Monitoring the NaMo Bull Market in Stocks: Update as of end August 2014

Indian Stock Market Watch

Please refer to my blog of July 9, 2014 for the original note on using TMV/GNP ratio to gauge

whether market is cheap or expensive.  

Third Bi-Monthly Monetary Policy Statement by Governor Rajan: RBI bats once again both for lower inflation and growth

Where does the policy interest  rate go from here?

RBI Watch                                                                                    Monetary Policy 2014-15

There were no surprises. No change in the interest rate, but SLR was further reduced by 0.5% to support growth. Please see my note of June 3 after the Second Bi-Monthly statement when I wrote that I expected further reductions in SLR.

Inflation is now at or below the RBI’s January 15^, 2015 target of 8%.  It has been so for two months – June (7.5%) and July (8%).

The RBI is confident of keeping to the 8% target by January 2015, and has now set its sights –it was always there but now it is clearly in focus - on its next target of 6% by January 2016. Note, since November 2013 inflation has actually trended sharply downwards, but for two months in April and May, from 11% to 8%! Can we expect a further sharp fall in inflation to the 6% level in the next eighteen months?

Surely, just as interest rate policy had a role in reducing inflation, weak demand conditions in the economy as seen in the sharply lower growth rates - partly independent of RBI’s higher interest rate policy - in the last two years have played a role.

Now the consensus is that investment and demand will pick up in the coming months and more so into next year. The new government has started on the path of reforms, and also committed itself to getting its own house in order (fiscal consolidation). However, bottlenecks in the maintenance and growth of infrastructure will take the long term to resolve. Also, we have a whole set of structural factors inhibiting the growth of the agricultural sector – from production to storage to marketing, which will also take the long term to resolve.

This combination to my mind means that inflation, where food inflation plays a major role, is unlikely to trend sharply lower, unless growth, contrary to expectations, continues to be weak both at home and internationally. If anything, a trend up in inflation cannot be ruled out.

Hence, I do not see any change in interest rate (the repo rate) by the RBI going ahead. In fact this is necessary to enhance and heighten the RBI’s inflation fighting credibility at an entirely new level – a goal that Governor Rajan has clearly set for himself.

This also ties in with the level of real interest rates. Now, they can be considered to be positive at about 1%. RBI’s credibility as a inflation fighting central bank needs positive real interest rates – and here it does help that given the Great Recession of 2008, central banks of Europe, Japan and the USA have been forced to abandon a positive real interest rate policy for now.  However, this will need the support of the Government.

For a detailed look at monetary policy issues raised in this note, please see my note of April 16, 2014.

The lengthy post-statement conference calls with analysts and media are worth wading through. Here are some important comments by Rajan to questions.

Does the interest rate differential play a role in interest rate policy?

“My sense is that for the most part we would be driven by domestic conditions rather than external conditions in determining the interest rate. Which is precisely why we are fighting very hard to build inflation credibility, because I think once you get some inflation credibility it gives you a certain amount of flexibility in focusing on domestic conditions rather than trying to act kneejerk towards external developments.”

Inflation targeting and the use of the Taylor rule

“The first, while we have a glide path in mind, I would not say we are currently in an inflation targeting framework, but we have many of the elements in place. That said, I think we do look at what kind of policy would be consistent with a Taylor rule. But remember, Taylor rule is just an empirical statement based on behaviour of some other central banks, and we cannot be guided solely by that at this point.”

Real interest rates and monetary policy

“Real rate, if you take the deposit rate as around 9%, and you take year-on-year inflation at about 7.5% , 7.3% was last month, we are into positive real rates and these real rates are certainly on par if not better with deposit real rates across the world. So, we are getting there in terms of real rates.”

RBI’s credibility in fighting inflation

“And fourth, this I do not want to diminish, I think the expectation that we will confront and deal with inflation is much stronger now than it was earlier.”

On RBI’s target of inflation at 8% by January 2015 and 6% by January 2016

“We are confident we can get to 8%, at the current setting we are also confident we can get to 6% .”

The value of the Rupee: An update

RBI Watch                                                                                                                Indian Rupee

See below two tables showing the performance of the Indian Rupee in nominal and real terms over the last one year. Please also read my blog of April 25, 2014.

Monitoring the NaMo Bull Market in Stocks: Update as of end July 2014

Indian Stock Market Watch

                                              

                

July 31, 2014
Total Market Value (market cap.) of BSE Stocks as a % of GNP	76.9%
Source: RBI, BSE, our Estimates

                                         
                                                               

Please refer to my blog of July 9, 2014 for the original note on using TMV/GNP ratio to gauge whether market is cheap or expensive.                                                                                                                                                                        

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.