Wednesday, February 25, 2009

Lead Indicators of Economy & Stock markets

Some fundae...

Some "Lead indicators" to predict Economic Performance:

1) Bank Credit Growth: Increase in Bank Credit Disbursal can indicate a future increase in the GDP, since this credit will be used for higher production, etc. According to an ICICI report, this parameter leads the GDP growth by 2 quarters.

2) Baltic Dry Index: It captures the trade that happens through the sea route (& since most of this trade is Raw Materials, it can give a lead indication of the GDP growth.) I don’t know by what period this parameter will lead the GDP growth, but it will obviously be dependent on the Average Lead time for converting these raw materials into finished goods.

A "Lead indicator" to predict Stock Market Performance, based on GDP:

1) M-cap to GDP ratio: This estimate is a popular method of looking at whether the markets have bottomed out or not. As a rule of thumb, it is believed that when market-capitalisation to gross domestic product (GDP) ratio goes above one, the equity market starts getting attractively valued. “For instance, the average m-cap to GDP ratio for Sensex has averaged between 45-48% and in December 2007, this ratio was 1.78 and the rest is history,” says Bagchi of ICICIdirect.

Will kp on updating this, if i am able to maintain interest in it :-)

Came across this article, after a few days of writing the above post. This article seems to corroborate one of the above lead indicators:

Banks' health key to pick-up in world eco: David Buick

Published on Tue, Mar 17, 2009 at 17:11 , Updated at Wed, Mar 18, 2009 at 10:51
Source : CNBC-TV18

David Buick, Partner at BGC, sharing his views on global market concerns, said, �The whole key to the kingdom, as far as everybody is concerned, is the health of the banking sector. When that improves, I think you will find that the pick-up in the world economy improves correspondingly quickly.�

Buick said there might be one more sell-off before a positive push towards the end of 2009 is seen.

Here is a verbatim transcript of the exclusive interview with David Buick on CNBC-TV18. Also see the accompanying video.

Q: In these four-five days, the markets have had a very positive reaction. But do you believe the underlying economic situation has changed to an extent where we can say we can leave everything behind and expect the markets to continue on a roll?

A: No, I don�t. I don�t think there is always a natural correlation between stock market behaviour and economic behaviour. One thing we have got in the last few days is a very positive comment by [US Federal Reserve Chairman] Ben Bernanke to the degree that he believes that the recession in the US could be nearly over by the end of the year and that, in 2010, there will be some growth.

Then, of course, we have had some indication from the G-20 meeting that the mood is to deal with the toxic asset situation, as well as introduce quantitative easing in the US. This, together with the fact that there is some evidence over a theory in the UK and in Europe, that banks are beginning to lend again and also that the commercial bond markets improving, has improved sentiment.

But we do know that there are huge problems in the next few months, for instance, the auto industry in the US or unemployment in the UK. The unemployment scenario in the UK is going to hit two million tomorrow and will probably be up above three million by the end of the year.

So, the general situation, as you normally find equities a little ahead of economic activity, we feel that the underlying tone is quite good. But there may be one more sell-off before we see a very positive push towards the end of 2009.

Q: What you are saying is that the credit seizure has gone out of the market and perhaps we are starting to see the capital market system work again. But what about the fact that we had a bull run in real estate, commodities, equities, together and there has been a massive destruction of wealth? What happens to that kind of money coming back, investors coming back? How much of a lag is that?

A: I think it is a very similar lag. I think it is probably three months behind. But there is still � despite the most appalling erosion of wealth � quite a lot of money waiting in the wings. We genuinely believe that this will actually find its way back in the market. We need to see a little bit more in terms of Tim Geithner, the US Treasury Secretary, agreeing to a sensible plan for the bank bailout with the Congress, which he is yet to do, and he is three weeks behind schedule.

This is a very complicated issue. But the whole key to the kingdom as far as everybody is concerned, is the health of the banking sector. When that improves, I think you will find that the pick-up in the world economy improves correspondingly quickly.

1 more article published in Economic Times on 30th Mar 09, high-lighting the following 2 lead indicators of Equity markets:
1) Dividend payout by companies
2) Yield on Govt bonds (Inversely proportional relationship)

"Around a year back, we at ETIG had devised a simple and more intuitive way of estimating the right market level –tracking trends in the dividend payouts by companies. The historical data suggests that the movement in benchmark indices closely follow the long-term trends in dividends , albeit with a lag. This should not be surprising. After all, the prevailing stock price is nothing but the current value of all future dividend payouts by the company. Whenever the Nifty trendline overshoots the dividend line, it declines to close the gap and vice versa. This happened during the dot-com bust of 2000, the stock market crashes of May 2004 and June 2006. And whenever dividend outgrows index, the Nifty catches up albeit with a lag such as was the case in 2003 and 2004."

"The above prognosis is supported by various macro and non-equity indicators. One of the most obvious is the yield on the government bonds, which is currently on an upward curve. The government has announced plans to auction bonds worth a whopping Rs 240,000 crore in the next six months. Such a heavy borrowing programme will not sail through at the current interest rate levels. The government will necessarily have to juice up its bonds offering with higher yields. This will have a cascading effect on the entire economy, including the stock market. If the borrowing costs of the best borrower in town go up, the interest rates applicable to corporates and individuals will just shoot up. While this will raise India Inc’s interest payments and lower profitability, it will further diminish the demand for interest rate sensitive products such as passenger cars, commercial vehicles, high-end consumer durables and housing. All this is negative news for the equity market. Anyway, there is always a negative correlation between interest rates and return on equities. Being a risky asset, equities thrive in an environment of low interest rates and easy money."

Here's 1 more article on the Lead Indicators of the economy (courtesy: economic times)...Here they are tracking "new orders less inventories", which i think can be linked to the "Baltic dry index" indicator...

Goldman economist sees signs of US gloom lifting
2 Apr 2009, 0641 hrs IST, REUTERS

CHICAGO: The US economy is showing the first signs in months that it could be getting ready to crawl out of a long recession, the top economist
at Goldman Sachs said on Wednesday.

Jim O'Neill, Goldman's head of global economic research, said among key leading indicators, the measure of "new orders less inventories," derived from the Institute for Supply Management March factory report was a bright light.

That data point is included in Goldman's monthly "Global Leading Indicators" index. At +9 in March, against -0.7 in February, it was "the best sign for a few months that the severity of the US recession might be easing," O'Neill said while giving a presentation to the Chicago Council on Global Affairs.

Goldman Sachs' current forecast is for the US economy to shrink by 1.3 per cent in 2009 before growing by 2.8 per cent in 2010. O'Neill said he looked for the Federal Reserve to keep up its "aggressive" measures to turn around financial conditions damaged by the credit crisis that started in 2007.

"And I think if those things don't work, they will do more," he said, quipping that the moves could include "hiring the helicopters and dropping money from the sky."

China last month proposed a sweeping overhaul in the global monetary system, suggesting the U.S. dollar could eventually be replaced as the world's main reserve currency by the IMF's Special Drawing Right. O'Neill, acknowledged as one of the world's top currency analysts, said such a "radical shift in the role of the dollar" was not "close."

China's idea will be most interesting if it is paired with more flexibility in the rate of its currency, the renminbi, O'Neill said. "If it isn't, it's not of much use at all."

The current situation of 1 of the above lead indicators:

Business Daily from THE HINDU group of publications
Thursday, Apr 09, 2009

Bank chiefs see tough year ahead; bad debts may go up
‘Credit growth likely to slip to 18% this year’.

Large number of accounts are being restructured to cope with recession

Net Interest Margins are likely to fall steeply in the fourth quarter

Our Bureau

Mumbai, April 8 The year ahead is going to be tougher than expected for the banking sector as banks grapple with slowing credit growth, rising delinquencies and declining margins.

This was the message conveyed by bank chiefs in their consultative pre-credit policy meeting with the Reserve Bank of India Governor, Dr D. Subbarao, here on Wednesday.

Talking to reporters immediately after the meeting, Mr T.S. Narayanasami, Chairman and Managing Director, Bank of India, and Chairman, Indian Banks’ Association, said that credit growth will get moderated this financial year.

The credit growth in 2009-10 could at best be 18 per cent as against 27-28 per cent in last fiscal, said Mr M.V. Nair, Chairman, Union Bank of India.

Analysts have also been predicting a lower credit growth in the current fiscal. Broking firm, Angel Broking in a recent report said, “We expect credit growth to go down in FY2010 to 15-17 per cent as fresh investment demand becomes less forthcoming.”

The meeting was called to gauge the outlook for the year and to seek bankers’ feedback.

Bankers said a large number of accounts are being restructured following the RBI advice to help borrowers to cope with the recession. Although this could provide a temporary relief, rising delinquency continues to remain a serious concern.

The NPAs will go up this year as asset quality will be a problem. If there is a further downturn in the economy, it will affect the bank’s asset quality further, Mr Narayanasami said.

Bankers also apprised the RBI that Net Interest Margins (NIM) are likely to fall steeply in the fourth quarter of the just ended fiscal because of the high funding costs. Although deposit rates started coming down in mid-February, they are still high and will continue to ease slowly. However, as the impact of the cut in benchmark prime lending rates is immediate, this has put pressure on NIM. Therefore, further BPLR reduction may not happen for some time, said bankers.

The interest rates and subsidised interest rates cannot come down further, Dr K.C. Chakraborty, Chairman and Managing Director, Punjab National Bank.

Although the RBI has not directly told banks to cut lending rates, there is enough signal from the current repo and reverse repo rates, said Mr Narayanasami.

“It is in the banks’ own interest to bring down lending and deposit rates. They are trying to bring down their cost of funds. More banks will cut their deposit rates in the next fortnight,” he said.

The RBI on its part assured bankers that the Government borrowing programme would be managed smoothly by combining it with Open Market Operations and bond redemptions under the Market Stabilisation Scheme.

Though inflation may turn negative for a brief period, there are no fears of deflation, the Governor assured bankers.

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