For some time, investors have had a pair strategy – Short on euro-rupee and long on dollar-rupee. Time to change the trend?
Ever since the global crisis broke in 2008, there has been speculation about the shape of the recovery. Initial hopes of a fast “V-shaped” recovery were belied when global GDP contracted by about 1.4 per cent in 2009, according to the IMF.
While a recovery is expected to continue through 2010 and 2011, it could be either “U-shaped” or “W-shaped”. An “U” would be a slow, steady pick up. A “W” would mean a double-dip with another crash before a genuine sustainable move North.
The Greek debt crisis and the fiscal problems of the PIGS (Portugal, Ireland, Greece and Spain) of the Eurozone makes the chance of a double-dip stronger. Among professional economists, Joseph Stiglitz has stated in Freefall that a double-dip was likely and may require another massive bailout. Nouriel Roubini wrote in Crisis Economics that he thinks it'll be a U-shaped recovery. Both books were released before the Greek crisis came to light.
Problems in Europe mirror problems in the US and Japan where the same factors of low or negative GDP growth, large public debt, high unemployment, and high fiscal deficits are visible. This means roughly 50 per cent of global GDP is under-performing.
IMF mid-year estimates say that, although global GDP is expected to grow at 2.5 per cent in 2010, the advanced nations will contribute little. Eurozone GDP growth will be negative while the US will manage around 0.8 per cent and Japan 1.7 per cent. The IMF also warns that “impaired financial markets”, could lead to lower than expected growth.
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China and India are supposed to lead the recovery with 8.5 per cent growth and 6.5 per cent growth respectively. The Indian estimates are more or less in line with the RBI forecasts of the budgetary estimates
One implication: India (and China) will have to rely on domestic demand. Exports are likely to remain sluggish. Another implication: India in particular, will rely more on consumption than investment. The GoI has started trying to cut fiscal deficits while FDI and FII flows remain uncertain in the current climate though both are doing better than a year ago.
In the past year, we've seen a major global stock market rally, which started approximately 9-12 months before the recession bottomed out. The next year will probably see better GDP performance but a large proportion of that has already been priced in. The stockmarket might flatten out.
Valuations have definitely taken a beating since Greece's problems came to light. Earnings expectations have moderated. At current levels of Nifty 5000, the market looks fairly valued though it's not cheap at 21 PE. Assume however, that 21 PE can be maintained with roughly 20-25 per cent earnings growth visible. Two years later, the Nifty should be 7000+ and that would be a tidy return.
A concentrated bet on domestic consumption in the short to medium term would mean a focus on sectors like automobiles, FMCG and banking while being underweight in exports and capital goods. Big ticket consumption may not grow much, since the real estate sector still appears to be in trouble. Globally-linked sectors like energy and metals appear to be high-risk.
One strange problem is global currency weakness. The euro is in trouble, the yen is in trouble, the USD is in trouble and GBP is also not in great shape. There is no single major currency that looks markedly stronger than others. Logic suggests the currency markets will be very choppy through the next few months. There may be a lot of trading opportunities as the contradictions play out but it would take a brave man to bet on long-term trends.
The US has survived in part because the US dollar is the default currency for denominating the bulk of world trade. But America has a huge fiscal deficit and massive external debt. Apprehensions about what that might do to the dollar has led to trade moving away to other currency-denominations.
Since early April, a set of paired currency trades have done well. One is a short euro-rupee and the other is a long dollar-rupee. The rupee has gained against the euro after the Greek crisis while simultaneously losing ground to the dollar, due to FII sales. However, now that the Eurozone seems to be settling down, this combination may no longer work. In fact, it might be time to reverse the pairs in the expectation of a euro bounce and the rupee strengthening versus the dollar.