GLOBAL INTER-MARKET ANALYSIS

CURRENT TRENDS and THEMES IN GLOBAL FINANCIAL MARKETSProf. (Dr.) Gourav VallabhProfessor of FinanceXLRI JamshedpurE Mail gourav.vallabh@gmail.comPlease accept my welcome

INTRODUCTIONAll markets are interrelated financial and nonfinancial, domestic and international. No market trades in a vacuum. The stock market is heavily influenced by the bond market. Bond prices are very much affected by the direction of the commodity markets, which in turn depend on the trend of the U.S. dollar.INTRODUCTIONIt is, therefore, no longer possible to study any financial market in isolation, whether its the U.S. stock market or gold futures. Stock traders have to watch the bond market. Bond traders have to watch the commodity markets. And everyone has to watch the U.S. Dollar. INTER-MARKET THEMESThe key to Intermarket work lies in dividing the financial markets into four sectors viz. Currencies, Commodities, Bonds & Stocks.

Key RelationshipsThe positive relationship between bonds and the stock market.The inverse relationship between commodities and bonds.The inverse relationship between the U.S. dollar and the various commodity markets, in particular the gold market.

Relationship between Commodities and BondsThe key relationship that binds all four sectors together is the link between Bonds & Commodities.The reason why Commodity prices are so important is because of their role as a LEADING indicator of INFLATION.Commodity Markets trend in the same direction as Treasury bond Yields & in opposite direction of Bond Prices.Relationship between Commodities and BondsRationale: During the period of Economic Expansion, the demand for raw materials increase along with the demand for money to fuel Economic Expansion. As a result prices of Commodity rise along with the price of money (i.e.. interest rates). A period of rising Commodity prices arouses fear of inflation which prompts monetary authority to raise the interest rates to combat that inflation.

Relationship between Commodities and BondsEventually the rise of Interest Rates chokes off the Economic Expansion, which leads to economic slowdown and recession.Now, during recession demand for raw materials & Money decreases, resulting in lower Commodity-prices & Interest-Rates.

Relationship between Stocks and BondsStocks are most influenced by the direction of Inflation & Interest Rates Rising Interest rates are bearish for stocks & vice-versa.

Therefore, a rising bond market is generally bullish for the stock markets.

Relationship between Commodities and US DollarTurns in dollar eventually impact Bonds but only often long lead times. Thus, impact of Dollar on Bonds & Stocks must be viewed through commodities. A falling Dollar is bearish for bonds & stocks because it is inflationary & it takes time for inflation effects of a falling dollar to filter through the system. Thus, inflationary effects of a falling dollar start taking hold only when the commodity markets start to move higher.Relationship between Commodities and US DollarThus, a falling Dollar becomes bearish for Bonds & Stocks only when, the commodity prices start rising.Thus key to inflation is commodity price trends.Relationship between Commodities and US DollarDOLLAR vs. FOREIGN CURRENCIES vs. GOLD

Gold trends opposite to dollarForeign Currencies also Trend opposite to Dollar i.e. as Dollar rises, foreign Currencies fall & vice versa.Therefore, Foreign Currencies & Gold mostly trend in the same direction.

Business Cycles4-year cycle of business Expansion & Contraction.The Contraction phase often turns into a Recession, which is a period of Negative Growth in the Economy.During Early Stages of a New Expansion (while a recession or slowdown is still in progress), bonds will turn up ahead of stocks & commodities.At the End of an Expansion, commodities are usually the last to turn down.

Business CyclesThe beginning of an Economic Expansion favors Financial Assets like Bonds & Stocks, while the latter past of an Expansion favors commodities or inflation hedges such as Gold & Oil Stocks.Periods of Economic Expansion favors stocks while periods of Economic contraction favors BONDS.

Business CyclesRecession cycle

As Expansion matures bonds are the first to turn down.Inflation pressures & resulting upward pressure on interest rates. Subsequently, higher interest rates put downward pressure on STOCKS, which are the SECOND to turn down.Commodities are the last to turn down, since inflationary pressures are the strongest near the END of an Expansion.

Business CyclesRecession cycle

At this point of time, the Economy is slowing & in the verge of slipping into a recession.A slowdown in Economy reduces demand for commodities & money. Thus, inflation pressures begin to Ease & Commodity prices start falling, usually led by GOLD.Thus, at this point (at the end of expansion), all THREE Markets are dropping.

Business CyclesExpansion cycle

Now, as interest rates begin to Soften, in these early stages of Recession, BONDS start to rally.Just within a few months after this, the STOCKS begin to TURN UP, usually after the MID-Point of a Recession.Only after the Bonds & Stocks have been rallying for a while, the Economy starts to Expand, the inflationary pressures will start building & which will lead to an Up trend in GOLD & other Commodities.

Business CyclesExpansion cycle

At this point, all the THREE Markets are rising.Out of the three markets, BONDS are the FOCAL point at this juncture. -BONDS have a tendency to peak, midway through an EXPANSION & BOTTOM about MID-WAY through a CONTRACTION.Thus, the PEAK, in the BOND Market, during an Economic Expansion is a signal that a period of Growth is over & has turned into an unhealthy period of decelerating Growth.

Business CyclesExpansion cycle

At this point, Commodity Markets start accelerating on the Upside & the Bull Market in STOCKS is about to get OVER.

Current themesDifferent markets are currently in different regimes.Hence, we are in different expansionary regimes across international markets.For simplicity, lets consider 2 divisions : developed and emerging markets.

Current themesDeveloped Markets

Initial expansionary phase albeit rocky recovery thus far Disinflationary periodBonds have outperformed due to low inflation regimesCo-ordinated G10 Central Banks infused liquidity in global markets last year in the form of Quantitative Easing (QE) to get recovery on board

Current themesDeveloped Markets

Stock markets have followed booming bond markets and are now almost at all time highsGlobally, commodities have not done as well, again pointing to the fact that the developed markets are sitting in the middle of expansionary phase and not peaked out yet in growth

Current themesDeveloped Markets Forward Guidance

Going forward, recovery in the US looks on track with better GDP print and employment data in the last one yearFederal Open Market Committee (FOMCs) off late have been more hawkish pointing to an earlier rise in US interest rates next year

Current themesDeveloped Markets Forward Guidance

This augurs well for the US Dollar over the intermediate term since rising rates mean higher US DollarStronger US Dollar and hence rising US interest rates would be bearish for bonds and stocks in the intermediate termRising US Dollar would also pressurize commodity prices that are USD-denominated

Current themesEmerging Markets

EMs are further on the expansionary curve than the DMsFaced with duality of higher growth but also higher inflationEmerging market Central banks are tussling to keep their interest rates below the desired levelsRecently, EMs are facing slowing growth coupled with high inflation

Current themesEmerging Markets

Lower growth with higher inflation is creating stagflationary scenarios in some emerging economies and thats a challenging environment to thrive inThis has caused EM to underperform this year Also, EM bonds have also underperformed due to relatively higher inflationStocks still near their peaks as we continue to be in an expansionary cycle

Current themesIndia Forward Guidance

India has been facing slowing growth with rising inflationBond markets have thus underperformed with the Rupee being under pressure inspite of higher FII inflows this yearStock market near highs mostly on expectations of structural reforms by the Modi-led Government

Current themesIndia Forward Guidance

RBI has been dealing with the high interest rate regime through consecutive hikes in interest rates (thrg repo and reverse repo, CRR and SLR hikes)Last policy has been relatively slightly hawkish, indicating that the spate of rate hikes could end this year. Especially with wholesale inflation inching downwards from double digits to 6-7% levels

Current themesIndia Forward Guidance

If inflation stabilizes and keeps at these low levels, RBI might start cutting rates early next yearRate cuts would be good for the industry since that would bring down borrowing costs and spur growthThis would fuel rallies in both bond and stock marketsRallying bond and stock markets as well as structural reforms being played out would bring in more capital and thus fuelling a rally in INR

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