Globally, Deflation ( declining demand and prices)has emerged as imminent threat. Developed economies (Govt and Central banks) have been attempting every possible option like –ve interest rates & debt to GDP raising in excess of 100%, to stimulate demand. But, it seems efforts are not paying targeted results and economies are sleeping into deflation.
If Deflation spiral will continue in 2015, developed economies would be in huge trouble as Govt and Central Banks have already used all available options( Rate cut to Zero, Quantitative Easing and Govt expanding Fiscal muscle in excess of 100% Debt to GDP). In Deflationary Spiral Asset Prices, Commodity Prices and Gross Demand of Economy precipitate to the trough. Persistent low Demand and low Prices squeezes the margins of the company and thus lay off starts. Which further aggravates the economic situation. In extreme Deflationary conditions, Banks starts defaulting and may go bankrupt as happened during 1929 Great Depression. Even Some nations with Debt to GDP more than 100% and foreign Debt forming much of the debt part can default on sovereign obligations, like Greece and Argentina recently.
Global Geopolitical situation, where one eye should be fixed of investors in 2015 as it has reached to very critical stage. Israel could be dragged into fight against ISIS and Russia can exert more pressure on bordering nations.
Indian Economy has been struggling hard to recover from last 2 years slow down. Though Stock market has been scaling all time highs, hoping fundamentals will reciprocate with the help of aggressive reforms done by the Govt at the Centre, situation on ground has not improved much. Credit demand has come down to 9.6% from as high as 21%, 3-4 years back. Partly also due to RBI’s tight monetary policy. But, lack of investment is proving to be tough bottleneck to get over. Govt is still running high fiscal deficit, private companies are leveraged( latest report shows, may take 15 months to deleverage) and Banks are running large NPAs from Infra and Capital goods sectors hence not willing to lend them.
Therefore, Investors need to fix eyes on one parameter in 2015 and that is Investments. It will require either Govt flexing Fiscal expansion again till the time Private economy readies itself or bringing Foreign Investments, which has been aggressively tried by both PM and FM. To start the Growth Engine of Indian Economy, it needs 1 to 2 lakh crore of investments initially.
Investor Portfolio should Have some Gold, Have reasonable Cash, Reduce Equity and Real Estate, Have some long term Govt Bonds( GILT) to align your portfolio with prevailing dynamics.
“ It is inevitable for investors, in 2015 ,to remain closely updated with Global Situation. 2015 can be another 2008, wherein India had collapsed though crisis did not origin in India. Global factors will remain main driver of year 2015, with greater focus attached to Deflation in developed economies, geopolitical tension in Gulf with Israel jumping in at some time and Russia exerting more pressure. “
It seems, Globally, 2015 is going to be very chaotic, confusing, surprising, shocking and noisy year with significant developments on Economic and Geopolitical front. Asset classes will also collide with each other then ally with each other and then depart from each other. It is so confusing and complex to predict what will happen in Global markets and economy in 2015, that Very smart investors and big hedge fund managers are adopting simple diversification strategy to preserve the Capital. And their strategy is, invest evenly(25%) in each asset class, which goes up when 1. Inflation is more than expected 2. Inflation is less than expected 3. Growth is more than expected and 4. When Growth is less than expected.
Therefore, if there is one important advise, I can suggest to investors is
“ You should not be overly invested in any one asset class, except Cash”
The main threat to Global economy in 2015 is Deflation. Let me explain the dangers attached to Deflation. We will have to go back some years to understand it.
Till 2008, almost all nations on the earth were going high. Economies were expanding, Demand was on continuous rise, Commodities were zooming to the sky, New investments were initiated in many large projects with the expectation of future price rise, all most all companies were expanding their current capacity expecting higher demand in time to come. Ever increasing Global demand was driving this expansion and borrowing.
But, in 2008, Suddenly crisis enveloped this burgeoning Global economies. People, Institutions and Companies, who had borrowed massively in past years, expecting perpetual demand rise, were unable to pay off the interest, even. Because , Demand collapsed. And, in all these boom years, they had spent whatever they earned, not leaving anything for rainy days. Saving rate of US was -7% before crisis. It means, People were deep in debt by 2008, they had borrowed much more they can afford to. They were leaving on borrowed money. Similar was the condition of Companies and Institutions, they had undertaken massive expansion, overestimating future demand.
In brief, Developed Economies had gone far ahead of realities.
Therefore, When crisis( Reality) struck in 2008, Many companies and Banks went bankrupt. Companies expansions were underutilised or unutilised and people were unable to pay off the debt. Lakhs of employees were laid off in US, Europe and other advanced economies. This collapsed Demand substantially. But, yes , People learned not to overspend and to save.
Now, Advanced Economies depend on Consumption by Citizens to the extent of 60 to 80% for economic growth. But, this demand has come down. Due to low Demand and higher Capacity to produce, it has forced companies to lower the prices. With lower prices and margins, Companies can not afford to keep large work force and thus Company reduces workforce to remain lean and competitive. This is start of Deflationary spiral, wherein low demand caused low price and it further feeds to low demand.
But, now the situation turns grim because Commodity prices fall 40 to 65%. This feeds further price fall of assets and goods. Continuous low price environment also induces Consumers to postpone the buying decision.
With continuous price fall and demand fall, it becomes difficult to sustain business and pay down the debts as Income level keeps going down in low price and low demand situation.
Commodity price fall also indicates low current and future demand.
Now, question arises, How low price and demand can fall?
Govt Bonds are the best measure of that. Govt Bond always discounts and reflects expected Inflation or Deflation in the economy. Like India’s bond yield was close to 9% in 2014 showing elevated inflation expectation, which dropped to near 8% now, indicating Inflation expectation has softened to some extent. Which is visible also in Inflation numbers.
Now, It is shocking and surprising to learn that most of the European nations bonds for 1 to 4 years are quoting negative yields! It means for next 1 to 4 years, Investors and Institutions are seeing low price-low demand scenario ( negative inflation i.e. deflation) in these nations!
Height is Switzerland, where even 10 year Govt Bond is trading at -0.008, It had gone down to -0.80!
Let me explain the effect of –ve Bond yield. Say Rs. 100 bond yield is 1% that means you will get Rs. 101 after a year. If same bond yield is -1% means you will get Rs. 99 after a year.
Now you understand, Investor are lending trillions of dollars to European nations and to Switzerland at –ve interest rates. Why? Do they love to loose money? Heck no.
They are lending at –ve yield because they know that price and demand(inflation ) is going to fall much more. It means, if bond yield is -1% then price and demand are expected to fall more than 1% in bond tenure. It means, inflation will fall to such an extent that even lending money at -1% will make them money.
In last 1 month, Inflation has fallen in almost all developed economies with almost no exception. It means, Deflationary spiral is not limited to Europe but is quickly spreading to US and other parts of the World including major Emerging nations. For example, Thailand’s latest CPI (Inflation Index) fell to -0.41% against expected 0.25%.
To stimulate Demand and to see rising inflation, Central Banks of the world have printed trillions of Dollar. Govts have also expanded fiscal limits to the extreme. But, Inflation(Demand) is still not on the horizon. Instead it(Demand or Inflation) is sinking and sinking fast. The matter of concern is, If inflation continuous to sink fast and deflationary spiral aggravates, there is limited room for counter attack.
Having printed trillions of Dollars, Euros, Yens and Yuans and Sterling, capacity to accommodate further monetary expansion is very limited. Fiscal constraints will force Govts to walk tight on Fiscal discipline else rating downgrade is feared like France downgraded recently by Fitch.
Let us see in below table the Fiscal position, Debt to GDP ratios, Unemployment rate and Current Bond yield (as on 30/01/2015) to understand the larger picture.
|Country||Govt Bond Yield % (10 yr)||Debt to GDP Ratio %||GDP Growth rate ( YoY) %||Unemployment rate %|
Hence, It is easy to understand that When smart investors and big institutions of the world are lending trillions of Dollars to Japan, Germany and France at less than 0.50% for next 10 years, they are expecting negative inflation in these economies for next some years. Bond yield in the vicinity of 1 to 1.50% in rest of the developed economies also clearly suggest that Inflation will remain near 0% to –ve for a period.
And, as I have said earlier, in Deflationary spiral, highly leveraged( deep in debt) Institutions, Corporations and individuals go bankrupt as real debt becomes much difficult to pay in.
Therefore, I recommend investors to remain evenly allocated to major asset classes.
Some exposure to GOLD is must. And, some higher allocation to Cash (Treasuries – 90 days Govt Bond) is compulsory.
If you are overly allocated to Equity and Real Estate, reduce it as soon as possible.
Deflationary spiral will lead to more currency war as it is visible, started by Japan and then by Europe and now by Switzerland and China. Hence, if you are overly allocated to international assets, reduce it within your risk limits.
India is on better footing, now. Rupee is stable and has shown great resilience against dollar’s recent strength. Current account deficit ( Exports-Imports) is contained now at 1.7%, Commodity prices have come down significantly helping to ease inflation pressure, rapid pace of reforms by Central govt are aiding India’s prospects. Most significant positive for India is stable and majority government to expedite decision making process. Decisions taken by Modi Govt since May, 2014 have very long lasting positive effects on Indian economy, its real effect and results will be seen 3-5 years later when implementation would have completed.
But, yes we have our share of problems too. Problem is Investments. As a nation, we need huge investments in Infrastructure to jump start the economic engine. It has been said time and again that poor infrastructure is one of the major reason behind stubborn and periodical rise of Inflation. The total need to spend on Infrastructure is close to $500 bn (Rs. 30 lakh crore).Due to ill governance and opaque policy environment, close to Rs. 18 lakh crore projects are pending for approval for lat many years. This is legacy of last Govt, Which will be cleared as laws are amended and reforms take place. But, many projects, even if approved, will fail to start as Banks are not ready to finance Infra projects as they are running very high NPA from these sectors.
Therefore, we need major sources of finance. In economy, you have two major sources of investments one is Govt and Other is Private companies.
Now, Govt is running very high Fiscal deficit. With cost cutting, cutting planned expenditure and selling off some PSU stake, Govt would be barely able to reach 4.1% fiscal deficit target. And even this would have not been possible, if Crude would have stayed around $100. The Point is, Govt is in tight situation and has very limited fiscal space to expand and spend in the economy.
Private Corporation and Conglomerates of our economy are still buried under large debt. And according to recent FICCI and CII estimate, it will take 15 months to deleverage.
From Business- Standard (23-12-2014)
“ Assocham (Associated Chambers of Commerce and Industry of India) President Rana Kapoor said: “It will take another 15 months before a significant deleveraging of the private sector can happen. By March 2016, they will be back in action.”
Barring a few large conglomerates, there was high leverage in the private sector, especially in the infrastructure and core segments, he said.”
Third option is, we bring foreign investments in our key infrastructure projects like Metros, Delhi Mumbai Industrial Corridor and Smart Cities and others. Mr. PM and Mr. FM are trying hard to bring foreign investments in these projects and they have been successful also. But, it too has limits.
We are getting some indication that Govt is trying fusion option. In bold step, we may see Jaitly expanding Fiscal boundary to accommodate Infra spend and all Govt machinery try hard to bring foreign investments. This was visible at Davos,too. Make in India was marketed very aggressively there.
Interest Rate Scenario
After keeping interest rates very high for long-long period, we could contain inflation. Yes, Commodity price decline has also played its role into it. And finally, Mr. Tough/ Wall – Mr. Raghuram Rajan( RBI Governor) has cut the interest rate by 25 basis points.
Change in the stance seems to have come from slide in Crude prices. The straight landing of Crude flight from $105 to $45 should have convinced Mr. Rajan that this is structural shift in Global demand and deflation will be greater threat and that should have prompted him to cut the rates. Domestically, too, He could see the Govt taking all necessary actions to increase the productivity and to boost the supply and at the same time reining in inflationary expectations by deregulation Diesel subsidy, small or no hike in MSP, approval of projects crucial to expand the supply side and promise to achieve fiscal deficit target of 4.1%.
I firmly believe that rate cut will become aggressive and it could be 100 to 150 basis points cut in this calendar year. The assumption and that has been highlighted by RBI, too , in its Financial Stability Report that Credit Demand in India has come down significantly from 21% to 9.6%. This shows that in last few years, People of India have either postponed buying or consumption decision or their income have come down and hence Credit limits. In both situations, it is very likely that demand will go down further and that will prompt asset price correction. We are already hearing of large inventory in Real estate sector in Metros and even price correction at some places.
I firmly believe, Real Estate will see major price decline in 2015.
Therefore, I expect Demand to slow down in India, too, in 2015. To stem the economic fall, Govt’s major thrust would be on Infrastructure spending, to generate large employment opportunities and to start the growth engine.
With above assumptions,
I believe one should keep investing in Equities through Mutual Fund route(so that portfolio remains adequately diversified). I recommend to invest SIP(Systematic Investment Plan-Monthly fixed investments)way in Mutual Fund not lumpsum.
One should also have exposure to Precious metals(Gold & Silver).
One must have reasonable proportion in liquid assets( Cash Management fund, liquid fund).
One must have some investments in log term Govt Bonds(GILT), which goes up as Interest rates are cut.
I wish Wealthy and Prosperous 2015.
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