Money Flow Is Directing the Markets

Once again, the flow of money is showing the way to asset markets; stories are being generated in direction of the trend.

Dissimilar, yet similar

Last year, asset prices zoomed till mid summer. Commodity investors found the inflation hedge as reason to get long; pension funds found it difficult to deploy their incremental cash into dried-up American debt markets; money had to find a way.

Is the story different this time?

This time we are starting from a very low base. Unlike last year, economic data are quite supportive to the rally. Domestic consumption in Asia is leading the growth story, unlike post the Olympics slowdown in China last year. International trade is picking up momentum, circulation of money in US economy is speeding up and credit spreads are easing as fear of further fall dissipates.

However, on several counts the current story is same as the one last year. Active interest from Index funds is a common factor. In the last 3 months, the passive investment monies have left several active fund managers grumbling of having missed the bus. Reluctance to invest in the US debt market is an important driver once again: last year, several avenues were closed, this year low yields do not leave too much upside. Last year, money was getting cheaper with drastic cuts in interest rates. This year, with record deficit financing in major economies, money is available in plenty.

The new “normal”

Most of the “matured” fund managers and analysts see a “new normal” for advanced economies, especially the US. Unemployment is at double the usual normal rate of 4%, spreads on consumer loans are at 2-4 times of pre-crisis levels and GDP growth is 1-3% versus 3-5% earlier on. Several such changes in the western world economics will stay for many years to come. The process of de-leveraging has just begun.

The “real” economy in Asia (especially China) is currently under the influence of stimulus plans. China has front-loaded its budget spending by expending 60% of annual budget in 4 months. Strategic reserves are finite solutions; those eventually need avenues for ultimate consumption. As the effect fades in coming months, the absence of invisible hand of western world as support to their economy will be felt. In a true sense, Asia also needs to find its new normal.

Wrong again?

The speedy withdrawal of money from asset markets in H2 2008 pushed some of us to foresee “Depression” arriving. And now a surprising return of money to markets in last few months have made many of us believe in a “V” shaped recovery. Both of these views are influenced by the flow of money, have more sentimental element than fundamental aspects and could be equally wrong in the hindsight.

Despite a refreshing pull back from the lows, US manufacturing is still contracting (below 50), Chinese PMI is just above 50, Europe entered recession late and could take longer to come out of it. Encouraged by “green shoots”, most of the asset markets have shown a remarkable pullback. BSE Sensex at 15,000 (52w range 21,000-8,000), Euro at 1.42 (52w range 1.60-1.23), Copper at 5000 (52w range 8800-2800) are at or around their 50% retracement. In other words, the paper market has discounted a 50% recovery while the real economy is just about stabilising.

Conclusion

When crude was creating record last year this time, the US Senate was discussing the significance of speculation in financial markets and ways to regulate it. While the arrival of recession may have put those talks on the back-burner, the fundamental problem in the financial asset market is yet ‘too much money chasing too few assets’. Emergence of Index funds (read pension funds) as a long-term passive investor class is changing the rules of the game, gradually but consistently.

While I believe that fundamentals will set the direction of markets eventually, the swing could get bigger as we move on. However, for those enjoying the rally, trend is the best friend… after all “Kal Kisne Dekha”.

Disclosure: None

Comments

[Chandragupta:]

Good article. You are right in saying that the problem is "‘...too much money chasing too few assets’. That explains the rise of the asset markets esp. stocks, commodities and bullion in the past couple of months despite little real economic recovery.

Jun 04 01:50 PM

[lightwarrior:]

I would like to know the difference of "the fundamental problem in the financial asset market is yet ‘too much money chasing too few assets’."
as in "bubbles" vs. inflation.

Jun 16 11:24 AM