Adam Smith Associates - Bullish In Winter

Adam Smith Associates offers trade & commodity finance related services & solutions to its domestic & international clients. Views expressed in this article are purely of the author - Mr Rohit Srivastava - a leading technical analyst. Visit www.adamsmith.tv for services offered by Adam Smith Associates Pvt Ltd

The Kondratieff cycle was a source of some serious discussion last month at the ATMA meet and I think it was relevant. A lot of science has been used to project end of the world scenarios to the public at large. A lot of science ends in intellectual mind breaking and our search for the holy grail. The answer to all answers. To an extent I do use the Kf cycle to present the case for the Indian economy in a clear light. The monetary cycle is to explain the behaviour of the economy and stock market. But remember that I too use this cycle once in my life. And the cycle is a generational cycle, meaning that it lasts an entire lifetime. So you can spend an entire part of your life sitting on the back of a forecast and going no where. There is no way that you can have past experience of the cycle to gauge on.

So is there a role that such studies have in market forecasting?

Yes I think so!

The most important role is that the cycle explains the factors that become relevant at this stage of the economic cycle. In the case of the Economic winter part of the Kondratieff cycle it states that during this phase Debt becomes the most important Macroeconomic factor. So was that not the case since 2010? Yes it was. What was not true was that that market in terms of Nifty is not in crash mode since then. Only debt laden stocks and sectors are. Knowing that this particular sector would crash was important. So it did play a role. Also a forecast for a crash because of too much debt overlooks the fact that debts can also be inflated away. So during an Economic winter you can either have deflation of Debt or inflation of GDP. And the path is a choice of monetary policy. To inflate or to deflate. The government will choose to inflate or deflate and that determines the impact on the economy and markets. Starting 2009 the world has been trying to inflate it's economy. India's fiscal stimulus and currency devaluations between 2009-2013 are the reason that the crash was averted at the Nifty level even as stocks made new lows. Active index management in terms of changing the index components has also helped. To inflate causes the support base for the market to rise. 2013-2015 we witnessed outright deflation in commodity prices  that came as a shock to Commodity producing countries sectors and stocks.

Starting 2016 we have started to witness Reflation. This year most world markets are reporting inflation. In the face of inflation stock market are likely to do well again. Commodity related sectors stocks and countries are outperforming. So I have been saying I am Long inflation. And sounding relatively bullish the stock market after a long time. However that does not solve the problem of debt right away. A large amount of inflation would bring down the debt to GDP ratio for sure. This can happen in one move or small increments over several years. Also at an index level during the winter season the Nifty does not beat inflation. The Nifty adjusted for inflation [NIFTY/CPI below] has been below the 2008 high. The Nifty/Gold chart or the Nifty/USDINR chart i.e. Nifty adjusted for Gold or the dollar has also under performed. So even during a period of outright inflation when stock markets go up it expected that the index as such will under perform relative to inflation/gold/usd.

CHART : NIFTY/CPI ratio

So an economic winter does not mean the index will go down. During periods of inflation or stimulus the index does go up but it lags inflation. The reason for this lag is only the inability of GDP growth in real terms. Nominal growth takes place as prices rise. The weight/cost of the existing debt on the economy makes it hard to grow at a rate faster than we would otherwise.​​​​​​​

CHART : NIFTY/GOLD ratio

So debt remains the primary reason for the actions of government and the performance of the economy and stock market. Currency devaluations are also a part of the inflation process as seen on this chart.

CHART : DOLLEX 30 = SENSEX/USDINR ratio

But the stock market can go up. And it has since 2010 despite commodity deflation. However the deflation was bad enough to keep a bearish market bias. Now that inflation is coming it is good enough to have a bullish market bias. Will it be enough to push the non performance of these relative charts above up far enough to change this picture? Based on the theory of the cycle it should not. Stocks market may rally on a nominal basis but not on a real basis till they do. We are closer to that point but not yet there.  Right now the trade is long inflation. Gold and Real estate do better in a winter bull market than equities though, again this is based on historical performance data under such conditions. If the inflation genie dies along the way take note and change your stance. If it results in hyperinflation have the appropriate hedges in place. I have discussed my preferences in the Value wave stocks and Long Short report for Jan/Dec and the recent Long Short Updates.