It is a party out there in the financial markets. Equity shares, gold, bitcoins, and other select commodities are all trading at record highs, or just a little shy of them. The rally is being fuelled by cheap money released into the financial markets by the United States and European monetary authorities. The fear of a recession has pushed rich countries into pumping more cash into economies, keeping asset prices at record high levels.
However, this party faces headwinds in 2021. “The long, long bull market since 2009 has finally matured into a fully-fledged epic bubble,” warned Jeremy Grantham, co-founder of GMO, a global asset manager in a recent note. Grantham fears that the event could be recorded as one of the great bubbles of financial history, similar to 1929 and 2000.
The stress is more related to the banking system around the world—the backbone of the global financial system. In its latest economic outlook, the World Bank highlights that an extended period of very low interest rates and high charges are looming for bad loans.
Banks could see a fall in their interest income as a result and an erosion in profits, hurting their ability to keep adequate buffers for potential losses and setting the stage for bank failures. “A wave of defaults could lead to financial crises,” argues the report, fearing that developing countries would suffer more than the rich ones. The 234-page report mentions the word ‘recession’ 85 times.
How could you be affected?
All asset classes rarely hover around their record highs at the same time. Historically, gold and equities have an inverse relationship. People buy alternate assets like bitcoin to protect themselves against the fear of losses in the financial markets. However, cryptocurrencies are hitting a record high too, and so are gold and other precious metals. Emotions like greed and fear are at play in the markets at the same time—an infrequent event.
In India, the latest advance estimates put the contraction for the financial year ending March 2021 at 7.7 per cent. On the other hand, the World Bank estimates it to be close to 10 per cent. Analysts crunching data at mutual funds and stockbroking companies estimate profit growth in India to remain weak for FY21. However, most of them expect a significant bounce back in corporate profits in FY22. Share prices are rallying on the back of a dramatic surge in corporate profits expected over the next 14 months.
For Nifty 50 companies, profit growth is likely to be the highest in three years for 2020-21 and the most elevated in 14 years for 2021-22. As retail inflation stays high, India’s interest rates are also unlikely to go lower. Analysts expect the RBI to keep the interest rate policy accommodative to stimulate economic growth. However, only America and, to some extent, the Eurozone can have such an approach. The US dollar and the Euro are reserve currencies. India, on the other hand, has to watch inflation much more closely and ensure that it is kept in check.
This means that the returns you get on your fixed deposits are likely to be lower or even harmful in the worst of cases. If assets across the board are moving up, you have to look for those trading at a fair value. With an over 80 per cent gain in the NSE Nifty since March 2020, that is a tough call. It is also possible that there could be a correction in the benchmark indices. Even if this does not happen, the fear that it might happen will loom.
If the new US government realises that it is spending more money than it can afford, a course correction towards higher rates could derail the spectacular upsides across multiple asset classes. Global investors would go back to US bonds. A section of international analysts do predict inflation making a comeback in rich countries due to excess spending by governments. That may trigger a reversal of gains across assets.
(The author is editor-in-chief at www.moneyminute.in)