SENSEX and USD-INR: A weak signal from the currency market, at least for now…

Starting with a base foundation… There is an obvious Negative Correlation between the Sensex and USDINR (as shown by the below graph too!), with the negative correlation becoming more prominent (as shown in the USDINR Vs Sensex chart and historical regression below)





Regression equation:

1. For period 2003-2008: Delta Sensex= -0.978 Delta USDINR + 0.049
2. For Period 2005-2008: Delta Sensex= -0.998 Delta USDINR + 0.049

(The negative relation became stronger recently)

1. For Period 2006-2008: Beta is -1.21
2. For Period 2007-2008: Beta is -1.288

Worth noticing is a fact that during January market fall in the market, INR did not fall against the USD, however from the 2nd half of Feb till now (mid March) INR is falling against the USD (once it came broke 39.60 level).

Sensex and corresponding Currency movement:

Jan 2008: Sensex: Decline of 13% USDINR: +0.2%
Feb 2008: Sensex: Almost flat USDINR: -1.7%
Mar 2008 (MTD): Sensex: Decline of 15% USDINR: -1.14%



USD vs Euro and JPY:

USD is already one of the weakest currencies among the big daddys. USD is weak against Euro (Hit all time low at around 1.59) and JPY (touched decade low at 95.8). Hence INR which was among the best currency in the world in 2007 (thanks to USD 20bn FII inflow), has lost steam of late (FII has been net seller of USD 3.5bn YTD)






Inference there from:

It gives a signal that FIIs which sold their stocks in January but kept their money in India in INR and did not convert in USD. The inference can be that they did selling (in Jan) with an intention to re-enter soon.

But come Feb and Mar 08, they continued selling, and INR started depreciating against the USD. The inference can be that they changed their short term positive stance on India and withdrew money (shifted from INR to USD). Seems they are busy in managing their own portfolio back home and have no short term intention to re-deploy money in India.

Hence, despite USD falling against other currencies, INR is falling against it-a very weak signal for INR and the market also.

Does US have what it takes to go into 1970s like Stagflation?

Will US go in 1970s kind of Stagflation- Next 2 quarters economic indicators are very important…

(Please e-mail me if you are not able to see the charts)

US economy faced with Stagflation in 1970s. The situation was extremely acute in 1973-1975 when Dow Jones fell from 1020 to 608 in 2 years. In a simple term, Stagflation is a macroeconomic term used to describe period of high inflation combined with slow economic growth (or recession) and rising unemployment rate.

Equity market falls due to double edged sword (economic slowdown and inflation). Bond market does not do well as the real interest rate is often negative. Commodity market does well as it gives good hedge against inflation and beneficiary of outflow of fund from Equity and Bond asset classes.

GDP (White) growth and DJIA (Orange) in 1970s:


DJIA (Orange) and CPI (White) in 1970s:


Unemployment (White) and DJIA (Orange) in 1970s: The rising inflation and falling GDP took a toll on the unemployment with a lag.


Inflation (White) and GDP growth (Orange) (1972-1975): While GDP growth was going down, inflation was picking up


Unemployment (White) and Inflation (Orange) (1970-75): While inflation was rising from Mid 1972, unemployment also started rising one year after. Unemployment follows rise in inflation during slowdown.


Current Scenario 2008:

GDP growth started falling down. For 2008, economists are expecting a GDP growth of a mere 0.3-0.4% which was revised down from earlier expected 0.8% a month ago. Though there isn’t any expectation of negative growth but the downward revision in 1 month is scary.

GDP Growth (White) and DJIA (Orange):


Inflation (Orange) and Unemployment (White): While unemployment remains at the same level (however 50bps higher than 4.4% bottom in late 2006), inflation has moved up. And as we have seen in 1970s, unemployment lags behind the GDP growth (decline) and rising inflation. Hence, unemployment figure is to be closely watched which will strengthen the current stagflation case.


Unemployment (White) and DJIA (Orange) (2003-2007): While unemployment was declining during the period, DJIA rose then. However the of late, DJIA is falling and unemployment is rising.


Inflation (White) and DJIA (Orange): CPI which bottomed out by late 2006 has started going up. Food, commodity (incl fuel) are majorly responsible for this. China which was earlier world deflator, has started exporting its inflation which is at 11 year high of 8-8.5%. The inflation expectation in China is scary at the moment.

20year CPI expectation in the US has also moved up and people are expecting a higher inflation regime.



Crude (White) and DJIA (Orange): Crude is one of the major factors driving CPI (CPI includes Fuel and Food inflation). Crude which was moving ahead in 2004-2007 period was because of higher growth demand but now more because of inflation hedge tool and underinvestment.


Gold (White) and DJIA (Orange): Gold is a classic inflation and uncertainty hedge. It gives no income, however we feel happy if we have it (intangible benefit!!!)


Point to Ponder:

Gold/DJIA at 12 (12000/1000) is now at lower end of the green range (Stock low Gold high scenario).

What lies ahead? Would we see an aberration again as in the past; or will Gold go down/ Dow go up.



Conclusion:

I would not say that we are again in 70s kind of Stagflation, but the recent economic trend is a way towards that. GDP is off from 4% to 0.3%, inflation is high at 4.3% from bottom of 1.4% during the same time. Unemployment is on the rise, though not alarming. Commodity prices are going of the roof. In real negative bond yield scenario (inflation is higher than nominal interest rate) investors would not prefer bonds. Equity is already the most hated word now.

Does US have what it takes to go into 1970s like Stagflation? Keep an open eye on economic numbers…

Is Flat Yield Curve associated with elongated Bull Run followed by Bear Market and vice versa?

Is Flat Yield Curve associated with elongated Bull Run followed by Bear Market and vice versa?

Please see the following charts and comments which are self explanatory (A study over 16 years of Dow Jones Industrial Average and US 10 Year Treasury Yield)

Highlights during 1992-1994

 DJIA consolidated between 3200-3500 and 3500-4000 in two phases.
 Yield Curve was steep during 1992-1994 and flat by 1994 end after which bull run started from 1995 onwards.

DJIA 1992-1994 Consolidation before onset of 95-00 Bull Run



Yield Curve 1992- End 1994 (Steep during 1992-1994, and flat at 1994 end)




Highlights during 1995-1999

 DJIA rose from 4000 to 11800 in prolonged Bull Run.
 The steeper Yield Curve in 1995 gradually flattened Y-O-Y till 1999

1995-2000 The great TMT Bull Run




The Yield Curve in 1995 was steeper followed by flattening Yield Curve Year after Year till 1999



Highlights during 2000-Mid 2003
 DJIA collapsed from 11800 to 7200
 The flat Yield Curve of 2000 turned into steep by 2003


The Great Post TMT Collapse Mid 2000-Mid 2003



The PURE FLAT Yield Curve in 2000 (the last leg of 95-00 Bull Market) turned into gradually a very Steep Curve till 2003



Highlights during Mid 2003- End 2007

 DJIA rose from 7200 to 14000 in the long Bull Run.
 The steep Yield Curve in 2003 turned flat and negative too by 2007
 The Yield Curve has become steep again (2003 alike) in the span of 6 months

The Great Bull Run of 2003-2007



The Steep Yield Curve in 2003 turned into extremely flat (at time negative) till 2007 and has suddenly become very steep again (infact 2003 alike) due to sudden Fed move.



Comments:

 When interest rate is at extremely lower level (1% at start 2003), consumers and corporates start borrowing gradually and the up-cycle begins.

 After the onset of positive sentiments, excessive borrowing on both consumer and corporate side begins. Consumer borrowing feeds consumption and housing demand. Corporate borrowing leads to investment demand (2004-2006).


 It leads to inflation and central banks keep raising short term interest rate to deal with it and yield curve goes flatter or at times negative (2004-2006)(As generally Central Banks' action leads to decline in short term interest rate while long term rates remain untouched). But due to positive sentiments and seemingly increased income stream projection, borrowing keeps happening with exotic structures to attract consumers (like teaser rates loan)

 After some time, consumers start feeling the pinch of loan repayment and start consuming less. Corporate, due to excessive capex, faces idle capacity (2007 onwards)

 Prolonged increase in interest rate leads to slowdown in economy and markets comes down. It is the fag end of flat yield curve period which leads to onset of bear market (end 2007).

 With the start of bear market, as economy slows down and inflation fears wane away, central bank decreases interest rate. However, due to negative sentiments, not much borrowing happens to lift up the economy.

 Gradually yield curve steepens with short term rate trending downwards, and the up-cycle begins with start of borrowing activity when the interest rate starts looking very attractive.