Winter Update

Economic Growth will Come Later

While building your case for economic cycles and its conjunction with Elliott Wave analysis you have to go back and forth with data and published works of many to come up with the best possible observations to your case. Among the works of Robert Prechter is his book "Conquer the Crash" Published in 2002. The timing of the book may not appear appropriate to many as it came years ahead of the Housing crash and at the end of the Nasdaq bottom. But what you should use this book for is its insights into symptoms of economic cycles in the wave counts and the behavior of financial markets and its participants during a deflation. Since these observations are based on the study of previous sypercycles they are ideal for mapping what India is going through today. Many of the observations are already true here as India has only started to enter an Economic winter after 2010. For example the collapse in borrowing and lending during a deflation as debtors and creditors stop transacting new loans causing credit growth to collapse discussed in the later chapters. This is what India has been witnessing for the last few years as credit growth in India has collapsed and borrowers are holding back even as interest rates are declining. This is what you expect in a deflation.

In Chapter 1 of the book an interesting observation was made relative to the supercycle degree wave counts. Robert Prechter observes a divergence in economic performance in wave 5. See these charts from the book CTC, 2002. He uses both US and Japan as examples to show this kind of divergence in the book. This chart is of US indicators.

 wave five 1

Let me admit when I first interpreted wave 5 ending in 2010-2012 data in India did not show this clearly in the GPD/IIP data so what I observed was mostly that debt was going to balloon on the corporate side. That allowed me to start writing about the coming economic winter in India. I was early for sure. But now wave 5 has been 7 years in the making. As shown below wave 5 that could have ended much earlier did not and has me on the wrong foot because wave 5 is an ending diagonal. This is also called a wedge or a rising triangle like structure that contracts to the end point. The internal waves are 3-3-3-3-3, up and down to the end point. These observations so far are true. So I do believe that the wave count is a 5th wave.

 wave five 2a

The economic data for wave 5 compared to wave 4 does now provide the eivdence I was looking for even within this final wave. The chart below of GDP quarterly growth shows the slowling growth as we spent these years in wave 5. Chart courtesy 

wave five 3

The chart above combined with the one below shows India was in an Economic Autumn Bull market starting 2003. This involves a boom on the back of low interest rates and low inflation that results in Asset booms in not just equities but Real estate and other financial assets. The low interest rates seen during the Autumn fuel borrowing based consumption and buying of assets. The debt level of the nation [public+private] in total go up as corportes and consumers go in debt. After a point the extended state of balance sheets causes the economy to slow. I did not make up this economic cycle theory, so credit "The Soviet economist Nikolai Kondratiev (also written Kondratieff or Kondratyev) was the first to bring these observations to international attention in his book The Major Economic Cycles (1925) alongside other works written in the same decade.[3][4]In 1939, Joseph Schumpeter suggested naming the cycles "Kondratieff waves" in his honor." For full details read 

The high levels is debt is therefore keeping India from growth taking shape. And it is sad that every time you get a few months of up tick in the data as you see from the blue line rising for the last month below, the entire media and Financial spokespersons come up to inform the world that the cycle has bottomed in India and earnings will grow next year. It is mostly misleading. Economic cycles suggest that without deleveraging you cannot kick off growth. And that can be done either by default, or bailouts and inflation. Neither path has been clearly been chosen in India. We are trying the middle path. Given our markets over optimism with growth, it has lead to over valuation based on a future that is far from near or around the corner. When corrective actions are taken they result in asset sales and write downs of equity. Later a jump in public expenditure to supplement growth. All that is coming. But it comes with rising volatility and not otherwises. 

wave five 4

You may tend to compare India's debt levels with other countries around the world and think that we are at the low end. This is not true. 
There is no definition for ''high end of the range'' except that after you cross 100% the music stops playing at some point and you have to take note. This again is based on numerous studies on the subject by the BIS and other economists. India is at levels that caused similar problems during previous historical Kondratieff cycles in the world in the past. That we have hit the growth wall means that we are already at the end of Autumn and into the Winter phase economically. The stock markets are still extending the Autumn boom as Sentiment at the retail investor level remains high on hope but the hopes are not realistic. An asset price correction, adjusted for inflation and currency effects that could intervene remains overdue in India. This positive sentiment has been aided by Salary increases in the form of Pay Commission reports, MSP for farmers and OMOs for the bond markets among others. These forms of stimulus have aided the soft landing but so far insufficient for the return of a higher growth trajectory because at a Macro level the economy is fully leveraged or overheated. 

All this does not mean that the reforms are not important. They will help us achieve a higher plateau on growth when the business cycle turns around on its own. Economic cycles are a function of public behaviour and will turn when they have to. Stimulants act as short term measures only. Reforms set the stage for the future but not the immediate state of affairs. This distinction is important. 1996-2001 is the best example of this. There were many reforms during that period but the cycle turned when it had to. interest rates dropped on their own in the last two years of the cycle to a new low not see before and finally triggered a new wave.

To be Continued....

Out of the Woods and Into the Sea

Out of the Woods and Into the Sea

A lot has happened in market behaviour, and economic events that there appears no need to try and connect the dots. In fact when the markets appear so good and bullish then everything else must not be as important. The worst must be over and discounted. What can go wrong now? In fact having been around this long I must agree that for everything that is going down there is always something that is going up. And it is only apt that I answer the question that comes to me repeatedly again and again and especially twice, in 2013 and now 2017. Is the Kondratieff [Kf] winter over?

Now first I must say that theories about cycles and market behaviour have been abused by global newsletters and advisers to a degree that the cycles are often considered as doomsday forecasting methods or conspiracy. However that is not the case. Economic cycles forecast both expansionary and contraction in cycles. Their application is not in calling market tops but allowing for the right Asset allocation. I too have learnt this with some mistakes. The role of these theories however gains more prominence during contractions because of the pain involved and everyone wants to avoid the pain.

So in 2009 identifying that India was entering an Economic winter, meant that we would have to deal with our debt problems and the right thing to do was simply avoid debt laden corporations. That would have made a huge difference in the performance of anyone's portfolio. That was the most important part of the role of knowing the cycle. It did not forecast a crash but a need for change. So in 2013 when the market took off to a new high I was asked for the first time if the winter was over. And now in 2017 the question must arise again. The answer lies in the troubles of our banking sector. 


Would the NPAs in the banks be addressed by a bailout, write down, haircuts? Will the bad bank cause losses to the corporations involved or prolong their pain. The banks will in any case need fresh funds or a capital restructuring of some kind. Similarly will companies drowning in debt survive be bailed out? Will their respective businesses survive given that they must be capital intensive businesses to start with. And without new capital doing new business would not be possible. So for banks the problem first is getting new capital to lend into the economy. Then they have to find borrowers that are deserving, surviving businesses or new entrepreneurs. Businesses need to find viable projects to invest in to add new capacity. All of this does not come without headwinds.

So the process of restructuring whenever it is done involves some short term pain. Any deleveraging exercise can have a deflationary rub off on the economy. And subsequent to that you need fresh spending that is a stimulus and expansionary. The action of spending and stimulus risks inflation but the deleveraging is meant to balance the two. Without going through this process to expect Macroeconomics to turn around would not be correct. So while Rajan did the Job of getting the NPA skeleton out of the closet. It is still walking around like a Zombie. This is why the 2013 rally did not end the Indian winter in an economic sense. 2016 saw the issue come out but the issues remain unresolved in 2017. 

I may add that while many thought the Demonitisation exercise was meant to help the Public sector banks. I wonder if that was the agenda. Maybe it was to bring down interest rates to allow for the survival of the bad loans longer. Nothing more. It served many other purposes of governance and corruption well and more maybe done in those respects. However it would have been known to those in power that a quarter down the line all the Cash will go back into the system and things will be back to square. This is already happening as Cash withdrawals continue at a record pace daily. So if the banking problem has to be addressed it is going to need another Crisis.

We are the World

So when we discuss Economic cycles I am not sure most get it where we are compared to the rest of the world. In my opinion we are one cycle behind the developed world mostly represented by the US. Let me put it in context at the risk of being a little technical. If you have read my Kondratieff winter article then you understand the four seasons that an economy goes though. So 1970-1980 was an Economic summer for the US. A summer involves an overheated economy which shows up in high rates of inflation and interest rates. 

India has always been late in the world and so we joined the Globalisation force in the 1990s, and by 1992 started our economic summer. 1994-2001 saw peak inflation and interest rates for this period of economic contraction as is witnessed in a Kf summer. So while the US started its Autumn bull market in 1982 and it went on to 2000. India started its own Autumn bull market in 2001. Did it end in 2009 or will it end in 2017? In an economic sense it ended in 2009 with the economic cycle but not yet in the stock market. But the point is that we are behind the curve with the world on the cycle. So by 2008 the US faced its debt problems face to face and managed it with bailout and QE stimulus. That revived the economy over the coming years. India has still to face up to this. The deflationary rub off of the deleveraging however continued into 2015 with the commodity crash of the period. Now the stimulus in the developed markets is starting to have the expansionary impact that it should have of Inflation rearing its head. 

cpi eurozone

Inflation around the developed world has turned around alarmingly. It should not come as a surprise as the turn comes with a lag to the commodity cycle. The Eurozone inflation is back up not just because of the devaluation of the Euro/Yen but also the QE stimulus of funding the banks.


Similarly the impact of the QE in the US is starting to show up only now. But remember that price deflation came first. US CPI at 2.7% and Core CPI at 2.2% has been rising vertically for a while now. Now we may want to believe that the trends above are temporary and will not last. But that would be based on the belief that the US economy is weak and slow. But that is just what the media has been feeding us along with the conspiracy theorists. Like the belief that the dollar is strong and will keep rising because interest rates are rising. The dollar had a 9 year bull market from 2008-2017 which involved only one interest rate hike in the last year of the move. People will believe anything they are told by the Media I guess. But the media is not alone to blame, many prominent analysts are also singing the same tune. So here is a picture of US Capital Expenditure plans published recently by sourced from Bloomberg. What do you see? Now from where did everyone start panning so much Capex and more important what will be the impact on the economy and mostly inflation?

CoD Capex 3 17 17

The return on price inflation as measured in rising commodity prices at least can often be linked to the dollar and so starting 2016 I took the view that the dollar is topping out. It read 100 in 2016 and did go above it to 103 in 2017 for a while but it could not stay there. What people missed is what happened in between. The basket of EM and other currency pairs including the Yen had already rallied a lot against the dollar driving it down. So the Euro or Pound were just like the last men standing. The Euro and Pound however make up the most of the most watched Dollar index. Similarly the new high in the dollar this year was not accompanied by new lows in Commodity prices anymore. They made higher bottoms. These inter market divergences are glaring and should not have been missed by any Technician. Occurring in the final phases of the rising trend of the dollar they were important contrarian indicators of the coming change in trend. The dollar should have stared what could end up being another 7 year bear market based on historical cycles. The bear market in the dollar will then bring with it the inflationary head wind that has been missing in the face of massive global stimulus. How much Inflation will we actually get? Can we risk Hyperinflation? These are more difficult questions to answer so just be prepared for the trend.


The immediate impact of this is on commodities and the lagged impact is then on inflation. In a world that boasts of survival on the highest levels of debt in the history of mankind high levels of Inflation is the last thing that anyone wants to deal with. Now quietly maybe that is what everyone wants, inflate away the debt by causing Nominal GDP to go up, but central banks cannot admit that. Thus interest rates are likely to be behind the curve and keep Real interest rates negative for a long time to come. All this said. what does it mean for India? The Inflationary storm that is about to hit the global markets is going to rub off on us as well and we should witness rising prices down the line. A strong rupee can try to wear off the effect of higher prices to a degree but not beyond that. The real headwind for us though will be that we will finally get the crisis we need to deal with our debt problems. If the coming Inflation pushes up interest rates again it would be tough corner to work in. Deleveraging and its deflationary effects for India might be, in a way, the ideal thing to use to fight off the global inflationary storm to a degree. Alternately we will just do what the rest are doing and allow the coming Inflation to inflate Nominal GDP in our favour. It is hard to predict precisely the course of action the government will take in the coming storm. But to put it in one line what might be the largest Macro trend of the coming years, it will be 'The Falling Dollar" 

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Bullish in the Winter

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.



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.​​​​​​​



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.



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. 

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Gold and the Kondratieff cycle

I was recently told on Twitter that I have been bearish for long and it is time to be bullish. Now bullish and bearish are a perspective. Elliott Waves are not a figment of one's imagination. They reflect the herding behaviour of a crowd as reflected in a group of prices like an index. Where Elliotticians go wrong however is they are not able to see extentions in advance. So a 3rd wave may complete 5 wave but can extend to 5+4=9 waves or 5+4+4=13 waves as well. We can get bearish early in the trend.

But what I really want to discuss again is the impact of Inflation on Equities on Long term returns during the Economic winter phase of the market. Yes we are in a winter, one that involves high levels of debt that results in high levels of NPAs that have to be written off as default or inflated into the air. Slow inflation over many years is often the choice of policy makers. This can also be referred to as financial repression where savers are paid lower interest rates than the rate of inflation, or rise in prices. Do this long enough and the Nominal debt to GDP ratio comes down to a manageable level. But as discussed in My Kondratieff winter reports, India has already broudht down the ratio for the Govt debt portion, while the private sector continued to expand its debt through the rood. This was a EM wide phenomena and not India centric. So Corporate debt is now an EM problem near 9 trillion dollar big.

Now the objective is to lower corporate debt by raising product prices. But do it at a pace that it does not hurt the public at large. While difficult this is what we have seen happen to some extent. History also shows that Equities do not outperform during inflationary periods associated with a Winter because eventually higher interest rates will hurt, even as higher prices help drive up equities. In other words the relative performance of Equities v/s inflation is poor.

Now to charts. After the 4 year correction in commoditiy prices did commodity prices really fall. The fall in commodities was a global issue not one ''Made in India''. In other words inflation has persisted in India since 2009 that corporate debt started to explode that the Nifty adjusted for either of INR, CPI, GOLD, is down from the 2008 peak. I covered all the charts in the Economic winter 2.0 report so you can see them there but I will cover just one today to make my point.


The above chart is the Sensex/Gold ratio and it has retraced 50% of the 2008-2009 fall and is falling again. In other words Inflation has outperformed equities and so has Gold. The chart below is the MCX gold chart and in 2008 when Sensex topped it was at 11000. At 30000 now it has almost tripled. The Nifty has not tripled to 18000. In fact unlike what most tell you gold has not been in a bear market in INR terms. Just because Gold declined by almost 50% in USD terms did not mean anything for Indian buyers of Gold. Gold prices never fell below 25000. Not more than a 33% correction from the peak. On the chart below Gold has been consolidating since 2011 and should start the next move higher now.


In fact if you think that Gold crashed after 1980 due to the interst rate hikes and was in a bear market for 20 years, that was not true in INR terms. The following chart of Gold in Rupees per Ounce gives a long term picture of Gold going back to the 70s. Gold in rupee terms doubled in that period.


However this zoomed out chart of the Sensex/Gold shows that the Sensex was rising for most of that period till its peak in 2008. So Equities did beat inflation for this time. It is the subsequent period of high debt and NPAs when history shows that this does not hold true and so far has been the case. You can use any measure instead of Gold like CPI or USDINR to validate this. I believe that this ratio is likely to fall much lower by the time we are done with this winter cycle. Either because of rising Gold prices of falling equity prices till the debt ratios normalise again and a new economic cycle can start.


Yes an ending diagonal in Gold means we have broken out of it into a bull market that should be far from over. But why just Gold?, You have to be Long Inflation. This again is not an India only phenomena but a Global one and I discussed it in the Oct Long Short report as well. The interplay of inflaiton with equities can be triky because interest rates can start to rise and that is probably why you do not beat inflation but inflation can keep equity prices elevated as well. But that is the numerator, the denominator is where the bulls will be.


10 year G Sec

Indian Government bond yields dropped again today and are near a double bottom to where they were before the 2013 currency crisis. This is important as it would be a major breach of a previous swing low for yields. Will the Bond yields double bottom near 7.089% or break below the 7% mark? This will truly determine whether we have overcome the interest rate cycle into a deeper deflationary trajectory. This is important from the Kondratieff cycle perspective. Today RBI left rates unchanged as he remains unsure of the trajectory of inflation. At the same time the FED appears to be sticking its neck out on raising interest rates just like they did with tapering 3 years ago. So will the rates start to respond to the rising dollar here? My Long term view on Indian G Sec's is that yields have to complete wave e up to one more new high before the long term rate cycle can conclusively turn down for India. This level is therefore important in changing that view. It would put my view in doubt for sure But if this level holds then it will be 9-10% in bond yields in the coming year. A major interest rate shock maybe on the cards. Stay on watch I do believe that this could be a defining moment. I know that talking of a rate rise at this moment to most people is like impossible and stupid. All the more to watch this level carefully because the last 3 years were all about financing the Indian economy with foreign bond money flows. I do not know if anyone noticed but the RBI actually hinted at dumping its reserves on the market if there was a problem with redemption's of the Foreign currency borrowings that are coming due in the coming months. I do not know of any Central bank that would do that. It is almost like a silent threat.