Greenspan on bubbles

Central Bank Watch
Continuing with the theme of asset bubbles, but this time from the policy angle of the USA and the developed world, I would strongly recommend viewers to read MarketWatch's interview with former Federal Reserve Board Chairman Greenspan, which appeared yesterday on their website. 

Monitoring the NaMo Bull Market in Stocks: When will it enter bubble territory?

Total market value of stocks (total market cap.) listed on BSE as a percentage of GNP estimated at 78%.

Indian Stock Market Watch

My understanding is that there needs to be a reasonable relationship between the total market value (total market cap.) of Indian stocks and GNP. Long run investors could keep a watch on this relationship along with other indicators in order to gauge whether Indian stocks are cheap or expensive. This metric is is watched by Warren Buffet, the renowned investor.

GNP is a measure of activity of the economy – the output of goods and services in a particular year. The total market value of Indian stocks expresses the market value of savings ploughed in by investors in the stock market.  On the flip side, it expresses the market value of money raised by companies through the stock market to provide goods and services to consumers.  If the market value of money raised by companies (or that put in by savers) is completely out of line with the goods and services being produced by the economy then something is amiss.

The chart below shows the total market value of stocks (total market cap.) listed on the BSE as a percentage of GNP at market prices. The chart also shows how the market has performed, using the BSE100 as a yardstick.  I have not taken the Sensex, as the BSE 100 is more broad based. The total market value of stocks listed on the BSE covers to my understanding the predominant share of all stocks listed in India – a fair guide then of the total market value of Indian stocks. The yardstick for economic activity I have taken is GNP at market prices since it also includes net income - received and paid - earned from abroad, and since market value of BSE stocks includes money put in by foreigners.

When the total market value of stocks listed on the BSE as a percentage of GNP is in the region of 40 to 60%, history from 1993 suggests the market is cheap.  When the ratio is 100% and above, history suggests the market is expensive.

The percentage is currently estimated (June end) to be around 78 %, having risen sharply from 62% in February this year once the market sensed a Narendra Modi led BJP victory.  This suggests the market is not yet expensive, but nor is it cheap.

During the last decade, at the peak of the bull market in in Dec 2007 (pre financial crisis) the percentage stood at an estimated 149%. Then when the market bottomed in February 2009, the percentage fell to 52%. As the market recovered in this decade, the percentage rose again to 100% in September 2010, close to the last peak in the market in December 2010. Then market fell again when various governance issues facing the Indian economy became a significant headwind to the growth of the economy, and the percentage fell to the 60% area in August 2013.

The Economic Times of July 7, 2014 had a front page headline titled “Sensex May Scale 31,000 by March Next Year”. Any guesses on what the total market value of stocks listed on the BSE as a percentage of GNP   would be then? 

A perspective on the US Bull Market in stocks

S&P 500 Watch

If you are one of those (I am) who looks at the S&P 500 to calm your nerves or to get a long term view on the BSE Sensex (or Nifty Fifty), then I would recommend that you read an article by Victoria Recklaitis that appeared in the MarketWatch website on May 31, 2014. The accompanying graph is insightful. The graph follows the length and returns of bull and bear markets from the 1920s. If history is a guide, the S&P 500 is in good shape for the long run.

If any readers of this blog have come across reports of the correlation between S&P 500 and Sensex , please let me know.

Pursuit of Financial Stability: Monetary Policy or the Macro Prudential Measures Route

Central Bank Watch                                                                                                  

The financial crisis of 2008 has brought to the fore the use of macro prudential measures in promoting financial stability, especially in the developed world.  An intriguing question that now is being debated is should monetary policy be used to solve financial stability issues.

First, is the view from the U.S.A. On July 2, Federal Reserve’s Chair Janet Yellen gave a speech at the IMF on “Monetary Policy and Financial Stability”, where she stated clearly that “macroprudential approach to supervision and regulation needs to play the primary role” in promoting financial stability and that “monetary policy faces significant limitations as a tool to promote financial stability” (http://www.federalreserve.gov/newsevents/speech/yellen20140702a.htm).

Next, on May 1, is a recent blog in the Financial Times by Gavyn Davies, the highly respected economist. He presents in his usual lucid and balanced style the case for both macro prudential policy and monetary policy in dealing with financial stability issues, and ends by asserting that “as risks continue to build throughout the financial system, it would be foolhardy to assume that macro prudential measures could or should be used as an excuse to postpone interest rate rises indefinitely” (http://blogs.ft.com/gavyndavies/2014/05/11/macro-pru-is-no-panacea/ ).

Finally, the Indian experience and here we have the recently retired Deputy Governor of RBI Dr. K .C. Chakrabarty covering India’s experience in the April Issue of Financial Stability Review (see RBI website) where he states that “there are strong complementarities between macro prudential policy and monetary policy. Measures aimed at strengthening the resilience of the financial system buttress monetary policy by potentially preventing sharp financial disruptions”.

In India and some other emerging markets macro prudential policies has been part of the policy framework for long, although the term macro prudential has come into existence in recent years and replaces what used to be simply called administrative/regulatory measures.  One thing is clear. As India has not been faced with a serious financial stability issue, it has been sufficient solely for macro prudential measures to focus on financial stability. It is only when India is faced with a crisis will the question arise on whether monetary policy should also be used as a tool to actively solve a financial stability crisis. That time does not appear to be near.