Economic Growth will Come Later

While building your case for economic cycles and its conjunction with Elliott Wave analysis you have to go back and forth with data and published works of many to come up with the best possible observations to your case. Among the works of Robert Prechter is his book "Conquer the Crash" Published in 2002. The timing of the book may not appear appropriate to many as it came years ahead of the Housing crash and at the end of the Nasdaq bottom. But what you should use this book for is its insights into symptoms of economic cycles in the wave counts and the behavior of financial markets and its participants during a deflation. Since these observations are based on the study of previous sypercycles they are ideal for mapping what India is going through today. Many of the observations are already true here as India has only started to enter an Economic winter after 2010. For example the collapse in borrowing and lending during a deflation as debtors and creditors stop transacting new loans causing credit growth to collapse discussed in the later chapters. This is what India has been witnessing for the last few years as credit growth in India has collapsed and borrowers are holding back even as interest rates are declining. This is what you expect in a deflation.

In Chapter 1 of the book an interesting observation was made relative to the supercycle degree wave counts. Robert Prechter observes a divergence in economic performance in wave 5. See these charts from the book CTC, 2002. He uses both US and Japan as examples to show this kind of divergence in the book. This chart is of US indicators.

 

Let me admit when I first interpreted wave 5 ending in 2010-2012 data in India did not show this clearly in the GPD/IIP data so what I observed was mostly that debt was going to balloon on the corporate side. That allowed me to start writing about the coming economic winter in India. I was early for sure. But now wave 5 has been 7 years in the making. As shown below wave 5 that could have ended much earlier did not and has me on the wrong foot because wave 5 is an ending diagonal. This is also called a wedge or a rising triangle like structure that contracts to the end point. The internal waves are 3-3-3-3-3, up and down to the end point. These observations so far are true. So I do believe that the wave count is a 5th wave.

 

The economic data for wave 5 compared to wave 4 does now provide the eivdence I was looking for even within this final wave. The chart below of GDP quarterly growth shows the slowling growth as we spent these years in wave 5. Chart courtesy tradingeconomics.com. 

The chart above combined with the one below shows India was in an Economic Autumn Bull market starting 2003. This involves a boom on the back of low interest rates and low inflation that results in Asset booms in not just equities but Real estate and other financial assets. The low interest rates seen during the Autumn fuel borrowing based consumption and buying of assets. The debt level of the nation [public+private] in total go up as corportes and consumers go in debt. After a point the extended state of balance sheets causes the economy to slow. I did not make up this economic cycle theory, so credit "The Soviet economist Nikolai Kondratiev (also written Kondratieff or Kondratyev) was the first to bring these observations to international attention in his book The Major Economic Cycles (1925) alongside other works written in the same decade.^[3][4]In 1939, Joseph Schumpeter suggested naming the cycles "Kondratieff waves" in his honor." For full details read https://en.wikipedia.org/wiki/Kondratiev_wave 

The high levels is debt is therefore keeping India from growth taking shape. And it is sad that every time you get a few months of up tick in the data as you see from the blue line rising for the last month below, the entire media and Financial spokespersons come up to inform the world that the cycle has bottomed in India and earnings will grow next year. It is mostly misleading. Economic cycles suggest that without deleveraging you cannot kick off growth. And that can be done either by default, or bailouts and inflation. Neither path has been clearly been chosen in India. We are trying the middle path. Given our markets over optimism with growth, it has lead to over valuation based on a future that is far from near or around the corner. When corrective actions are taken they result in asset sales and write downs of equity. Later a jump in public expenditure to supplement growth. All that is coming. But it comes with rising volatility and not otherwises. 

You may tend to compare India's debt levels with other countries around the world and think that we are at the low end. This is not true. 
There is no definition for ''high end of the range'' except that after you cross 100% the music stops playing at some point and you have to take note. This again is based on numerous studies on the subject by the BIS and other economists. India is at levels that caused similar problems during previous historical Kondratieff cycles in the world in the past. That we have hit the growth wall means that we are already at the end of Autumn and into the Winter phase economically. The stock markets are still extending the Autumn boom as Sentiment at the retail investor level remains high on hope but the hopes are not realistic. An asset price correction, adjusted for inflation and currency effects that could intervene remains overdue in India. This positive sentiment has been aided by Salary increases in the form of Pay Commission reports, MSP for farmers and OMOs for the bond markets among others. These forms of stimulus have aided the soft landing but so far insufficient for the return of a higher growth trajectory because at a Macro level the economy is fully leveraged or overheated. 

All this does not mean that the reforms are not important. They will help us achieve a higher plateau on growth when the business cycle turns around on its own. Economic cycles are a function of public behaviour and will turn when they have to. Stimulants act as short term measures only. Reforms set the stage for the future but not the immediate state of affairs. This distinction is important. 1996-2001 is the best example of this. There were many reforms during that period but the cycle turned when it had to. interest rates dropped on their own in the last two years of the cycle to a new low not see before and finally triggered a new wave.

Many market commentators taking the bull side of the case ignore Macroeconomic possibilities. The best case scenario is kept above all. But the RBI was faire to come out and make this comment if it did. As reported in the ET. This is also what I have been saying. It is easy to make a growth projection on base effects but are we really turning the cycle? It is too early to say. In my view corporate remain over leveraged and the NPAs are a reflection of that. Unless you delevarage the private sector, getting them to invest in capex is off the charts. That puts the burden of investment on the government. One month before the next Union budget, and after the recent Gujarat elections, what we ougth to expect, if growth targets are to be met, is a meaningful expansion in government outlays towards investment to make up for the private sector.

And to blow this horn for the nth time, every trend we witness in our market whether it is a sector performance or NPAs, the rise of corporate debt, EM $ borrowings, are all global trends. This chart then brings it out again, where we stand on banking stress. In my economic update almost 2 years ago I published a chart that was showing the turn around in NPA cycles from down to up.

As we head into the year end banks are busy finding ways to avoid the next crisis. To avoid marking down an increasing number of loans as bad based on the RBI directive.

And while growth rate of the economy has been slowing down, the high leverage has kept the average earnings from growing at an index level. Despte years of double digit projections by the street the outcome has not ben pretty. So while the projections continue this chart from Capitalmind, runs a 5 year annualised average grwoth in EPS for the NIfty 500 and a trend reversal is not exactly clear. There is likely to be an uptick due to the base effect in the coming months but the real question is whether it is sustainable. A lot is being pinned on hopes of a revival even as government spending crowds out borrowers and interest rates are rising. And if you have pinned yourself on global growth then so far exports have not exactly shown any correlation to global growth. something is seriously wrong in our industrial model and I am not sure it has been addressed.

If a weak currency is your only edge in a global trade war then the REER or real effective exchange rate puts the INR far behind the curve. Currency management has been great but at the cost of competitveness. The last currency stimulus was in 2013 before Dr. Rajan stepped in. The fruits of that have been consumed, as have been the fuites of the big gains that came from falling commodities prices especially Oil. This chart from the Guest Article by Shashwat Panda of the INR is clear on where we are. INR is an overvalued currency, becuase volatility management was made the norm by the most awed RBI Governor.

But that might be about to end sooner than later. The biggest macro trends this year and for the year ahead are the exact opposite of those that have shaped the last few years. The onset of higher inflation and higher interest rates have been fostered due to the trend reversal in the US dollar index. A trend that few saw coming. But I have of course gone hoarse shouting about it. And the inablitity to comprehend it has led to missing out on  what was the start of the commodity cycle upwards. The chart below shows how the dollar bull and bear markets have followed each other every 7-9 years. It is a cycle. 2008-2017 was the last dollar bull market that ended near 104 in Jan 2017.

The reason most would have missed the dollar bear market is they would have missed the idea that the last commodity bear market is over. The timing and depth of the last commodity bear market was enough for everyone to throw in the towel. But in EW analysis a bear market of higher degree travels to the 4th wave of lower degree. In that sense after a bubble prices fall back to or slightly below the starting point. This happened to the Sensex in 2001 when after the Y2K bubble the Sensex fell to 2596 below the 2800 low it made in 1998 and then started a 10 year plus bull market. Now the long term chart of the CRB index [this one I found on gold-eagle.com], It dates backwards significantly. And you can see that the 2008-2016 bear market in the CRB index is an A-B-C decline, 3 waves that complete a downtrend long term. Also the fall took the index back to where it started in 2001 and in fact the final bottom was below the 2001 low. So If 2008 was a commodity bubble that ended and completed in early 2016. So the worst is over for the commodities complex, and there is only upside. The question is only of how much. Can it be an all new bull market in commodities. Technically yes. And if you do not think it is so fundamentally possible, I will double my bets.

I will dicsuss the 100 year CRB index chart as well in the up coming Long Short report. Along with many commodities and some of my recent presentation that I have been making on this segment.

What you ought to know is that all this also means higher prices of Oil and crude and that directly reflects on inflation. Again infation is a global trend. Prices are finally rising many years after what was the spark that should have ignited it much earlier. QE1-QE3 by their very size were supposed to ignifte this much earlier but did not because the free floating dollar was getting stronger in those years. Now that the fire is lit it is a global trend. IT is showing up in Japan and China as well but here are a few DMs

Euro Zone inflation

USD CPI

USD PPI [producers]

or Indian WPI. I am not sure looking at the trends underlying the pop in inflation that these trends are ''Transitory'', and in that effect higher interest rates are alomost a given.

In the end all the policy management of central banks has centered around one thing along - ''Volatility management'', they know the consequences of the actions they have taken and the possible side effects. But crisis occur when something moves too fast or faster than you can handle. So volatility management is the game in town. As long as prices go up slowly no one will notice and deleraging over a 10 year time horizon might even work. But to expect all parts to remain constant is what leads to developing safe investment strategies that are often run down by black swans. But who cares till then. If the CBs are managing volatility why not just make the biggest bet ever on short volatility. And so we have it, the highest on record short VIX futures positions.

And investors left with no place to invest are all in on equities in India. That trade is based on the idea that inflation is dead and by that meaning that real estate gold and FDs are poor investments. So we are witnessing the highest on record inflows into MFs. And that bet on liquidity may go on till rates rise to the inflection point where risk meets and crosses over rewards. This chart is dated Aug 2017, as the November'17 flows surpassed the Aug flows already.

The is My Truth About the Markets !