Spain, Greece, Germany and others reported contraction. The UK also reported a fall in PMI in June. In India too, manufacturing growth loses steam in June 2011. The PMI drops two per cent to 55.3 per cent in June, its lowest level since Sept 2010. The PMI is considered a good indicator of manufacturing activity across the world, but in India, the large contribution from the unorganized sector yields a low correlation with industrial growth.

Why PMIs are falling?

In the state of higher interest rates, central banks are tightening the interest rates, thus, hurting the economic growth. The average cost of borrowing has increased which are hurting the investment. In India, the investment growth in the latest GDP growth has grown flat. Gross fixed capital formation for Q4FY11 stood at 0.4 per cent compared to 7.8 per cent and 8.6 per cent in Q3FY11 and FY 2011 respectively.

Market punters are blaming the global economic scenario for the current headwinds. But the tailwinds still exist. We expect that the domestic companies’ performances in the first quarter of FY 12 would also decide the movement of markets as the internal consumption growth story remains intact. The natural historical corrections are also certain and the future looks promising. So, let us be hopeful.

Happy Investing!

-          Amar Ranu

Why do markets go up/down?

Sellers outnumber buyers, says a simple market theory. But the game of economics in the current globalised world which keeps the countries coupled with each other makes the markets gyrate either in upward or downward direction. We often read the financial news “The financial markets reacted to the report with a sharp fall…”. But in reality, do the markets react to the news in this way? Our traditional economic theory says that markets are mostly in equilibrium, reflecting an overall balance of economic forces. Markets’ direction change when these forces change i.e. when any good news about a company increased demand for its stock, making its price go up.

But the theory of simple buying and selling which determines the price discovery seems to fail with the current crisis triggered by the bursting of a financial bubble in the US mortgage markets in 2007 that had grown to gruesome proportions, thanks to lax regulations and complex financial instruments that hid risks. The issue on the top was the issue of ‘moral hazard’. Brokers were incentivized to generate borrowers and investment banks took on these risky loans and lumped them together into “Collateralized Debt Obligations”. And a single failure at one of the nodes of a tree made it to collapse. The striking feature of the crisis is that the situation appeared to be driven by ‘emotion’. The word ‘fear’, not an equilibrium concept, appeared in almost all newspapers. “Too big to fail” syndrome tasted dust with the fall of Lehman Brothers, an investment bank giant. Traditional economic models don’t capture these dynamics. Market dynamics can be bewilderingly complicated, with thousands or even millions of participants – ranging from banks and mutual funds to individual punters – all interacting with one another.

The system of leverage has created a surprised situation in the market. Lots of leverage begins to pose a threat of failures cascading through the market and it bursts out if it crosses a certain threshold. A single failure sends ripples of trouble through the entire market, making it to nosedive.

Moreover, many economic parameters have become so relevant in the financial markets that even a marginal negative movement in these numbers can let markets move in uneven directions. Some of the dominating factors are Index of Industrial Production (IIP), Purchasing Managers Index (PMI), Libor-Dollar movement, GDP growth rate, fiscal deficits, government borrowings, Composite Leading Indicator (CLI) given by OECD, MSCI Index et al. Since the financial crisis in 2007, these numbers performed miserably, before some ‘green shoots’ were visible at the end of last quarter of 2008-09, thanks to series of stimulus plans, bail outs, low interest rates, tax sops etc by central banks across the world. The emotions played stronger, emerged as the major tool in deciding the market movements.

The natural reaction to a crisis is to update and upscale regulation and supervision. The markets unwillingly move in either direction by millions of investors; those with stronger steam make it move in their direction, thus, disproving the basic dynamics of demand and supply. To a large extent, it is the man made movement. The game goes simple, “there is no place for snoozers”. The theory of money making goes on with either party making losses or gains. The only unidirectional beneficiaries in this game are the bourses which just smile, make money and see these punters betting to each other.