Governments, central banks, businesses and investors are all a sober lot now days. The recent events have made them sit up and think about the consequences of the past actions and all of them are making efforts to change. The positive change brought about by the new thinking amongst all stakeholders in the economy will drive markets in the future. The current time is the best time to invest in asset classes of equity and bonds to reap the benefits of the focus on consolidation of debt and the focus on bringing down long term inflation expectations.
The fact that governments, central banks, businesses and investors behaved like reckless cowboys is an understatement. The events leading up to the credit crisis of 2008 was a lesson in recklessness. Governments were borrowing and spending, businesses were borrowing and spending, consumers were borrowing and spending, central banks were ignoring inflation and investors were borrowing and investing.
The response to the bubble burst of 2008 was even more reckless. Government’s increased fiscal while central banks reduced policy rates to all time lows and printed money to flood the system with liquidity. The worlds fiscal balance as a percentage of GDP as per IMF data rose from -0.3% in 2007 to -6.7% in 2009 as a result of fiscal pump priming. Central banks from the US Federal Reserve to India’s RBI bought government debt to provide cheap source of liquidity to the economy. The result of the fiscal pump priming was a short burst of activity in economies across the world leading to the world GDP growth rising from negative growth of -1.9% in 2009 to 2.7% in 2010.
The Greek debt crisis and India inflation is a direct result of the cowboy attitude of the past. Greece is facing a default on its debt, as it cannot raise funds to repay debt. Greek tow year bond yields are trading at levels of 70%, factoring in debt default. India inflation at 9.78% as of August 2011 is preventing the RBI from easing policy accommodation in the face of global growth concerns. Other countries including US and China have been affected by debt and inflation respectively with US government forced to cut spending to pass a debt limit bill while China has tightened monetary policy to bring down inflation which is trending a close to multiyear highs of 6.4%.
Sobering down effects
The buzzword at present is debt consolidation and inflation control. Governments from the US, UK, India and Europe are all focused on reducing fiscal deficit. In fact government debt reduction is a political slogan in UK and US. Highly leveraged businesses are also focusing on consolidation of debt. In India we are seeing the likes of highly leveraged groups such as DLF, United Spirits and ADAG group talking of reducing debt by consolidation of businesses. Consumers in the US are focused on improving savings by reducing spending. Central banks in inflation hit countries are maintaining tight policy despite growth threats. Growth is taking a back seat in the face of debt and inflation threats.
If debt reduction does happen and inflation comes off globally, the markets will be on stronger foundation for the next rally. Equities and bonds will benefit from lower debt and falling inflation. Indian equity indices the Sensex and Nifty are down over 15% in the last one year while bond yields on the benchmark ten year government bond is up 50bps. Levels of 16700 and 5000 in the Sensex and Nifty respectively and levels of 8.35% on the ten year bond are good levels to enter to take advantage of the sobering down effects.