The macro news emancipating from the global markets can not be termed as good news giving sings of coming prosperity. One after another the central banks are busy in quantitative easing to support flagging economy and with every such news the market moves up as if its the signs of strong economy.
On the contrary if central banks are worried and are busy in doing quantitative easing its the sign that economy which is suffering rather than being robust. But still markets cheers every news of quantitative easing with a triple digit gains. Therefore its becomes pressingly important to understand how Asset prices will behave in future.
Is it the new Normal?
Indian stocks are trading at a P/E of 26 X which is near their all time highs if we look at last 10 years of History. Last month FII pumped in 5 billion dollars in Indian markets and the index jumped up by 10%.
According to me the current valuation is almost stretched if history gives us an signal of times to come the market should correct very strongly. But this may not happen in near term.
The point is that if the cost of borrowing for banks is 0.10% per year they can borrow and lend massive amount of money to FII, Hedge funds and other investors at 1% to 2% or even lower and earn almost 10X the cost of borrowing.
If FII are borrowing the money at such low rates they have the capacity to pump billions of dollars in emerging market making them very expensive. (This is what we saw in September) This phenomena can continue in near future. FII's have the capacity to pump another 10 -20 billion dollars in Indian market which push market up another 15% or 20%. But my question is that is such valuation sustainable?
To my mind it is not sustainable. Its a bubble in formation. Even if I ignore the high current account deficit and assume that India will grow by 9% while rest of the world will grow by 2 -3% these valuations are not sustainable. Its anybody guess as to much much money these FII's will pump. At this point in time money supply is huge and pumping 50 Billion is also not difficult. This can create a classic bubble in Indian stock market las seen in 1999 -2000 where IT stocks were trading at a P/E of 100 X. Nifty can overall go to any valuation levels such as 30 X or 35X but buying stocks for this upside is like playing the bigger fools theory.
I will choose to exit the markets and sit on the side lines watch the market go up and and crash rather than buying at such high valuation.
I would like to add one more observation that the price of Gold are soaring. Gold had recently hit a high of 1350 USD an ounce. If the quantitative easing continues the price of gold can explode and go up to 2000 USD an ounce. The price of other assets like Real Estate, Shares, Precious metals, commodities will also explode along with it. This price increase is not the manifestation of an increase in value or demand of the product but it is the result of increased monetary base.
Such increase in prices of real asset is always detrimental to consumer as consumer income is sticky (for example the price of real estate in Bombay is up by 50 -80% since 2008 but salaries have increased by only 25 -40% at max). Therefore it becomes more difficult for people to buy these assets and real demand or consumption demand for these assets decreases while the price remains high.
This forms a classic bubble where price rises not on the back of higher demand but higher monetary base. The end of such bubble is always deflationary for entire economy and it creates mass destruction of real consumer demand and push the entire economy into deflation like what Japan is facing.
It must also be noted that increasing asset inflation is always favorable for the rich as they are the owner of most of the assets in the society and therefore they are benefited by asset inflation while its detrimental to the poor or have not's of the society as they aspire to buy or posses these assets which becomes increasing more costly. Such a phenomena is also detrimental for the stability of the society as it creates more skewed distribution of wealth.
If we price Nifty in gold that than we can see that Nifty is no where near to its all time high. At the peak during December 2007 you could buy 7.61 ounce of gold for every Nifty today you can buy only 4.588 ounce of gold for every Nifty.
This means that money is getting debased and its value is decreasing. The value of Nifty has decreased by 35% in last two years even if its trading at tis all time high.
Therefore it would have been far more advisable to buy gold rather than Nifty to preserve the buying power of your portfolio. As I feel that coming times are very turbulent and monetary debasement can accelerate form there its better to have 25% of your portfolio invested in Gold.
NIFTY PRICED IN GOLD CHART
If history is any indicator of times to come the coming decade will be marked by trade wars, currency debasement, and major geopolitical conflicts which may result into major armed struggle. Gold and food grains certainly seems to be a safe haven for times to come.
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