Why Stock Market has been going up

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Why Stock Market has been going up - StocksBuddy.com Exclusive
October 10, 2009


We have gotten so many emails from visitors and members on this blog in response to our earlier article Market Crash Alert for Nifty - StocksBuddy.com Exclusive asking us as to what is the main reason though for this market rally. Most visitors stated that the fundamentals and valuations do not match up and the hope that folks and FII's are showing may not be really real. Some even stated that this is forming of another bubble while we are still winding up from the previous bubble.

In this article, we try to assess the reasons why this market including global markets went up all along without any correction.

Indian markets are extremely illiquid when compared to developed markets such as US or Europe. Meaning, the number of shares available to trade and actually traded on a daily basis are not even close in comparison to other markets. In such cases, any large order or bulk order can create an imbalance in the trading of any specific stock. For example, an FII or an institutional investor wants to buy $1Mill worth of IFCI, the stock doubles in value in a matter of 2-3 weeks. Similarly when FII's have to sell huge amounts of the stock, it loses 50% within the same time period. This kind of imbalance is extremely dangerous because one cannot manage risk properly to address such cases.

Let us use the above information and create a small story as to what were the chain of events.

December 2008 was when all the deleveraging was happening and hedge funds going down under. Meaning, all those investors who invested in stocks on borrowed money from their brokers started getting margin calls. Most of them got wiped off instantaneously while others had to arrange for more money.

Demand for $$$ was extremely high and with so much uncertainty nobody was lending anymore. This resulted in even more accelerated downside in the stock markets. Markets kept going down until March in the US and actually they did NOT go down as much after November 08 in India though because india never had such massive leveraging to begin with. In fact this is the main reason why Emerging markets came back strongly much before US and European markets even thought there could be a recovery possible.

Then in march, once most of the winding up was done, which also resulted in some hedge funds going bust, government started printing more $$$. Which eased up the created lines and banks got a whole lot in their kitty now to play around.

Conspiracy theorists believe that this was the time when major banks envisioned this market rally for the following reasons.

    * The amount of money that they got from govt was not enough to cover their bad loans and assets and they needed more. For that they had to reach out to common/private investors. But with their share prices so low, they wouldn't have gotten a whole lot of money from the market. Hence, the rally.
    * Around late February 2009, over 96% of investors/traders were shorting the market. This is extreme pessimism. And the plan was to catch them by surprise and obviously have them cover at much higher prices. Resulting in losses for them, again common/private investors and profits for them. Hence the rally.

There are many more theories around this, but let us rest this case here. So, basically what this rally did is that all the private investors/traders lost lot of money when they were caught on the wrong foot as they were shorting the market AND now they potentially are again caught on the wrong foot when the market has already rallied over 65% which means the banks will once again make hell lot of money here.

Getting out of conspiracy theory for a moment, let us see why markets went up worldwide.

The most important reason was valuation and the fact that nothing can defy gravity. What goes up must come down and vice-versa. The intensity defines the pace. The pace at which markets went down was one of the main reasons why markets went up so fast.

But one question that everyone has is that why is that the markets are rallying even after 2-3 months of covering up for the losses/pace that occurred prior to markets going up. The main reason for this is $$$. $$$ has continued to go down and that has propelled the commodity rally and also the stock rally. But wait a minute. How can $$$ going down force a rally in stock markets? It's simple. $$$ goes down meaning other currencies get richer and they can now get more for their buck. Let us explain this a little further.

US has printed so much that it doesn't really have anymore room to print further. It needs to find ways and avenues to beef up their economy. US has purposefully devalued their $$$. Why? let's take an example.

1 $ was Rs. 52 at one point this year. Which means, if india had to import $100 worth of goods, it would have to shell out Rs. 5200 for that. Now $$$ is devalued and is trading around Rs 47. Which means, the same imports will cost around Rs.4700. In fact india can import more for the same amount of Rs. 5200.

Why would someone devalue their own currency? Because that is how you can get more business. 70% of US economy comprises of consumer spending which isn't happening owing to the downturn in the economy. Take a look at how much saving is going on Personal Savings rate in the US. Remember, this is entire US with less than 30% REAL working population. If you remove children, women and old people. You are left with less than 51% of the population. Current unemployment rate (REAL) stands at over 21%. So basically the Personal savings rate of 5% is accountable for the entire 100% while only 30% population is really earning. That in essence means if 30% of the population makes 30,000, and savings is 5% for entire 100%, the real savings rate will be over 20%. In essence, US consumers are not spending 20% of what they make, which is net.

Now in such a scenario, where will the US economy grow? They are forced to look outside. Which is why they devalued their currency and thus improved the prospects of exports. In fact this theory is clearly proven by Reduction in trade deficits within the US and increased exports.

But how does this help World stock markets and indian markets? Basically, more money comes into the US from exports and already floating tons of $$$ go into stocks. Whenever investors see a small sign of revival, they jump into the Emerging markets. That's why if you notice carefully, Emerging markets started rallying much before US markets did.

There is One problem though with this approach. US devalues it's own currency to increase exports. This impacts the trade balance in other countries. Take for example, India, whose ITES forms a big part of exports will actually get lesser revenues because INR is getting stronger. Countries may not like this for long and they will in turn devalue their own currency to match US $$$. On top of that, $$$ devaluation puts lot of pressure on OIL and OIL producing countries as well and hence they don't want this to continue the way it is.

Moreover, $$$ and OIL run mostly on Technical Analysis. And TA analysts around the world are starting to realize the strong support that $$$ is currently at. If it can hold onto 75-76 levels, it will rally from here. Which in essence means commodities will go down along with stock markets.

Another major factor that will influence $$$ and it's move to the upside is that it has now become the "default TRASH currency" because everyone is now using $$$ for carry trade by shorting it almost everyday and making money by investing elsewhere. Now when something becomes so obvious, it doesn't stay there for long.

Next 6-9 months we expect $$$ to gain a lot of strength owing the above and many other internal issues within the US. This will clearly once again lead to correction in equity markets worldwide.

Curious Fact : If everything has already gone back to normalcy and there are NO issues and earnings for companies are already all set to improve, then why does FED still NOT raise interest rates?

    The Fed's key bank lending rate is now at a record low near zero and will probably stay there for an "extended period," Bernanke said in prepared remarks to a Fed conference here.

Now if everything is fine and recovery is on it's way, inflation seems to be kicking in as GOLD is making new highs and $$$ making new lows, then shouldn't FED at least "consider" thinking of controlling inflation, NOT implementing at the least. The very fact that US FED is letting $$$ go down the drain so that it can get more export oriented $$$ and not worry about inflation even when GOLD is going up every day states clearly that US is in clear state of Deflation. Nobody within US wants to spend money. Barely 15% of the approved TARP/TALF money has actually been lent out when the whole purpose of creating such instruments was to ease credit lines. US Retail sales completely dead and the forecasts are even worse. So, again where are the Green Shoots?

Trade with caution.

PS: Everyone believes in the saying, "Buy when everyone is selling and sell when everyone is buying", but hardly anyone follows it in practice.

Like in February when 96% of traders/investors were Bearish, currently over 92% are Bullish. These extremes led to reversals. Let us see if we get one soon. Check out Robert Prechter's Interview from Forbes "The dollar is bottoming and the stock market is topping," said Prechter, who became well known for forecasting the 1987 stock market crash

In short, the action in the US stocks are just adjusting to the declining dollar as neither valuations nor expectations are in line with the stock prices. Once $$$ starts it's move back up, equity markets will probably see something worse than the March Bottom.

Regards
SB Admin
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