PERCEPTION and the Need For Greater Global Policy Coordination in a 2014 WORLD

Posted on February 4, 2014. Filed under: Uncategorized | Tags: , , , , , , , , , , , , , , , , , , |

Perception is a major factor driving volatility in the market and this is why I am of the firm opinion now that it’s the market psychology and the overall investors sentiment aka the “mood of the markets” that creates and drives the volatility. And when a perception starts getting entrenched then people generally tend to ignore the sense of reasoning and stop looking at the big picture and this is why at times markets tends to behave like headless chickens because the underlying perception creates uncertainty and CHOAS takes over. So it is important to arrest this momentum before it ends up damaging the economy, it’s like this…we create a perception and then use that perception to create a reality.

In an interconnected global economy perception can create volatility and uncertainty and this is one of the reasons why a contagion risk remains a plausible scenario especially when people tend to get overwhelmed by the sound bites coming from various quarters of the financial markets. But it must be said that there is always value in looking at each market and economy individually. For instance, if we look at Turkey and Argentina, the fundamentals of these economies didn’t really deteriorate overnight. The Turkish central bank should have raised rates over a year ago but today the stretched fiscal situation combined with the political uncertainty is hurting the economy real bad but having said that a quick political resolution will likely calm the fears around Turkey and with regards to Argentina, the central bank of the country has been running a wacko monetary policy for sometime now so what the country is facing today is an outcome of such policies.

And assuming the worst case scenario, both Argentine and Turkish economies isn’t big enough to possess a systemic or a damaging contagion risk for all the emerging market economies, at least not based on the ground realities but yes in perception there might be. And to get some perspective, it is worth remembering that both Turkish as well as Argentine economies have gone through crises in the past without causing any significant problems for the world economy and also the rest of the EM didn’t really see any damaging contagion  come through and that’s the reality. Also, it is important to note that economies both in EM as well as developed markets tend to be at a different levels of maturity and they are different in many ways. For example, China and Brazil although a part of the same block of BRICS nations are in fact two different economies in many ways. The leadership in China for instance needs to implement the planned financial reform agenda whereas Brazil clearly needs a wholesale supply side reforms. So in short they aren’t dealing with the same issues.

We live in a very interconnected 24 x 7 world where perception drives the overall investors sentiment creating volatility and the global economy of 2014 reflects that reality. Perception can have a snowball effect and is no doubt contagious. So even though the IMF has revised up its global growth projection for the year 2014, there are a number of factors that could influence the real economic growth going forward. And one of them is a possible decline in positive sentiment and confidence in general around the global economy driven by a change in overall perception. And in most likelihood a potential sluggish growth and deteriorating fundamentals across emerging markets will have an impact on the overall growth dynamics of the developed world so it will be unwise to assume that the developed markets are going to be somehow immune. This is why it will be ill-advised to conclude that the developed markets have entered a self sustaining growth in 2014 so when I hear the sound bites coming from parts of the markets suggesting that the current volatility in the market is more or less an emerging market issue and thus the policy markers in the EM should get their house in order by adjusting to the market expectations, I can’t help but wonder, are they seriously suggesting or assuming that the developed world can grow in isolation especially in a post financial crisis world and also that the turbulent cloud over the emerging markets won’t enter the developed world? The markets clearly believe that a potential turmoil in the developing world could have an effect on the developed world. And there is probably a strong reason behind  that assumption.

When the western economies were on the verge of collapsing during 07/08 crisis, the politicians and the policy makers were busy calling anyone and everyone including their counterparts in emerging markets to help the global economy get out of the mess and most emerging markets did come together and a global policy coordination was worked out to keep the world economy going and from falling under. To help safe the financial sector and the economy, the central banks adopted an ultra loose monetary policy and there is very little doubt that part of the current volatility in the EM is driven by this ultra loose monetary policy adopted by the central banks in the developed world. So clearly, the EMs are dealing with the side effects of QE. The hot and easy money that flowed into various emerging markets chasing yields created asset price distortion. So the fundamentals of the emerging markets were known to the investors while they flocked into EM chasing high returns but now that the supply of hot money flow is being cut, the worry is that the real ground on which they were standing will get revealed.

Generally investors tend to invest in emerging markets attracted by the growth story but GDP numbers shouldn’t be the only indicator when considering an investment opportunity. In theory, we can measure GDP using three different approaches. 1 – overall production approach, 2- overall expenditure approach, 3- and the overall income approach but none of these 3 approaches can fully and comprehensively report or record the overall economic activities or output of a country let alone the world. High growth in a high inflationary environment creates distortion and isn’t really a sustainable growth model. And here is why, entrenched Inflation in the developing world tends to destroy disposable income and living standards and the idea that somehow high growth could fix everything in the long run doesn’t really hold water. In short, strong GDP growth numbers isn’t necessarily a one way ticket to prosperity because high growth creates various types of unforeseen problems and challenges so any growth model has to factor the exponential function rules, for example a 10% growth rate year-on-year means the economy will double in just 7 years and doubling of the economy isn’t just all positive. So any sustainable economic growth model will have to factor in a period of adjustment to allow for consolidation.

An economic journey isn’t about just about speed at which a country can reach from point A to Z quite simply because there is no Z or in other words there is no final destination but targets  to help deliver overall progress. A sustainable economy will have to keep evolving every 5 years or so to remain relevant and this is where the challenge lies for the global economy. By design, the global economic model along with the existing structure of the financial markets are less than efficient and this is why every now and then we find ourselves in a CRISIS. For example, today while the developing world is struggling with inflation, the developed world would love to have some of that inflation in the system.

And the ultra loose monetary policy has so far failed to deliver inflation in the developed world. Also though the tapering of quantitative easing (QE) by FED which I must say is inline with my own expectations ( not that is matters ) is being perceived as a start of an early tightening measure than ideally preferred by some in the market. But this perception does not accurately reflect the reality and here is why. So based on the latest (Jan 2014) data, FED’s balance sheet is now around US$ 4.1 trillion and even with tapering the balance sheet will continue to expand and also by committing to keep the rates near zero the FED continues to be in expansive mode. So by reducing the QE level ,the FED is basically trying to slowly dial down the booster engine put in place during the crisis to support the economy and switch over to traditional and conventional monetary policy tools to manage the economy going forward. And the reality is, it will be unwise to expect the FED to keep operating in crisis emergency mode so a gradual switching over makes good sense. Also it is important to note that if the FED gets its QE exit wrong then it could have substantial losses so it will have to be mindful of the market condition. A continued improvement in the economy along with the housing market will enable the central bank to book a substantial profit on the purchased securities and obviously a big chunk of the overall profit will end up at the US treasury and could very well be used to pay down the debt.

Whatever may be the perception of the market today, there is very little evidence to suggest that Quantitative Easing has in fact financed the global growth however, it has been extremely useful in supporting the financial markets and to a large extent helped create a distortion in the asset pricing across the world so a curb in QE will most likely help the global economy remove all the speculations and fear around the nature of the overall growth going forward because quite clearly the markets today aren’t sure if the world economy has entered a self sustaining growth cycle hence the extreme volatility.

And when looking at the bigger picture, in the medium to long term investment perspective, the Emerging Markets ( with the exception of some ) will most likely grow at a better rate than their counterparts in the developed world. Having said that, today when the markets are dealing with extreme volatility that is clearly creating CHAOS then talking about medium to long term investment horizon may not make much sense to most in the market. Also, a wait and watch approach and hoping that markets will look at the big picture and by applying some common sense figure things out is an extremely risky strategy because the markets are all about perception, momentum and confidence so an announcement on a global policy coordination by major central banks from around the world going forward should go a long way in providing a degree of certainty and should help arrest the current CHOAS from spreading into every corner of the market. And the thing about perception is, if you could keep a perception going for a period time irrespective of it being right or wrong then there is a good chance that perception will most likely be perceived by some as the REALITY.

And this is why the global economy of today requires a greater degree of policy coordination from major economies and is essential to addressing both immediate and long term challenges facing the world economy. Also this has to be by far the biggest lesson learnt from the 07/08 financial crisis.

Read Full Post | Make a Comment ( 1 so far )

Talking About The All Scary Emerging Market, Market Perception and Investing in General

Posted on January 26, 2014. Filed under: Uncategorized | Tags: , , , , , , , , , , , , , , , , , , , , , , |

The markets are once again busy with chatter about Emerging Market ( EM ) and the sound of CHOAS seems to be re-emerging and many in the market are starting to wonder, what’s next ? A number of analysts have gone on record suggesting in their daily market commentary that emerging markets could now be a danger to global financial stability. No doubt, these are strong statements so it begs the obvious question, are we looking at another financial crisis, this time coming from the emerging markets ? And I do wonder if the fundamentals of EM have changed so dramatically leading some commentators to believe that a crisis is somehow imminent as evident from the way markets have reacted last week? Well, unlike our friends in the financial world, we ( I am referring to our group ) like many others who operate on a daily basis in the real economy can see and feel that the global economy is shaping up nicely and the IMF’s latest revised up global growth projection of 3.7% for 2014 and it’s growth expectation of around 5.1% for emerging markets from an earlier 4.7% GDP growth rate guidance, more or less reflects the ground the reality of the day.  So the obvious question, why this panic and uncertainty ?

Now one could rightly argue that the revised up guidance are just projections and the risks both known and unknown still remains. Also the recent volatility in the markets to a large extent has been driven by downward pressure on the Turkish LIRA as well as Argentine PESOS devaluation and the South African RAND, which is also come under a bit of pressure. And then there are obvious chatters around how good or bad China is doing and how will the leadership manage the US 4.8 trillion dollar worth ( estimated ) shadow banking system along with a relatively high local government debts, and then there are concerns about India as well as Brazil’s fundamentals. These are real and genuine concerns but having said that, I can’t help but wonder, how is all this a SURPRISE to anyone in the market ? For example most of us are aware of the ongoing political uncertainty in Turkey and based on our own common sense, we could safely conclude that if the political turmoil drags on then there will be consequences to the economy.

And also assuming the worst case scenario, one needs to ask and know, did the previous crises in Turkish and Argentine economy kill the overall emerging markets across the board ? the clear answer is NO, so in short it will be unwise to assume that Turkey will some how bring down the emerging markets of Asia, Africa or Latin America, the reality is a potential crisis in Turkey may be more damaging to developed European economies then China or India for that matter. Also it is important to emphasise that there is a crisis of leadership in Turkey today which is weighing down on the economy and a positive resolution could very easily change the overall dynamics of the economy. Now with regards to China, a US 9.4 trillion dollar economy growing at around 7.7% isn’t just going to fall off the cliff under the weight of its shadow banking system and the local government debt. Yes, there are real concerns about how the government may go about handling the whole situation but it will be unwise to assume that somehow the economy will implode bringing down the global economy. There are simply too many opinions on China both bearish and bullish but understanding the structure and behaviour of the overall Chinese economy is an extremely complex task and betting against the government’s ability to deliver on its set forth agenda never really works and this may be one of the reasons why foreign investors tend to struggle in China. And with regards to India, the Indian economy today is in a much better shape fundamentally than last year also the overall investors sentiment around India has improved significantly, the country’s real problem today is a lack of decisive leadership which will hopefully get resolved after the upcoming general election and also most CEOs representing both local and overseas companies are quite upbeat about India’s medium and long term growth prospect. The current government has also made a series of reform announcements aimed at opening up various parts of the economy to overseas investors.

So why then the market is projecting a risk of contagion and giving a sense that somehow an imminent crisis is brewing up in the Emerging market ? I must say, I do wonder if by holding an emerging market stock or bonds or taking up speculative positions in local currency an overseas investor is ever able to get the full picture and flavour of the overall economy ? And the answer is, most likely not because in reality most emerging markets are layered and quite different to each other and also it must be said that there is a reason why they come under the category of being classified as ” emerging markets ” but this is not to say that developed markets are somehow immune to crisis as evident from the financial crisis of 07/08.

In the big picture scenario understanding a market or an asset class isn’t just about reading opinions from various experts of the subject and one must not forget that even in good times people and companies do fail so yes some emerging markets may struggle but today the global economy is in a much better shape than it was few years ago and it is quite unlikely that from here on we are looking at an imminent collapse. However, the inherent risk in the global economic system as well as the financial markets by design still remains so the system isn’t CRISIS proof and never was. Also opinions and projections are part and parcel of how a markets operate but people do need to be rationale and honest because clearly there are those in the market who may prefer a free ride and to keep making  money on the back of easy money printed by the central bankers. This is not to suggest that the global economy has now reached a stage when all the loose monetary policy stimulus should be withdrawn right away, the tapering and tightening of traditional monetary policy tools will most likely be gradual.

But having said that the market will continue to make tapering related bets. Vanguard, PIMCO and BLACKROCK  lost roughly over 35% in value on their investment  in the last 6 months of 2013 by getting their inflation bet wrong on Treasury Inflation Protection Securities (TIPS ). These firms made bets on the assumption that Quantitative easing (QE ) will deliver inflation down the road and although it is quite evident that they got their bet wrong but we mustn’t  forget the fact that QE did in fact create Inflation in ASSET PRICING and also across various Emerging Markets, but obviously not where it was expected so clearly those who held a view that QE will create inflationary mayhem in the economy killing  the dollar down road most likely didn’t incorporate the fact that the economy of today works and behaves a bit differently. There  needs to be a realisation that too much money in the system and ultra lose monetary policy will not necessarily create an immediate spectacular growth trajectory especially when the economy is coming out of a MASSIVE HEART ATTACK. And there are clear evidence that QE has created ASSET pricing inflation through misallocation of capital and this may be what is eating up growth ( growth rate below market expectation ). Also while some managers did get their inflationary bet wrong they should also realise that central bank’s ability to create or control inflation in a 2014 world isn’t always guaranteed or straight forward but having said that inflation will slowly but surely show up in the real economy but most probably not tomorrow.

Investment is about taking risk by relying your own assessment of a specific risk and then taking a decision based on your own judgement. MARKETS OR COMPANIES are all run by Human ideas and thought process so the market or a company is only as good as people behind them. And without being philosophical, we all know that life comes with no guarantee so what do we do? well, we learn to take risks and the same goes for creating a business and how we invest. There are no guarantees and the guarantees you may have or seek could easily become worthless when the circumstances change. And whatever investment decision you make or take will always come with an inherent RISK so there is always a chance that it may or may not work out as planned. You can only make a decision based on what you can see and know today but there are always many unknowns that you may not be able to factor in and going forward  these unknowns may very well influence the outcome.

So investing in general isn’t all about following a trend or analysts reports or getting overwhelmed by the sound bites coming from various corners of the market or committing yourself to a fancy model. In most cases, a good investment is generally about following your own intuition or in other words your own inner radar just like many decisions we make or take in our lives and you can always use the information available in the market to make up your own mind in a similar way as you would seek advice from friends or family when taking an important decision in your life but always remember you will have to live with outcome and blaming others for an undesired outcome never helps although it might be quite tempting to play the game but if you do then you are denying yourself an IMPORTANT OPPORTUNITY TO LEARN and there is nothing scary about learning. So the all scary emerging market as projected by some in the market today in fact may not be that scary after all and remember a perception doesn’t always equal reality.

Read Full Post | Make a Comment ( None so far )

Liked it here?
Why not try sites on the blogroll...

%d bloggers like this: