Future: What Lies Ahead?

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Agreed, we have come out of a great crisis. The jury is still out, on what led us into the credit and financial crisis. Was it excessive leverage and over-consumption in the West, or mercantilism and excess savings in the East, laxity in regulation or proliferation of derivatives? Genesis of the crisis was in excessive leverage and a credit boom, which typically ends as a bubble that bursts. Ironically, the people responsible for inflating the pipes to the point of burst are the ones trying to fix it again. They are still using Dr. Fixit when what really needed are new pipes, or, rather a completely new system. Temporary bandages can’t be a solution to patients with severe injuries.

A heated debate is on between Keynesians who are preaching policymakers to continue pumping more fuel to keep the animal spirits on while effectively inflating the accumulated debt and others who argue for austerity and warn against this ‘more alcohol to treat hangover’ policy. Truth lies somewhere between. Given the powerful forces of private sector deleveraging, governments have to fill the void by taking leverage. However, the scale and magnitude is reaching alarming levels and a credible medium-term plan to cut deficits and debt ratios are the need of the hour. We believe that central banks in the US, Europe and Japan are unlikely to raise rates in the foreseeable future.

Greece seems to have managed a bailout or so to say with the help of other EU members, major support from Germany and France and likely intervention from IMF. However, peripheral European government balance sheets are too stretched and would remain a cause of concern.[PAGE BREAK]

Another debate is going on China’s role in the global economy. Between who call China a currency manipulator and want severe trade sanctions against it and liberals who believe China has played a pivotal role to revive global growth. Indeed, China needs to make a transition from investment-led growth to a more balanced growth model and a closer look at recent trade and GDP data indicate that they are moving towards that direction. One can certainly debate the pace and how smooth the transition could be made without likelihood of serious disruption. To solve the global imbalances, it is inevitable that in this decade, the US will have to export goods instead of debt and China has to boost consumption through a strong currency. There is a high possibility of India overtaking China in terms of growth in this decade.

Globally, the environment will remain one where the only certainty is uncertainty, so what should investors do. Given the expected higher volatility in real economy variables and shorter cycles, we believe the investors require more nimble and humble approach towards portfolios. In this kind of environment, maintaining a discipline of asset allocation while retaining flexibility of mid-term course correction would be important for investors. While we remain very positive on long-term prospects of Indian economy and focus on generating alpha through bottom up stock picking, we will keep an eye on the macro developments to hedge against the tail risk.

You don’t know when you are part of history. We live in one such time. Did someone bless us “may you live in interesting times!”?