Europe seems to have avoided its Lehman moment, focus shifts to growth

The EU summit started with extremely low expectations and that was also reflected in the movement of the markets prior to the summit where most markets sold off going into the summit. This by itself was a good sign that post event; at least we will not have a severe market selloff.

The key takeaway as far as I am concerned s that the so called “Lehman Moment” has been avoided by the decisions taken at the summit and with the moves of the ECB. Although most people have taken the resolve of the ECB not to print money negatively I think that it is a positive move as money printing at a time when the overnight deposits with the ECB are at all time highs and the discount rate is 1% will only accelerate inflationary expectations without contributing significantly to growth. This was the very reason why the US FED decided not to go in for another QE at the end of the last one and opted for Operation Twist.  At that time also I had pointed out that it was a good move, however in the short run markets had taken it negatively, however its positive impact showed up after a few days.

The main concern in the Euro zone is not the availability of money but the lack of faith. In order to restore faith the new deal that has been proposed which will put strict limits as well as monitoring of Fiscal Deficits is a good move for the long run. Over the short run my view has been that with there now being Technocrat led governments in Greece and Italy and a new government in Spain there is unlikely to be any significant negative news flow from this part of the world over the next few months. The commentary that I read seems to suggest that the lack of offer from the ECB to buy large amounts of bonds is being taken negatively. However the key is that there needs to be a return of faith in the Euro’s future existence and once investors are convinced on that they the negativity will start reducing gradually. If the entire market is on one side and the ECB is on the other side, irrespective of how much they buy the markets will not turn. I believe that the key from here on is on implementation.

Directionally I believe that volatility in the markets should reduce as most key events are behind us now. From there on economic data will become more important.

In the Indian context this week is full of data with the Industrial Production data that came out today was in line with the number that came out in the Times of India a few days back at -5.1%. The consensus was for a half percent decline. Capital goods data has turned extremely negative with no new projects taking off.  Inflation data on Wednesday and Thursday & the RBI policy on Friday. No major economic decisions are likely from the governments’ side till the 21^st when the winter session of parliament comes to an end. Post that we could see the government becoming more serious on the economy. It is likely that economic activity would have bottomed out in India now, the key will be to  see the pace of revival. The revival will be slow given the way the economy has come to a standstill due to extremely tight liquidity conditions and high interest rates. Inflation out on Wednesday should be in the region of 8.6% vis a vis Reuters consensus of 9.04%. 

With global commodity prices ex of crude cooling off and food inflation coming off sharply we are likely to see a sharp decline in inflation in India over the next three months. This will set the tone for significant easing from the RBI. Interest rates a year from now should be at least 150-200 basis points lower from the current levels. This will be supportive of both consumption and investment demand. However lack of policy response to boost capital formation might lead to India continuing to underperform other Emerging Markets. Sentiments for investment into Indian equities is at its nadir today and the key is to see when the sentiments turnaround. Since early October when the markets bottomed out after their last selloff, key large EM's like Brazil, Korea, Hong Kong etc are up nearly 15% and India is almost flat, thus reflecting domestic growth concerns. 

It was interesting to read the panel discussion of ET NOW in the economic times today where most investors seemed to be on the pessimistic side. I remember attending a similar discussion in February 2009 where the sentiments were similar and the markets turned around within a few weeks of that. Let’s hope it is the same this time too.