Growth- Is it good or bad for markets?

"Even in such a time of madness as the late twenties, a great many men on Wall Street remained quite sane. But they also remained very quiet. The sense of responsibility in the financial community for the community as a whole is not small. It is nearly nil. Perhaps this is inherent. In a community where the primary concern is making money, one of the necessary rules is to live and let live. To speak out against madness may be to ruin those who have succumb to it. So the wise in Wall Street are nearly always silent. The foolish thus have the field to themselves.”-John K Galbraith

“It follows that once the investor pays a substantial amount for the growth factor, he is inevitably assuming certain kinds of risks; viz., that the growth will be less than he anticipates, that over the long pull he will have paid too much for what he gets, that for a considerate period the market will value the stock less optimistically than he does.”- Benjamin Graham and David Dodd



India’s 3Q09 GDP growth came in at 7.9%, better than expectation. Growth in good, but it comes at a price. Monetary tightening is a certainty, sooner rather than later, which puts upward pressure on rupee (look out for export oriented companies!) and downward pressure on markets. However it is highly unlikely that the EM rally will fizzle out soon. As developed world continue to slug through subpar growth (loose monetary and fiscal conditions will continue to remain benign in developed market) and as EM growth profile improves, EM asset class will continue to do well led by low rates globally, the dollar carry trade will be alive & kicking and even the EM central banks will be more constrained in raising rates. Global investors will be willing to pay more for any growth visibility and will look for returns and growth in Asia. The biggest risk to the aforesaid scenario, both on an absolute and a relative basis, will be if growth in the US or more broadly, OECD surprises on the upside, and monetary and quantitative tightening is faster than currently envisaged. Thus, it is very important to know and analyse what we are asking for.



Dr. John Hussman writes in his latest article to investors about Reckless Myopia and says that in his estimate, there is still close to an 80% probability (Bayes' Rule) that a second market plunge and economic downturn will unfold during the coming year. Also, Gluskin Sheff chief economist David Rosenberg noted last week, “Even if the recession is over, the historical record shows that downturns induced by asset deflation and credit contraction are different than a garden-variety recession induced by Fed tightening and excessive manufacturing inventories since the former typically induce a secular shift in behavior and attitudes towards debt, asset allocation, savings, discretionary spending and homeownership. The latter fades more quickly.”

Thus, the gloom and doom scenario, in OECD, as outlined by Hussman, David Rosenberg, Roubini, et al, ( through various articles) looks to be good for EM market asset class, as was discussed above.


Other important points from Hussman article worth exploring, “I should have assumed that Wall Street's tendency toward reckless myopia – ingrained over the past decade – would return at the first sign of even temporary stability. The eagerness of investors to chase prevailing trends, and their unwillingness to concern themselves with predictable longer-term risks, drove a successive series of speculative advances and crashes during the past decade – the dot-com bubble, the tech bubble, the mortgage bubble, the private-equity bubble, and the commodities bubble. And here we are again………Whether or not I have focused too much on probable “second-wave” credit risks is something we will find out in the quarters ahead – my record of economic analysis is strong enough that a “miss” on that front would be an outlier. What I do think is that over the past decade, investors (including people who hold themselves out as investment professionals) have become far more susceptible to reckless myopia than I would have liked to believe. They have become speculators up to the point of disaster…………Frankly, I've come to believe that the markets are no longer reliable or sound discounting mechanisms. The repeated cycle of bubbles and predictable crashes over the recent decade makes that clear. Rather, investors appear to respond to emerging risks no more than about three months ahead of time. Worse, far too many analysts and strategists appear to discount the future only in the most pedestrian way, by taking year-ahead earnings estimates at face value, and mindlessly applying some arbitrary and historically inconsistent multiple to them. This is utterly different from true discounting – which does not rely on multiples, but instead carefully traces out the likely path of future revenues, profit margins, cash flows and earnings over time, and explicitly discounts expected payouts and probable terminal values back at an appropriate rate of return. That's what we actually do here. Talking in terms of multiples can make the process easier to explain, and can be a reasonable approach to the market as a whole if earnings are normalized properly, but ultimately, an investment security is a claim to a long-term stream of cash flows. It is not simply a blind multiple to the latest analyst estimate. Fortunately, the evidence suggests that the long-term returns to a careful discounting approach tend to be strong even if investors repeatedly behave in speculative and short-sighted ways. This is because long-term returns are fully determined by the stream of cash flows actually received by investors over time, and because inappropriate valuations ultimately tend to mean-revert. In the face of speculative noise, the long-term returns from a proper discounting approach may not capture as much speculative return as might be possible, but over time, many of those speculative swings tend to wash out anyway.”



The dollar carry trade route is pumping up the stock, real estate and commodity markets all over the world. Also, the money being printed by various central banks all over the world to ensure that the value of their currency doesn't shoot up too much against the dollar (example-Swiss, China, HK, et al) is also at some level getting diverted for speculation purposes. A fascinating article on the aforementioned two points can be read from here.

Happy Reading!!