It is hard to imagine a game of football or tennis where rules get changed while it is being played. It would be virtually impossible to strategise and position your game beforehand. Picture the plight of the coach as he would have no clarity on anything except that his team has to win. Can the spectators enjoy a match like that? Who knows, half the time they maybe figuring out on what actually is happening on the ground.
The above analogy is being used as this seems to be the plight of financial markets worldwide. Bond yields have gone crazy. Negative Bond yields are rewriting the rules of the game which no one knows how to play over a period of time.
Proponents of negative bond yields have created a new world order in bond markets and the equity risk premium to be considered while investing in stocks. The risk free return was the return a sovereign bond or a government security yields and the equity risk premium is the risk one takes to earn a higher return over the sovereign bond by investing in equities.
Interest rate is the cost of capital. It is simply the price of money. If the return from investing in risk free asset is very low or negative the perceived benefits from equity or other assets return magnifies which may result in more money flowing into them.
Distortions can happen in a situation like this and asset prices can remain irrationally high or low for a very long period of time.
The monetary policy ground rules are being rewritten as they are being played and there isn’t a particular country’s committee who is writing them. It is being collectively and jointly played by the strong economies that make the moves and the effect and consequences of it others have to observe and grapple with.
Central banks in a bid to prop up economies followed ultra loose monetary policies and are now unable to roll them back. In fact they may have to continue flushing their economies with more funds to avert deflationary situations.
The stronger economies in turn are toppled by seemingly weaker economies whose debt they own and have turned virtually bankrupt.
Questions are now being raised on the ability of Central Banks monetary policy to manage floundering economies. There is a view that if intervention is limited and the economy is left to its devices it may stagger and stumble for years but will eventually finds its equilibrium.
Another area where rules will be rewritten is geopolitical balance. Racial tensions and terrorism are on the rise and are not localised anymore. Discontent is rising over factors like rising income inequality, immigration and a general unhappiness with the established order.
The rebellion has empowered the ballot boxes but without definite answers to the issues which need to be tackled with. The resolution of these issues will be cathartic and will play out over the next few years.
All in all financial markets are in a game where rules are being changed. There is a startling view which says gold instead of being used as a hedge against inflation or as a safe haven should be considered as an investment in monetary disarray and disorder.
Governor Rajans infamous quote of India being a one eyed king in the land of blind does hold true. Our macros are stronger then where they stood couple of years back,we have strong leadership at the helm, monsoons have been kind, interest rates may be cut and our corporate sector is showing signs of revival.
India certainly is a happy island but cannot be totally protected from the global disruptions. In this market, if you do not stay too married to your long held views and biases and decode the rules as they are being changed; picking out winners can be fun.