In the 1990s, the trading community started relying on the “Greenspan Put”. Every time there was a crisis, Greenspan, then chairman of the US Federal Reserve, would say inscrutable things and open the liquidity tap. He did it with the Mexican peso crisis of 1994, he did it during the Asian Flu of 1997 and again when Russia defaulted in 1998 and Long-Term Capital Management went bust.
By the 2000s, this had created a huge moral hazard. Traders could take huge risks secure in the knowledge that the Fed would bail them out if anything went wrong. It was definitely a contributory factor to the subprime crisis.
The first person to suggest that there was a problem with Greenspan’s strategy was Raghuram Rajan. Rajan made himself unpopular at the annual symposium at Jackson Hole, Wyoming, in August 2005. This was unofficially billed as Greenspan’s farewell party, since he was due to retire. Rajan read a paper suggesting that the world had become riskier and was headed towards a financial crisis as a consequence of Greenspan’s actions.
Some of the world’s banking and economic elite will be gathering again next week at the picturesque little town where Butch Cassidy and the Sundance Kid had their headquarters. Mario Draghi, president of the European Central Bank (ECB), will be there as part of the Hole-in-the-Wall gang.
Traders are waiting on the results of that meeting and speculating wistfully about the possibility of a “Draghi Put”. The ECB boss recently asserted his determination to rescue the euro. That might mean arranging a full-scale bailout for Spain, after shoring up its banks. If Draghi opens the ECB tap and he persuades the other Jackson Hole attendees to go along, there will be a new flood of liquidity. Of course, this is contingent on the Germans going along. Germany will also decide on key euro stabilisation measures in mid-September. India’s busy season credit policy review occurs around the same time.
Global markets “believe” there will be a bailout of some description and that it’s likely to be substantial. Some of that liquidity will flow into equities around the world, including into Indian stocks. The euro has already strengthened owing to speculation that this will occur.
| Current (Aug 24) | Value 14 days ago | Change % | |
| Nifty value | 5386.7 | 5320.4 | 1.25 |
| Index PE | 18.07 | 17.34 | 0.73 |
| Index dividend yield | 1.54 | 1.51 | 0.03 |
| Index book value | 2.94 | 3.01 | -0.07 |
| USD/INR (RBI ref rate) | 55.382 | 55.344 | -0.07 |
| FII net buys/sales(Aug 11-24)* | 2096.8 | 3949.66 | |
| DII net buys/sales(Aug 11-24)* | -113.59 | -1049.89 | |
| *Rs crore, Aug 24 provisional figures; the timeline reflects a 10-week break | |||
This is the narrative keeping Indian and global stock markets afloat in the absence of a positive change in the real economy. There has been steady buying of Indian equity from foreign institutional investors (FIIs) through the Monsoon Session of Parliament, despite Coalgate, riots, Internet crackdowns and other assorted shenanigans. Not much heed has been paid to the latest Reserve Bank of India (RBI) Annual Report that articulates the Indian central bank’s fear about inflation’s negative impact on net national savings.
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If there is indeed a bailout of reasonable dimensions, the markets will see net gains through the September settlement. Indeed there are technical signals that this could occur. Although there hasn’t been a clear breakout, the Nifty has moved up to test resistance, so far unsuccessfully, above 5450. Trendline analysis (shown on the chart simply as a line joining the last two market peaks) suggests that the market is preparing for a break out.
A breakout beyond resistance in the 5450-5550 zone could swing the market quite a distance up. Target projections in the two-month time frame might be 5750-5800 or even higher. How far up the market goes if there’s a breakout would depend on how much money the FII pumped in. Domestic institutions have been consistently negative in attitude and they’re likely to sell into any rally.
In terms of fundamentals, such an upside breakout may be unsustainable. Economic projections continue to be revised downwards and earnings growth estimates remain in the single-digit range. Of course, RBI could also help things along with a mid-September rate cut. Going by official pronouncements and the latest consumer price index data, it doesn’t seem likely. Meanwhile, Coalgate has pretty much ensured that there will be no worthwhile legislation, or policy gains, emerging from the Monsoon Session.
One good thing is that the monsoon seems to have picked up and, therefore, agriculture will not do as badly as was being feared. A poor monsoon is already discounted in macro-economic projections if not by financial markets. Semi-rural demand might not fall as much as anticipated.
But any share price impetus from another bailout is likely to lose momentum before the economic fundamentals show signs of catching up. After all, there is no real sign that the economy has bottomed out yet. Valuations are already stretched at PE 18; they will be stretched further if the market moves up, despite stagnant earnings and flattening growth.
This scenario leaves the trader with some possibilities. One is to be braced to participate in a rally, especially if there’s a rupee rate cut to help things along. Another is to be braced for any rally to end with an equally sharp correction. If you go long in September, it won’t hurt to hedge with deep puts. In fact, there’s a strong case for rolling over deep puts until December, if the market does rally.
In the currency markets, there could be further spikes in the euro, coupled to a fall in the USD. This would be reflected in EUR/INR and USD/INR as well. Another possibility is that gold, which hit a new high recently, could see a decline if there is a credible Draghi Put. Platinum, on the other hand, is likely to move up on fears of supply disruption.
Sometimes financial rallies can create an illusion of turnarounds. Sometimes, the illusion can actually help create a turnaround. While Greenspan eventually helped inflate a gigantic bubble, his “Puts” did work on several prior occasions. One lives in hope.