The above figure suggests that Brazil is the only country(in BRIC nations) which has been able to sustain growth in their equity markets during high inflation pressure & world credit crises.
The above figure gives PE multiples of the MSCI China, India, APAC indices relative to the MSCI all world index. (P/E multiple is essentially the Price you are willing to pay for a $ earning of the company. Obviously you would expect it to be high if you expect high growth & hence its a reflection of expected growth ). The graph we see is a reflection of expected growth of emerging markets relative to the world markets in the near term. One thing which is apparent from the graph is people have always expected India to grow at a faster rate than China. Would definitely be interesting to plot a PEG( P/E ratio / Growth in EPS ) graph as it gives a measure of expected growth/ Realized growth.
The above graph gives the annual Inflation figures (in CPI %). The devil "CRUDE" is majorly reposnsible for the rising inflation. Since crude has played so much havoc, its worth analyzing the crude economics.Crude's a commodity traded in $. Sources of supply: Middle East Arab Nations, Sources of demand: All of us ! Lets try and justify the rise of crude from $98 per bbl in Jan 08 to the current level of $143 per bbl. Major factors affecting crude prices are as follows.
1. Political disturbances in the middle-east - Not any major ones that I know of in the period Jan 08 - June 08 . Except the current Israel-Iran conflict.
2. FX USD/Investor CCY - since crude is traded in $.
The above figure accentuates the FX/ Crude correlation. Just before the fall Trichet, ECBs chairman announced that it has no further rate cuts in mind & hence dollar strenghtened against EUR & Crude fell.
$ has depreciated against most of the ccy's like EUR, JPY,GBP (Major crude investors) which has prompted Investors to invest in crude & hence a rise in price.
3. Supply & Demand
Another pressure might be in the fundamentals – how much supply is available, and how much demand there is. In a normal market, an increase in demand for a finite amount of a commodity (which would result in a decrease in inventories) would cause the price to rise. But not so with crude oil: since January 1, 2008, the spot price for crude oil has been rising in spite of an increase in crude oil inventories. See the graph above. (As seen in this graph, as the inventory rose from 295,000 thousand bbls. to 325,000 thousand bbls., the price increased from approximately $90 to $120 per bbl.). From the data in this graph, it is apparent that the normal relation of supply vs. price has not been occurring since January 1, 2008. So the price rise is not due to real demand & most of the positions are speculative ones.
There's going to be a time when the speculators are going to realize that their love for crude was just an infatuation & they will move on to some other asset class & book in profits on their oil positions - This should see the end of oil bubble BUT given the conditions USD doesnt weaken anymore & US economy rebounds with no major rate cuts, But again bouncing back of US economy so much depends on crude prices......Meanwhile Real-esate has already bottomed out in US so the next move of the speculators is very much predictable.
Structure recommended for the current Scenario: I am not sure of the time when crude prices will start receding to normal levels, Rather I am not sure when a particular asset would give me its best performace in the near term(2yrs) horizon. Structure like Himalayas, Cherry Pickers can prove to be handy in such scenarios.
Basket Construction for such products:
1.Equities: Given the fact that Brazilian Economy has outperformed its peers in tough times & Retail has been a major growth driver for all emerging markets, an equally wghted basket of Indian & Brazilian Retail+FMCG stocks would'nt be a bad pick.
2. Commodities: Crude has the power to outperform any asset class in the near term.
3. US Real estate Index for Long term: Hoping it gives a considerable return after 2 years as a result of US economy bouncing back from the recessionary period.
4. FX (Basket of USDEUR, USDJPY, USDGBP): Has a strong correlation with crude, If FX performs well, crude can turn out to be a waste...
Volatility of commodities has risen up lately. DJAIG Commodity Index vol (6m) has risen to the levels of 21%~22% as compared to previous low levels of 15%~16%. Traditionally it has been equities on which clients have sold or bought vols (as counterparties - generally banks have been able to easily hedge it by buying/selling calls/puts), but with commodties showing significant vol levels, this time Clients might be just interested in playing the big vol game on commodities as well (especially hedge funds). Its a good opportunity for banks as they can charge a better margin since its difficult to hedge volatility exposures on commodities. (To hedge vega, i.e is by buying calls/puts - Broker's the way out, but obviously you have to pay an extra premium & that you can charge from the Client).
Currently commodities have been a part of structures such as Volcaps which dont have high Vega. In Volcaps the asset wt. keeps on rebalancing on the basis of the levels of volatilities reached.
