First question any investor would ask another investor, what do you feel about the market? You would get different answers to this question depending on his perspective. My answer to the above question, yes we are in a bubble situation and the markets world wide can come tumbling down depending on the extent they are leveraged.
Why do i feel so?
World markets were in a recession in 2008 and various measures were taken post the event to bring life back to normal world over, in this process central banks created huge debt to finance growth by way of QE by US and similar methods by Europe, Japan and China.Are they successful in this adventure? To some extent, but the debt they have created to fuel growth is far more than they would have in a normal scenario. So every dollar spent to create a new job or setup a new factory is much higher, this has created over capacity and the demand is not picking up. Just look at all the startups around the funding which has gone into them in last 8 years, all was only possible because of this easy money. Have these start ups done well? Yes quite a few maybe around 5-10% but at the end only 5% might survive what would happen to the rest of the money invested, all of this investor money vanishes into thin air. People might argue private equity(PE) by nature is risky and the investors are aware of it, but what is the source of the money? Its excess liquidity and low return in other products in the market which is fueling this adventure. It is the same with the equity and debt markets across the globe including India, the investments in corporate debt is at all time high from FIIs so what would happen to all this investments in PE, equity and debt if the supply of this money is shut, or even a increase in interest rates by another 50-100BPS by FED. The investments which were looking good now would slowly start to look bad and the smart money would slowly start to liquidate, causing the markets to come tumbling down. The corporate debt levels are at soaringly high in most countries thanks to QE. My readers in India would ask me how would such an event outside India affect us, today due to globalization most Indian companies have business interest with their counterparts which might have an exposure to this. But more direct is the FPI investments into Indian assets. This money would move out causing the asset prices to plunge and even job losses would increase. Do read about a layoff in one of the most glorified startup of India.
An example why this can happen: Say Mr.X has option to invest in a Bank FD(Asset-A) and get 6% or 20% by investing in a slightly risky asset(Asset-B), he would consider investing in the one returning higher return Asset-B. The situation after 2 years change and the Bank now is still offering 6% interest but the expectation of return on Asset-B is 10% with same or increased risk. Now there is a higher chance that Mr.X liquidates his Asset-B and move to Asset-A. When this happens overpriced assets would re-align close to its real worth.
Million dollar question : When would this happen?
Its a process and the above article about startups laying off shows that its a ticking time bomb waiting to explode. Each investor would have a different cost of capital and the interest rates raising to the level were it would affect the investor with the lowest cost of capital, A retail loan in India is at around 15% today but a corporate gets it at 11% or lower based on there profile. In a similar way all investors would not get impacted right away if FED increases rates by 25bps in its next meeting, the one with highest cost would reach the exit first. So it would take some more time before they call it Quit. Its a chain reaction which would trigger one reaction after another. A second situation would be when the liquidity is eased to such an extent that more easing does not have any effect on the prices or the economy. So we have got some more time left before these levels are reached.
Few trillion dollars of assets would be wiped out because of this, the worst affected would be the common man. There salaries did not increase with easy money the assets they purchased were expensive and now if the above event happens and all their savings and assets would loose value.
The Indian situation, the rest of the world goes down by 70 and we go down by 30 and we would only feel we are much better than the rest. Quoting our former RBI governor “Indian economy like ‘one-eyed’ king in land of blind”.
Slowly invest into assets which would not have a large impact of this in the next few months and ride out this fall and then slowly enter when the prices are lower.
Very nice article