“Did I say I’ll be back, when I left?” I asked.
“No,” she replied. “’You just said, this is the end my beautiful friend.”
“Ah! Jim Morrison had me doped.”
“Never mind,” she said. “Hope this time you are back for good.”
“That time will tell,” I replied cheekily.
“You are still as fickle minded as the stock market.”
“Well, there is clearly some logic in the way the stock markets operate. Just that it is not obvious to everyone.”
“Ah. There you go V, blowing your own trumpet!”
“Let me explain.”
“Please go ahead.”
“Let’s start with Spain where all the trouble seems to be concentrated these days. There benchmark index IBEX 35 is down around 10% since the beginning of this year and is down 30% over the last one year.”
“Their banks are in big trouble. The stock price of their biggest bank Banco Santander has fallen 18% over the last one month and 45% over the last one year.”
“But why?” she interrupted again.
“Spain had the mother of all housing bubbles! It currently has as many unsold homes as the United States (US), even though the US is six times bigger than Spain.”
“Oh! I didn’t know that.”
“Yes. And even though Spain contributes only 12% of the gross domestic product of the European Union it accounted for 30% of all homes built in the EU since the turn of the century.”
“And all this construction must have been financed by loans from banks?”she asked.
“Yes. Loans to developers and construction companies amount to nearly 50% of the $1.4trillion Spanish gross domestic product (GDP). Of course, with homes lying unsold developers cannot repay their loans and this means the banks are in trouble. And Spain’s banks are too big. In fact the asset size of the three biggest banks in Spain is around $2.7trillion, twice of their GDP,” I explained.
“So if banks go bust, Spain goes bust!”
“Exactly! And Spain is not the only country in trouble. Other European countries are not doing too well either. This has an impact on China because Europe is China’s biggest trading partner. Exports to Europe in March were down 3.1% in comparison to last year. Chinese exports had ranged between $475billion and $518billion in the last three quarters of 2011. In the first three months of this year the number has fallen to $430million. The Shanghai Composite, China’s leading stock market index fell by 6.8% in the month of March.”
“So a slowdown in Europe is having an impact on China?”
“Yes madam! Profits of Chinese companies were also down for the first two months of 2012.”
“So a slowdown in Europe, slows down China. What happens next?” she enquired.
“That in turn has an impact on Australia. Australian exports to China in 2011 stood at A$72billion (Australian dollar), up 24% from 2011. Now around 26% of Australian exports are to China. An ever expanding China bought coal, iron ore and natural gas from Australia, driving up Aussie exports. But exports for the month of February fell to A$24.4 billion, the lowest in an year. Coal exports were down by 21% to A$3.4billion.”
“All because of a slowdown in China,” she concluded.
“Yes. The other country which has suffered because of a slowdown in China is Brazil, which has been enjoying an economic boom to a huge demand for crude oil and agricultural products. A slowdown in China impacts any commodity exporting country because prices tend to fall as China consumes less. But that is not the only reason by Brazil’s exports have fallen.”
“So what is the major problem?”
“The major problem is an appreciating Brazilian currency. The central banks of United States, Japan and Great Britain have been running zero interest policies, in the hope of reviving their own economies. But what this has done is that international investors have been borrowing in these countries and taking the money into emerging markets like Brazil to invest there. When they come to Brazil with their dollars, they need to sell those dollars and buy the Brazilian real. This leads to an increase in demand for Brazilian real and hence the value of the real appreciates against the dollar, which in turn means that the Brazilian exports become expensive. Hence, the Brazilian Bovespa, the premier stock market index of Brazil has fallen 7.4% over the last one month,” came a long explanation from my end.
“Interesting, the way it’s all linking up!”
“So Europe slows down leading to China slowing down and then Australia slows down as well. Brazil slows down because of China and the United States. In the United States elections are due in November this year. If Obama is re-elected tax on long term capital gains could increase to 20% and income tax rates are also likely to rise as tax cuts initiated George Bush junior may be allowed to expire. The stock market of course won’t like this.”
“But what about India?”
“Do I need to say anything? We are in a big mess to say the least! And the state of the Indian stock market is largely decided by the foreign investors. If they are not feeling good about things, the Indian stock market will not go anywhere. In the last one month the BSE Sensex has been almost flat.”
“Hmmm. As my former boss used to ask, so what is the takeaway?” she asked.
“Things are not looking good all over the world.”
“So, is there any hope?”
“Yup, there always is. Ben Bernanke may come to the rescue with another round of money printing, technically now called quantitative easing. That is possible because it is an election year in America, and past Chairman of the Federal Reserve have helped incumbent Presidents fighting elections by running an easy money policy before elections. This money could find its way into stock markets around the world and juice up returns,” I replied.
“But that may or may not happen. So what does one do now?”
“An old stock market saying goes “sell in May, go away! It is time to change that to April!”
(Vivek Kaul is a writer and can be reached at [email protected])
(The article appeared in the Daily News and Analysis on April 23,2012. http://www.dnaindia.com/analysis/column_sell-in-may-oops-april-and-go-away_1679339)
Endgame – The End of Debt Supercycle and How it Changes Everything, John Mauldin and Jonathan Tepper, John Wiley &Sons. 2011
Minefields that can Blow-up Global Stock markets in 2012, Gary Dorsch, April 12, 2012, www.sirchartsalot.com