Vijay Kumar Gaba

Obviously, the headlines left many traders worried about the markets, particularly, their long positions. The S&P500 index corrected over 2% last week and has now lost over 3.60% in the past month. Besides, the US, markets like Hong Kong (-6%), South Korea (-4.5%), the UK (-5.2%), and Japan (-2.6%) have also corrected in the past month. Indian markets have done relatively better, losing about 2.2% in the past month.

In my view, it’s not Michael Burry’s positioning that is the reason for the market fall; it is the concerns over the stability of the financial system and markets that may have prompted Burry to take a short position.

Pertinent to revisit 2007

Before we take note of the current situation, revisiting the sequence of market events in 2007 may be worthwhile.

By April 2007, over 50 mortgage lenders in the US, which mostly specialized in subprime lending had declared bankruptcy, the largest amongst these being New Century Financial, and over 100 such lenders had already closed their operations. Taking note of the events in the US, all global stock markets had corrected around 10% during June-July 2007 when the media headlines began to be dominated by the subprime crisis unfolding in the US and Europe.

However, to everyone’s surprise (and shock to many who had by then built up massive short positions in the financial markets) the markets rose sharply with Chinese stocks gaining over 40% in just three months and US stocks gaining over 10% during the same period. Most markets made a peak in October 2007 with the top banks like Bear Sterns, Merrill Lynch, and Morgan Stanley showing stress and raising additional capital from Asian sovereign funds; and started their final descent.

The Indian equities however continue to rise till the first week of January, gaining over 50% from the July 2007 low. The Great India Story, There Is No Alternative (TINA) to India, etc. were famously part of the global fund managers’ narrative at that time.

Plane loads of foreign investors with bags full of money were landing daily in Mumbai and Bengaluru. However, the dream run of Indian equities did not last much longer. The correction started on the 8^th of January 2008, and by October 2008, Indian equities had lost about 60% from their January 2008 highs, becoming one of the worst-performing markets in the world.

Notably, the Indian economy had grown 9.3% in FY08, on a high base of 9.5% in FY06 and 9.6% in FY07. In the subsequent three years (FY09 to FY11) the Indian economy recorded an average real growth rate of over 8%. The benchmark bond yields corrected from a high of 9.3% in January 2008 to a low of 5.3% in December 2008; only to rise again to 8.9% in the next twenty-one months.

Ominous dark clouds (Nimbostratus) covering the Sun

The events of 2023 bear some resemblance to 2007. After years of low rates, and supportive money & fiscal policies, the economies have heated. Asset prices have risen sharply showing clear signs of unsustainability and irrationality. Consumer inflation is running high despite accelerated tightening. Debt defaults and bankruptcies have started to happen. Bond yields are rising to multiyear highs. Central bankers continue to remain hawkish; indicating further tightening. Conspicuous signs of an impending economic slowdown are everywhere. The US Government bonds have been downgraded and the major US banks are also under close scrutiny for a possible downgrade. The growth engines of world China and India are not able to accelerate growth.

US economy facing strong headwinds

For the past year at least, the US economy is facing strong headwinds.

·         As the Covid stimulus has started to unwind, the growth has dwindled.

·         The household debt burden is at a record high with diminishing debt servicing capability.

·         Household savings are depleting at an accelerated pace.

·         The interest burden of the US treasury has almost doubled from pre Covid level to appx US dollar one trillion.

·         Fiscal deficit funding faces hurdles as the global demand for the US treasury is declining. Reportedly, the US treasury portfolio of China alone is down by over US$500bn from peak of 2013.

·         Bond yields are at a multi-decade high, inflicting massive MTM losses on bond portfolios of insurance companies, pension funds and banks etc. The leveraged bond portfolios are bleeding badly, raising the specter of a major financial sector crisis.

The growth engine of the world is stuttering

China has been a major driver of global growth in the past couple of decades. In particular, after the global financial crisis, China and India have been the major contributors to global growth, contributing over 15% of total global growth.

The Chinese economy has been struggling to sustain its high rate of growth and consistently reporting lower growth. The growth rates of retail sales, property sales, industrial production, employment, investment, etc., and overall GDP have declined in recent months. In fact, China’s People’s Bank of China, is perhaps the only major central bank that has not increased interest rates even once in the past decade. Several experts have raised questions about the sustainability of the Chinese model of growth in the recent past. Some have even pronounced the end of the Chinese era of economic high growth led by investment in manufacturing and property.

In fact, it is not only China. The fabled BRICs that were seen as a major support to the global economy is struggling. Russia is engaged in a prolonged war. Brazil and South Africa have hardly grown in the past decade. India has been maintaining a decent growth rate, but not adequate to make a significant difference to the global economy. Besides, it is not likely that India’s growth will accelerate in any meaningful measure in FY24-FY25 also.

The next 6 months are critical for global markets

Given the current level of fragility and uncertainty, in my view, the next six months are very critical for the global markets. At present, few would rule out a credit event like the collapse of Lehman Bros, or a sovereign debt crisis like Greece in the near future.

The financial markets will definitely take a significant hit in such an eventuality; even if the central banks resort to indulgent monetary loosening immediately to stem the crisis.