Financial liquidity is the key for market revival

Financial markets anticipate changes in the real economy. A bull market can start months before earnings pick up. A bear market can also start months before earnings dip. But nobody has devised a way to accurately judge the leads and lag times.

Markets are also prone to false anticipation. There are times when prices jump but earnings don’t revive. There are also market crashes, which aren’t followed by earnings drops. Therefore, if you’re early into a genuine trend going with the market momentum, you make more. But you also accept the higher risk of betting on a false signal.

There is one common factor to all market revivals. These movements are always associated with financial liquidity. When there’s a great deal of liquidity, bubbles can develop. The obverse is also sometimes true. That is, if liquidity is temporarily tight, perhaps because it’s tax payment time, markets may fall even as earnings move upwards.

 

Before globalisation, it was relatively easy to judge liquidity. Economies weren’t inter-connected. Each domestic economy was a silo. You could take a look at money supply, and at key factors like the bank credit-deposit ratio and domestic interest rates, to figure out the liquidity position.

Since funds can now flow into financial assets from abroad with ease, it is no longer enough to get a handle on domestic liquidity. In effect, there is usually potential liquidity to spare because of foreign institutional investors. It’s more a question of judging FII attitude. It is useful to know where, as in which nations and which sectors they will choose to park their funds.

In the past 12 months, the Indian markets have lost a little ground. It would have been a lot worse except for the positive FII attitude. In the past 12 months, they have invested a net of over Rs 41,000 crore in equity, along with another Rs 49,000 crore in debt. Actually they were net sellers through the second half of calendar 2011.

In calendar 2012, FIIs have been net buyers of Rs 52,000 crore of equity. This runs contrary to the popular perception that the global investment community has given up on India due to policy paralysis. It is actually the domestic investor community - both institutions and retail - that has been a net seller.

The trend of net FII buying might continue, in the absence of some surprising new negative news. On the domestic front, slow earnings growth, high interest rates, a poor monsoon, terrible public finance deficits and GDP growth downgrades are all discounted. So is policy paralysis. Globally too, weak economic growth is discounted. What one needs is a turnaround in domestic sentiment to spark a bull run.

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The author is a technical and equity analyst