INVESTMENT PERSPECTIVE

By J Mulraj

Jul 24-30, 2022

Geopolitics will affect markets

Jerome Powell raised, yet again, the Fed fund rate by 0.75%. As the image above shows, he has to build a lot more muscle (higher interest rates) to have a chance to succeed.

US inflation is the offspring of Jerome Powell’s QE, or quantitative easing, programmes, and Joe Biden’s spending bills, splurging money as if it were growing on trees. The spending bills were intended to fund consumption (which accounts for 70% of US GDP) and investment. Money, though, has a mind of its own, and is not subservient to diktat. It flowed, instead, into assets, creating enormous bubbles in equity and debt markets, in real estate and commodities, in alternative assets like art, crypto currencies and fine wines. These bubbles are popping. But, until the excess liquidity pumped in through QE and spending programmes dries up, inflation will remain high.

The interest rate hikes are meant to tame inflation, and the rule of thumb is that the Fed fund rate (now between 2.25-2.50%) should go above the inflation rate (9%) to tame inflation. A previous Fed Chairman, Paul Volcker, had, in Jun ‘81, raised rates to 20% and killed inflation. Though this caused a severe recession in ’82, it laid the foundation for sustained GDP growth from ’83. It can be done, if there is a will to, by the Fed, and the political backbone to, by the US President. Both are missing.

Instead, Powell’s statement, whilst announcing the 0.75% hike, that future hikes would be based on data (hey, I thought ALL hikes were so based jeez!) was interpreted by the stock markets to be a dovish approach to inflation. Stock markets rallied, as hope springs eternal.

Figures of US GDP growth in Q2 ended Jun ’22, released the next day, showed a fall in Q2 GDP, year over year, the second quarter of negative growth. Two successive quarters of negative growth are defined as a recession.

But announcing a recession is anathema to a Democrat president who faces the prospect of losing majority of either one, if not both, houses in the November election. Inspired, perhaps by CRISPR, a technique to cleave strands of DNA, Joe Biden split hairs and refused to acknowledge that the US was in a recession, citing low unemployment numbers and continued job growth.

So it seems as if interest rates will need to be hiked often, in order to reach the inflation rate. At least until the excess liquidity generated by QE and spending programmes is sucked out or utilised. And rising interest rates will trigger a recession.

All the more so because, other than USA, the world’s largest economy, the number 2 economy, China, is going through its own karma. It is reaping the fruits of what it had sown.

It was barely 2 years ago, in August 2020 that China had introduced the ‘3 red lines’ policy to curb over borrowing by the realty sector. Unable to borrow from banks, real estate developers, led by the largest, Evergrande, (with an unsustaainable debt of $ 305 b.) were unable to grow or to meet their liabilities. Scrabble players would have sounded an alert – an anagram of Evergrande is ‘ever danger’!

Just how myopic Government policy and action is, can be gauged by the fact that, less than 2 years after it sought to curb bank borrowing for the realty sector, by imposing 3 red lines, China’s central bank is  seeking to mobilise a $ 148 b. bailout for real estate projects! This will hopefully complete construction of unfinished flats.

The Chinese Government has been forced into this by a popular protest. Thousands of home buyers refused to pay their EMIs (Equated Monthly Instalments) on mortgage loans until the flats they had borrowed for were delivered to them.

China also saw runs on its banks. It started with rural co operative banks which gathered deposits online by offering higher interest rates. When depositors went to withdraw, they were told there was no money in the account, as they had paid for an investment product, and not made a deposit. The problem later spread to Government owned banks, including large ones.

The problems with China’a realty sector, which accounted for 31% of GDP, have affected local, or provincial Governments (i.e. state governments). A main portion of funding for these local governments is by auctioning land use rights. Buyers of these were the realty firms, which are now unable to borrow to bid for (the three red lines, remember?).

To add to the woes is the policy of zero tolerance to Covid, resulting in lockdowns, which have led to drastic falls in production, exports and GDP. China’s GDP growth in Q2 2022 has slowed to just 0.4%, yoy, if one relies on official figures.

After US and China the # 3 largest economy is Japan. It, too, is a sluggish economy, continuing to be propped up by QE.  It has a poor demographic profile, one in which the demand for adult diapers exceeds that of infant diapers, no shit!

Next is Germany, # 4 world economy. It is badly hit by the shortage of oil/gas, after taking on its main supplier of it, Russia. Russia has further cut supply of gas to Germany via the Nord Stream 1 pipeline, to just 20% of earlier supply. The prospect of closure of a lot of German industry is very real, as stated by the CEO of BASF. Without gas to heat homes, Germany faces a bleak winter.

So it is difficult to see how stock markets can turn bullish. True, there is a huge huge pile of funds waiting to invest at the first opportunity. But the question to ask is, whether this is the right time? In view of the problems of the top four economies, mostly self created ones, it does not seem to be so.

To complicate matters worse is a plan by Nancy Pelosi, Speaker of US Congress, to visit Taiwan. There seems to be no advantage in doing so, other than to score a point. China has vehemently opposed such a visit, to the extent of saying it would be willing to intercept a military aircraft carrying Pelosi, on the ground that a military aircraft landing in Taiwan is an act of war. Congressmen have the choice of using a military or a civilian aircraft.

Is a visit by Pelosi so important as to risk a war, which can become WW3? Remember, it was the assassination of Archduke Franz Ferdinand in 1914 that caused WW1.

So, the US may say that Nancy has a right to fly to Taiwan, if she wants to. A few months ago, it had said that Ukraine has a right to join NATO if it wants to. Look at what happened then. In the absence of the ability or the willingness to uphold such rights, real politik suggests a more diplomatic approach. In the case of USA, its wasteful spending on a woke agenda has weakened its ability, and the disaster of the Afghan withdrawal, its willingness.

Is there no common sense left in this mad mad world?

Last week the BSE sensex added 1498 points to close at 57570, in line with the bear market rallies of  global market after the Fed Chairman seemed to suggest a dovish stance on inflation. It could be taken as an opportunity to dump poorly performing shares.

As per IMF’s revised projections, India is the #2 best performing economy, after Saudi Arabia (pumped by higher oil revenues), which is tremendous news.

India’s problems remains, as often repeated, its woefully inadequate judicial and investigative system. Let us see if the arrest of a West Bengal minister, where the CBI found a horde of over Rs 50 crores of cash, plus precious metals results in meaningful action or a mere political settlement! The judiciary should have a 2 week timetable to adjudicate, and, if found guilty, the cash should be used to pay off part of West Bengal’s huge debt of over Rs 3 lac crores ($36 b+). It is high time corruption is not allowed to continue, and perpetrators not allowed to enjoy the spoils of it, simply as a political accommodation. Should that happen, there is no India story. Period.

Pix source: Powell tries to tame inflation! — https://in.pinterest.com/pin/130111876704694415/