Over the last 10 weeks the stock markets have had a phenomenal run up with indices around the world gaining over 30-40% from the lows they made in early march. The rally was triggered by a string of positive news from the US markets & economy termed by Fed chairman Bernanke as the "Green shoots of economic recovery". Some of the leading Indicators that gauge the health of the US economy had shown signs of revival or were slowing down in their rapidity of fall. As all world markets including our Indian markets are following the trend of US & global cues it becomes increasingly important to keep an eye on these developments. Let us first examine the indicators that are showing positive trend.
The Baltic Dry Index:
Baltic dry index is believed to be one of the purest indicators that reflect the state of the world trade. In simple terms it shows the shipping activity happening around the world. So in a way it directly shows the state of of the supply - demand scenario as shipping is the main means of transporting raw materials in global trade.
On 20 May 2008 the index reached its record high level of 11,793 points. Six months later during the height of the economic collapse, on 5 December 2008, the index had dropped by 94%, to 663 points. The index has now recovered and is trading around 2000 levels, which indicates some sort of recovery in the global slump.
LIBOR RATES :
The London Interbank Offered Rate or Libor rate is the rate at which banks lend money to one another. Libor rates give indication of credit flow in the financial system. During the collapse of Lehman Bros the credit markets literally froze and lending almost came to a halt. As central banks around the world took measures to ease liquidity, the libor rates began to thaw. In May the 3 month Libor fell below 1%, clearing signs of credit markets returning to normalcy.
TED SPREADS:
The TED spread is the difference between the 3 month libor rate and 3 month US Treasury bill rate (T-Bills). The TED spread indicates risk and liquidity premiums of the market. During the subprime crisis the TED spread spiked to 150-200 bps. In Sep-Oct 2008, it reached an extreme level of 300-400 bps. Recently the rates have subsided to sub 100 bps levels, again an indication of better liquidity conditions in the markets.
THE VIX (Volatility Index):
The US VIX is widely used as an indicator to judge the market sentiment. It shows the market participants' greed or conviction with the markets. The VIX shot up to 80 levels during the Oct - Nov 2008 when Lehman and AIG were in trouble. Recently the VIX has managed to break below its 200 DMA, signs that market participants are less fearful.
U.S - ECONOMIC INDICATORS:
Some of the economic indicators including the consumer sentiment posted a slight increase in March and improved considerably in April , the index now stood at 39.2 , up from 26.9 in March . A key measure of manufacturing activity, the manufacturing index rose to a reading of 40.1 in April from 36.3 in March , fourth straight gain in last 4 months . Also easing deflationary concerns brought some confidence that the worst of the down turns may be behind us. There is some small revival is US housing markets, but it is too early to call it a reversal of any sort. The recent quarter earnings were better than street expectations and analysts say that the current market levels reflect fair value for the markets.
It is clear that the down turn of the economy is easing and some economists believe that growth would return as early as in the 3rd quarter. According to Federal Reserve estimates they expect the US economy to grow by 2% next year. However there are some contrary signals as well.
Let us have a look at some data that continue to show negative trend.
The US unemployment rate: Recent data shows that the US unemployment rate has shot to 8.9%, highest level in 25 years. The economy is continuing to lose jobs and there are very little signs of easing in the job market. It is expected to hit double digits by end of 2009 or in early 2010. The most recent jobs data shows that jobless claims continue to rise.
Housing starts: Housing starts are down by more than 70% from its peak. The subprime issue started with the housing market and it needs to stabilize for any sustainable recovery.
Auto Industry & Banks: The US auto industry is continuing to collapse, auto sales are down by 40%, large automakers are either bankrupt or at the verge of bankruptcy. The stress test conducted on big banks by the US treasury caused some positive noises, but it appears more likely to be an reverse engineered exercise whose worst case scenario assumptions are more are less existent now itself. Also it needs to be seen if banks can continue to post better results in coming quarters.
Retails sales: Retail sales that comprise of 2/3rd of consumption painted a disappointing picture. The recent retail sales number shows a slip of 0.4% after falling by 1.3% in March.
It is evident that there are some positive signs emerging as the billions of dollars of stimulus money pumped by governments around the world is working its way through the economy. But the question remains whether the recovery could be sustainable. Although for Indian markets the election results came out as a huge positive boost, in terms of macro factors it is advisable to stay cautious once markets surge to higher valuations.
