Inflation – Rate Hikes – War: WHAT NEXT?
Current Levers that drive the markets: Lets directly discuss the current parameters at play!!
Geopolitics: We did think that modern world has become more civilized or at least only covertly uncivilized if at all. Firstly the economics -Russia’s exports is 70% dependent on oil. It produces 8% of global supply. But oil is under threat of disruption. If phasing out of bio-fuel happens it could be – first petrol, then diesel, then CNG and so forth. Ukraine, after Norway, is the 2nd largest Gas reserve of the world. Russia has not been able to keep up to pace with modernization of its economies. It is trying to bypass the current status quo by trying out new payment transfer system, accumulation of gold reserves, tallying payment systems with China & trying to create a new front. Increase of natural reserves can give Russia some more time (may be an added 5 or 10 years) to diversify and update its industries. Secondly, there is a historical aspect – Russian rulers considered Ukraine a part of itself and never considered its separate identity. Lastly there is a survival instinct aspect – Russia finds itself surrounded by NATO/ US defense systems around its land and sea borders. Putin has expressed before – “We were USSR. Then ‘they’ broke us into a dozen pieces and we were left with 146 Million people. ‘They’ are still not satisfied. Some of ‘them’ want further divisions. We will not let ‘them’.” Now consider an analogy – “A very powerful country is influencing Nepal and Bhutan and using their land to surround us. So India will make sure that whole of Nepal and Bhutan becomes a war zone and we will drop missiles in their civilian homes.” Does not sound very acceptable to me. European countries depend on Russia for 40% of their oil supply. It saves transportation cost to import from Russia. There the governments are cautious about politically wrong decisions. Current responses and their on-ground impact have to seen. One Arctic Country Ruler and one Asian country Ruler tries to reach new heights of glory through conquest. The Arctic country plunders Europe, the Asian country plunders South-east Asian states. Result – a World War begins. No these are not predictions. This is the history of World War 2 – Japan and Germany. War has not ended until it has. Hope humanity prevails over power-lust and reptilian instincts.
Inflation: Geopolitics will be acting as a deflationary factor. If FED keeps rates down then markets can celebrate that. But ultimately if inflation numbers do not come down rates have to go up. They are near zero so going further down is not a possibility. Increase of money supply over population increase rates means the money supply gets stored in asset prices and not consumables. And money supply in the last decade of ‘Quantitative Easing’ (triggered by 2008 crash) has been hundreds of times greater than population growth. Why only now this will have an impact? Answer is simply speaking, put in the next segment.
Credit Cycle: Credit cycles happen just like stock market bubbles and bursts. Banks keep on expanding and expanding. And every 10 years or so inefficiencies creep in and need to be flushed out. We are at a peak of a credit cycle. Because Central bank economy itself is credit driven credit contraction means a year of bad economy and can create market crashes.
Euro-Dollar: Euro dollar curve has shown signs of inversion. Historically this has indicated correction. Meaning of this we need not go into but it only means there are demand related issues being predicted. Now the question is if demand is low how can inflation persist?
Stagflation: This term was popularized by Alan Greenspan, Former FED Chairman. When economy is in a space where prices are driven by policy /collective psychology and not real demand, inflation may persist while reduction in real demand. This phenomenon is called stagflation. A more severe outcome can be hyper-inflation – a stage where people loose trust in the system and want to purchase goods instantly whenever they receive cash in hand thereby exponentially increasing ‘currency velocity’ which in turn crashes ‘currency value’. Value of our fiat currencies is nothing but ‘trust’ in the ‘Central Authority’. An example of continued mild stagflation can be Japan. For last 30 years although they have induced huge money supply. Despite that Japanese Stock Market Index could reach their 30 year old peak only recently, and that at the cost of severe price inflation with low real growth. Hyper-inflation can be explored in post war Germany, current Venezuela, Zimbabwe.
Why am I being such a pessimist? I have to repeat myself – I see a 10 year incredible bull run atleast for India. The demographics, political set-up, human capital increment rates, other production factors, cost of labor to output-efficiency – all factors point towards that. We have to improve our manufacturing capabilities to reduce output per unit of capital expense because we are still more dependent on certain imports than we should. But all this I believe will change in this very decade that we are in. However, again at the cost of repeating my self I shall say – the current times are periods to be cautious. This has nothing to do with fear or pessimism, I am speaking out of data analytics which has worked really well for us. We are part of the global economy and right now a larger global cycle is playing itself out, we are watching that closely and sharing our honest opinions.
Conclusions: There are several other factors that can be cited other than the ones mentioned above. Our predictions have saved a lot of money for our clients. The more we reach out and convince people the more we are able to serve. Coming to what next – I don’t see markets bottoming next week or next month. But if situations do resolve quickly – as in – Russia stops escalation, West doesn’t need to retaliate, other geopolitical fronts do not escalate, FED is able to juggle between normalization and keeping demands up, oil prices remains stable, credit inefficiencies observed are not too drastic, asset prices stabilize quicker than expected, then markets may not correct drastically and bottom may be reached soon. For now – “Keep some cash in hand”.
~Regards
Susmit ‘Aaditya’ Mukherjee
investeye33.com | SEBI Licensed Analyst
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