From Nifty to Nasdaq

It is not just in India that the markets are assuming a full-blown recovery when only a few green shoots are present. The optimism generated by recent economic data in the US has resulted in the S&P 500 reaching a life-time high and pushing the Nasdaq to levels last witnessed in 2000. There is a sense of celebration about the surprise improvement in job-creation in October, the recovery in new home sales and property prices, and the improvement in auto sales. These have contributed to helping economic growth recover from a low of 0.1 per cent in the fourth quarter of the last calendar to 2.8 per cent in the third quarter this year. But the US Bureau of Economic Analysis has cautioned that the spending by the Fed is slowing down. As the Congress forces further budgetary cuts in government spending, GDP growth is likely to be further dampened. Another factor that the market is overlooking is the slowdown in consumer spending growth to the lowest rate in two years. The current GDP growth rate is also well below the recent peak of 4.9 per cent recorded in 2011.

The signal emanating from the corporate performance of US companies provides no comfort either. Growth in both revenue and earnings has been decelerating steadily since 2011, even as optimism about the economy was on the rise. While earnings for S&P 500 companies are expected to grow at a modest 5 per cent in 2013, revenue growth is expected to be at an anaemic 2 per cent. For the fourth quarter of 2013, revenue growth is expected to be close to zero, providing clear evidence of the absence of demand. Companies are managing earnings growth by cutting costs, restructuring operations and so on. These growth numbers cast doubt on whether the S&P 500 deserves to trade at a price earning multiple of 16 and the Nasdaq Composite at 30 times. It is also doubtful whether stock prices have any room to move higher since the indices have already notched gains of over 20 per cent this calendar.

Given the weak fundamentals for the US stocks and the equally wobbly foundation on which the rally in Indian stock prices is built, it is no surprise that the financial markets are praying that the Federal Reserve does not begin reducing its quantitative easing programme soon. It is the liquidity, thanks to this easing, that has driven prices above their fundamental value. But this overheating suggests that it may not entirely be a bad idea if the US begins to tighten the liquidity tap gradually. Reducing excessive liquidity will bring some sobriety to the stock market. This may soften the landing when the markets begin to fall from their unjustified highs.

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