Weekly Market Commentary - Mar 25 - 29, 2013

Uneventful week for Indian markets with two day holidays for Holi and Good Friday.

Monday - Sensex down 0.50%, Nifty down 0.31%, Midcap down 0.18%
Markets stayed jittery as UPA's critical ally SP continued making noises about early elections keeping the markets nervous.

Tuesday - Sensex up 0.34%, Nifty up 0.14%, Midcap down 0.18%
Markets broke away from their recent trend of losses and posted some gains. Nothing eventful.

Wednesday - Holi

Thursday - Sensex up 0.70%, Nifty up 0.73%, Midcap up 1.52%
Markets posted a gain on the last day of fiscal 2013. Nothing eventful.

Friday - Good Friday

Weekly Market Commentary - Mar 18 - 22, 2013

Quite a bad week for Indian markets. Sensex and Nifty fell by around 4%, while CNX Midcap declined by more than 5%.

Monday - Sensex down 0.69%, Nifty down 0.64%, Midcap down 0.3%
Markets ended down with not so optimistic view from RBI monetary policy review meeting next day. Broader sentiment was also negative due to Cyprus bail out plan of taxing its bank depositors made markets nervous. Moody's comments on warning on country's rating due to sustained food inflation also added to the woes of the market.

Tuesday - Sensex down 1.48%, Nifty down 1.53%, Midcap down 1.51%
DMK's decision to pull out from ruling UPA govt sent shockwaves through the market. RBI's decision to limit its repo rate cut to 25 bps and leaving CRR unchanged at 4% took the banks and realty firms down. RBI also sent a clear signal to the market to not to be too hopeful of a rate cut in the near future.

Wednesday - Sensex down 0.65%, Nifty down 0.90%, Midcap down 2.08%
Markets continued to be in red as the political climate turned uncertain. Markets were facing a real risk of early election which will put all the reforms initiated by UPA in limbo and attempts to bring down the fiscal deficit under control will have no air to breathe.

Thursday - Sensex down 0.48%, Nifty down 0.63%, Midcap down 1.22%
Markets continue to grapple with uncertain political climate, bank scandal and RBI's signal of keeping the monetary stance hawkish.

Friday - Sensex down 0.30%, Nifty down 0.13%, Midcap down 0.26%
Markets remained range bound for the last day of the week.

Inflation conundrum

Okay, let’s start from basic definition of inflation which is increase in the prices of goods due to reasons such as high demand (which is demand-pull inflation), due to some supply constraints or increase in the resource cost (cost-push inflation) and inflation caused by some past events whose effects are still felt (hangover inflation). Inflation is also defined as too much money chasing too few goods. What it certainly means and what many people fail to see is that inflation is a monetary phenomenon.

Yes, I say it again; inflation is a monetary phenomenon which can entirely be controlled by manipulating the money supply in the market, as most central bankers in the world are busy doing these days. One of my friend argued that, if it is that simple then how would you explain that flood in Indonesian mines leads to increase in coal prices or something like even during the period when the money supply is constant, prices of goods continues going up? Well this post will try to answer just these questions.

Let’s take a simple example of a country with only three residents Amar, Akbar and Anthony. Every month Amar purchases some amount of coal from Akbar and rice from Anthony. He pays Rs.50 each for one kg of both items. One particular month, there’s not been much rain, so rice crop was not that great. So Anthony has to put some extra efforts to grow one kg of rice to sell to Amar. When Amar came to purchase rice from Anthony, he saw a sign board with a sign of "Rice – Rs.100/kg" at his shop. He was little disappointed as he had only Rs.100 in the pocket and he was also suppose to purchase one kg of coal from Akbar. So what should this poor guy do?

There are two ways this guy can go; either he purchase ½ kg of rice and 1 kg of coal or he may buy some more rice and cut a slack on amount of coal. In either case, the amount spend by Amar would sum up to Rs.100 only (considering he can go nowhere to borrow); only thing that will be affected will be demand for rice and maybe for coal, depending upon the priority of Amar, the buyer. That’s from the Amar's part, what about Akbar and Anthony who are left with extra rice and coal in their shop and no buyers. With no other options and buyers, they will sell the stuff at lower prices depending upon the demand, which in first case will be Rs.50/kg for one kg of both items (ideal case, of course). So, when Amar calculate his monthly expenditure, it still is Rs.100, so inflation for Amar is 0%. So, any change in demand and supply equation (supply shocks etc.) of the commodity did not have any effect on the prices in the case of constant money supply.

Now imagine that there is a banker, who is ready to provide Amar extra money, let’s say Rs.50 to purchase rice, what will happen then? Well, Amar is going to use that money in addition to the money he has, to buy one kg of rice at Rs.100 and coal at Rs.50 from Akbar and Anthony respectively. Now if you compare Amar’s commodity price basket, you may well comment that total expenditure for same quantity of goods has increased from Rs.100 to 150, an increase of Rs. 50 from previous month i.e. 50% inflation rate!

This inflation would not have been there, if there was no other source of liquidity available to this country. This change in price level has got nothing to do with the supply and demand of rice and coal but with the supply and demand of money. How much money is flowing in the market is actually the one and only determiner of inflation rate experienced by everyone. There might be few supply and demand shocks that may change the prices to drastic levels but that will be for short term as consumers will adjusts their portfolios to accommodate these changes. In the long run, it is the supply and demand of money which decided the inflation rate. As the central banker keeps on printing money, there will be more money available in the market which will lead to decline in the value of money which further will lead to every other good look expensive relative to the money.

Indices to watch out for!!

Here are few graphs which confirms the view that all’s not well with the global economy and we are still a long way off to come out of the grips of bear markets.

The first graph is plot of VIX (volatility index) which is also known as “fear index” as it indicates how far markets (esp. S&P 500) are from stability. Higher values shows that investors are expecting higher volatility (which translates into less stability) in coming future.

VIX has historically traded around 15-20 levels. But, in wake of recent financial turmoil, it has touched new highs of 80. More about VIX here and here.

The other graph indicates confidence in the commercial lending system of the economy. The indicator known as TED Spread is the difference between 3 month T-Bills interest rate and LIBOR. Increasing values indicate increase in counterparty risk which means banks are feeling uneasy about lending to each other which leads to increase in cost of borrowings.

TED has crossed the level of 4% after remaining in the range of 10-50 bps historically.

The above two graphs illustrates the problems faced by financial economy in general, but the last graph show a trend which speaks volumes about slowdown in real economy and aggravates the fear of recession. Baltic Dry Index as it is called indicated the level of trade done globally through the sea-route. Unlike stock market, it is free of any speculative biases. As Wikipedia puts it

“Most directly, the index measures the demand for shipping capacity versus the supply of dry bulk carriers. However, since the demand for shipping varies with the amount of cargo that is being traded in the market (supply and demand) and the supply of ships is much less elastic than the demand for them, the index indirectly measures global supply and demand for the commodities shipped aboard dry bulk carriers, such as cement, coal and grain.”

BDI is trading at 1500 levels after touching all time highs to 11,793 in may 2008. For more information on BDI, see here and here.