Monday, March 19, 2007

Bears Making A Ruckus

A trend is your friend they say, and when the going gets tough, bears come out to hunt. Herd mentality, I guess. We have to filter out the noise made by the bears and just look at things in its proper perspective. If we were to look at the current bull run, it is not a massive one. In fact it ranks just seventh out of the nine bull runs in terms of scope and magnitude. Its hard to be over-exuberant or grossly over-inflated when you are #7.

Does anybody remember the global scenario a year ago? Corporate valuations are about similar but oil was some US$13-16 higher per barrel, we didn't see the edginess then as we do now, did we? Yes, there are worries in the market, the liquidity situation: as in all bull runs, it is generally fueled by strong liquidity - too much liquidity chasing assets creates bubbles, I doubt we are at a bubble stage yet.

But what is liquidity? It is certainly not just yen carry trade, its just a simple demand and supply equation. Liquidity has been growing, no doubt about that. Supply as in supply of scrips have been shrinking - either from being privatised/LBO or companies buying back shares and cancelling them. Remember that US companies cash balances have never been healthier and buybacks have been very good. Liquidity has been growing well via aggregation as well: thanks to the success of private equity and hedge funds popularity, a large amount of fund have been raised over the last few years. This kind of aggregation allows for a larger group of more-focused buying liquidity in the system, and don't forget the leverage factor in the present benign interest rate environment. Just in 2006 alone, the amount of actual equity supply decreased by 5% in the US alone. (On a totally different plane, the private equity expansion will ultimately lead to a few big bust-ups, that will signal the tapering off of growth in private equity. It will probably happen in a rising interest rate scenario... not just yet, a bit later.)
Bears will be right if we have in our hands new information which is highly negative and surprising. But the subprime worries appears to be a bit late and overdone. If we look at US GDP growth for the past 3 quarters, the combined growth was just 2%, well below the previous year's 3.7%: which means to say that housing slowdown was already evident more than 6 months back. Investors were not terribly worried then because of the firm labour markets. Six months later, its the same scenario, yes a few big firms related to subprime appears to be in trouble - that to me signals the peaking of worries, not the start.

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