As per the above quote from Sir John Templeton, the current bull market was also born amid blatant pessimism due to the Covid crisis 18 months ago. Since then, global financial markets appear to have embarked on a one-way trip in which there has been no turning back.
But as this excess liquidity-fueled bull market kicks in, cracks appear to be developing both on Wall Street and in real economies.
Excesses and incidents
Excess has always invited pain in the stock market. In March-April 2021, one of Wall Street’s biggest hedge fund managers, Bill Hwang, went bankrupt after his Archegos Capital fund lost $ 20 billion in just two days. It had to do with excessive borrowing. This incident severely damaged and battered Credit Suisse’s wealth management division.
In Beijing, real estate giant Evergrande faces a similar problem of excess. The company, which had humble beginnings in the mid-1990s, has grown into China’s largest real estate developer selling apartments to middle and upper income groups, perhaps thanks to the easy money that fueled his growth. In 2018, it was considered the world’s most popular real estate developer and ranked 122nd on the Fortune 500 list of companies.
But as China began a crackdown on shadow lenders and tried to slow the rapid rise in house prices, Evergrande found itself on the verge of collapse and it sparked panic in financial markets around the world. . Its September 24 deadline for paying the $ 80 million coupons went quietly without any updates from the company as global markets braced for a hard landing.
So can Evergrande turn out to be the proverbial canary in the coal mine for the ongoing bull run? Archegos Capital’s default was substantial, with a message to financial markets that it can be viewed as a rogue speculator case and written off as a one-time event. But Evergrande cannot be taken that way. This developer has a huge debt of $ 300 billion and its investments in the real estate sector are estimated at around 2% of the total investments in China.
The contribution of the real estate sector to the Chinese economy is 29%. In recent years, Chinese households have been encouraged to save more in the real estate sector, which now holds 75% of total household savings.
A recent research article published by Kenneth Rogoff, professor at Harvard University, and co-authored by Yuancheng Yang, observes that since the Chinese real estate sector is huge, a significant slowdown in house prices can have an impact. significant impact on China’s overall growth, even in the absence of a financial crisis.
Interestingly, the same research paper points out that the ratio of house prices to income is much higher in Chinese cities than in global hot spots like New York, London, and Tokyo.
With Evergrande having exceptional properties under construction worth around $ 1,000 billion, China’s housing market could face a larger crisis, which could eventually escalate into systemic chaos unless the Chinese government does not intervene to bail out the promoter.
Pitfalls of excessive optimism
The history of financial markets shows that excessive optimism in the mature stages of bull markets has often led to major financial accidents.
In the 1998 bull market, John Meriwether’s famous hedge fund suddenly collapsed when Russia defaulted on its sovereign debt. At the time of its failure, the fund called LTCM had exorbitant leverage and the value of its positions in the world was estimated at $ 1,000 billion. To avert a catastrophe for global financial markets and avoid systemic risk, the US Federal Reserve stepped in and negotiated a deal to unravel the financial bets in an orderly fashion. This caused Dow Jones to correct 20% from the 1998 high of 9,367 to a low of 7,400.
Likewise, in the roaring bull market of 2003-2007, Lehman Brothers became a notorious child and a symbol of excess due to its division of mortgage-backed securities. The collapse of the US housing market ended the glorious 160-year-old chapter of the fourth-largest investment banker, which filed for bankruptcy of $ 619 billion.
In 1992, although there was no excess liquidity in the system as we see it today, corrupt banking practices in conjunction with greedy individuals like Harshad Mehta sparked what has become infamous. under the name of Securities Scam, or the Harshad Mehta scam that led to the collapse of the Indian stock market. The banks’ huge liquidity support had played a key role in this market rally as Mehta exploited loopholes in the system in conjunction with bankers to use the 14-day settlement cycle that then existed.
Bull markets and liquidity
The current bull market leg dates 18 months without any major corrections and liquidity injected by global central banks has been the main driver of this rally, which has more than doubled benchmark stock indexes since the March 2020 lows.
In 2013-2015, we experienced a similar rally which culminated after 18 months and it was attributed to the liquidity measures taken by the European Central Bank in accordance with the “anyway” position of its President Mario Draghi for stabilize Europe Union debt crisis.
Going back a little further in 2009-2010, Nifty had rebounded for eight quarters with no negative candles on the quarterly charts, which translated into a 180% appreciation from the bottom. This rally began after the US Congress approved the Troubled Asset Relief Program (TARP) in 2009 to address the subprime mortgage crisis.
After these kind of rallies, Nifty generally underwent a correction of several quarters with a minimum of 25% cut from above.
The 2003-07 rally
The current market rally is often compared to the one we saw in 2003-07, but the main difference between the current rally and the 2003-07 bull market is that in the latter we have had healthy corrections at regular intervals. , even for the 30% magnitude, throughout the bull run.
As abundant liquidity was present in the system at that time, as the Fed struggled with the consequences of the failure of the LTCM hedge fund and the year 2000 problem in 2000, the bull market followed a massive bear market between 1999 and 2000. Therefore, the current market rally of the market is not comparable to the bull market of 2003-2007.
So, does this mean we’re in trouble or do we really have an opportunity at our fingertips? Let me answer this question with a line from Paulo Coelho’s character saint in The Alchemist, who often says that omens are written all around us and the only thing is that we have to read them correctly.
(Mazhar Mohammad is Founder and Chief Market Strategist at Chartviewindia.in. Opinions are his)