Archive for September, 2011

Market Notes: 7th September, 2011

September 7, 2011 Leave a comment

Dollar Index:  The Dollar Index has moved in an orderly fashion despite the tumultuous news flow that had markets in turmoil.  That in itself is remarkable. Starting at 2nd May, 2011, the $ Index commenced an impulse wave up and is currently traversing the first half of Wave III. The $ made a fairly large move up on 6th September and the first major overhead resistance lies at 76.75.  A break atop 78 will confirm the medium term prognosis of test of 81.5 sometime before the end of this year.  Despite all the bearish news on the $, the charts don’t show up any $ weakness apart from a need to consolidate yesterday’s large move up.  $ Strength near-term is negatively correlated with US equity markets. But we will have more on that correlation later.


Gold spot:  Gold did some expected things yesterday that are worth noting.  Firstly, the closing high in spot gold markets was $1897.1 achieved on 22nd August this year.  Gold has dropped sharply from that level to 1750.55 in two trading sessions before coming up again to test the previous top of 1897.1 yesterday.  Gold opened higher on 6th at 1902.59, higher than the closing high of the previous session, went on to make a high of 1920.3 before dropping to a close of 1872.9, below the previous close.  That makes for a key reversal in price action worth noting.  The failed test of the previous top marks a potential double top in gold at 1900 level.  The next few days’ market action in gold will be critical.  Unless the market takes gold well atop 1902.59 on good volume, the gold rally ends with the double top at 1900 in the medium term.


Sensex: After making a low of 15,765 on 26th August the Sensex has rallied to a high of 16,989 on 2nd September.  An early sign that the markets have completed their correction would be a rally above 17,500.  Considering that we are the tail end of a correction markets can be expected to be choppy as different groups of stocks bottom out at different times during this period.  Prognosis remains the same. Pick your preferred blue chips on dips when the news is all doom and gloom between now and mid-October.  It is accumulation time for blue chips.

NB: These notes are just personal musings on the world market trends as a sort of reminder to me on what I thought of them at a particular point in time. They are not predictions and none should rely on them for any investment decisions.

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Reversing India’s falling growth rate

September 5, 2011 1 comment


The completeness of the Ricardian victory is something of a curiosity and a mystery. It must have been due to a complex of suitabilities in the doctrine to the environment into which it was projected. That it reached conclusions quite different from what the ordinary uninstructed person would expect, added, I suppose, to its intellectual prestige. That its teaching, translated into practice, was austere and often unpalatable, lent it virtue. That it was adapted to carry a vast and consistent logical superstructure, gave it beauty. That it could explain much social injustice and apparent cruelty as an inevitable incident in the scheme of progress, and the attempt to change such things as likely on the whole to do more harm than good, commended it to authority. That it afforded a measure of justification to the free activities of the individual capitalist, attracted to it the support of the dominant social force behind authority.
–John Maynard Keynes

Where do business profits come from?


It is remarkable that in an age dominated by Capitalism, capitalistic theories of economics have so little to say about the very force that motivates all entrepreneurial activity – the quest for profits!  Micro-economic theory briefly ventures into the field. But what is true for an individual firm is not necessarily true for the economy at the macro level.  What then drives aggregate business profits in an economy?  To the extent investment is predicated on expectations of future profits, and investments determine growth in GDP of developing economies like India, you would think this question would be at the heart of policy formulation.  The sad fact is such considerations don’t figure in policy making because mainstream economics lacks a theory of profits!  Worse, and with no apologies to Ayn Rand fans, to understand where profits come from one has to turn to Karl Marx, and a later day Marxist from Poland, Michal Kalecki, for a workable theory of profits.


Marx’s insight into the source of profits comes from his studies of money.  Simply put Marx said an entrepreneur invests M amount of money to buy a commodity which he then attempts to sell at a higher price M’, the difference between the two being profit.  But he lost his way in metaphysical questions surrounding value and ended up ascribing all value as being created by labour which the entrepreneur “unfairly” captured.  Michal Kalecki started with Marx’s original insight and ended up holding that business profits are nothing but the original money spent by the entrepreneur returned to him if he is clever enough to capture it. One can summarize his theory in two statements: Firstly, workers as consumers spend what they get. Secondly entrepreneurs get as profits what they spend. The model is explained well in the references below. For our purposes the model may be stated as:


Pn = I + [G-T] + NX + Cp – Sw


where Pn is the gross profit of all businesses after tax, I is the investment made by all firms in the economy, [G-T] is the Government deficit representing the difference between Government spending and tax receipts, Nx is net exports, Cp is consumption by entrepreneurs themselves [think capital flight] and Sw is the aggregate saving of all workers in the economy. What we are basically saying is aggregate profits earned by firms in any economy are the sum of investments made by them plus net contribution to the pool of profits by Government, earnings from exports less what is put away for a rainy day by workers who refuse to spend all they earn.  Cp is usually very small at the macro level unless you think of capital flight from an economy.


Now we have basically turned economic theory on its head. Yet ask any entrepreneur and he will vouch for the truth of the above equation. Why do neoclassical economic theorists gloss over the central role of business profits in macro-economic theory?  That is well beyond the scope of this article here but I refer you to the blog below. Briefly, if you take business profits into account then the so-called stability of the economy as whole falls apart. So for the moment we will simply use the above Kalecki equation to look at what might be done in order to arrest and reverse the falling growth rate in the Indian economy.


Let us begin by noting what is not in the equation.  That by  itself is remarkable.  Inflation doesn’t figure here, neither do interest rates.  What matters first and foremost is investment by businesses themselves. When investment falls, business profits fall, and when expectations of business profit fall, investment falls even more, setting up a vicious downward spiral.  Note the direction of causation. Profits are caused by investment. It is simply what businesses spend that is returned to them. Second, budget deficits are good for profits.  Any entrepreneur worth his salt will tell you that. He doesn’t mind inflation either as long as it doesn’t destruct demand. Interest rates are irrelevant from a macro perspective as long as aggregate demand holds up. It is the absolute value of money added to the profit pool that matters for business profits.


Net exports add to the profit pool because the workers and investment used to create the export goods are in the local economy while the money that pays for them comes from abroad. Exports earnings contribute to the profit pool.  Conversely imports take away from the profit pool because the money to pay for goods and services takes away from the local spending. So if an economy is running a current account deficit, like ours is, the deficit takes away from the profit pool and must be compensated for by a matching Government deficit or the economy would spin into a deflationary spiral.


Lastly consider the matter of workers’ savings. To the extent they save, the total pool of profits available to firms diminishes.  Now you know why firms don’t want you to save and bankers actually drive you into debt.  Savings a just bad news and if workers save the Government must offset the savings by spending if firms are to recover their investments.  If workers save, and Government doesn’t offset that by spending itself, you risk the dreaded deflationary spiral of death.


Seen in light of the Kalecki equation, why has the Indian growth rate dropped to 7% from 9% earlier?  Among the many factors that one can think of 3 that stand out for policy action.


Firstly, expectations of profits have fallen because of worldwide deflation reducing investment. Government needs to step in boldly by reversing those expectations by stepping up its own investment in infrastructure. The deficit it creates is good for business profits and catalyzing more investment by private firms. Corruption, bottle necks in land acquisition, red tape etc are often cited as contributing to the slow down. That wasn’t true of China and isn’t true of India. What matters is Government willingness to invest in infrastructure by itself or catalyzing such investment through State owned institutions as in China. Firms will look at the size of profit pool available: either made available by Government or by the investments made by fellow firms. That is a searing insight provided by the Kalecki model.


Secondly, India’s savings habbits are dangerously deflationary, especially the recent upsurge in savings through investment in gold. Gold imports take away from the profit pool through imports. It is a double whammy. Not only must Government offset these savings by a matching deficit but also the asset created contributes nothing to local spending since gold is imported. Government would do well to tax gold and offer matching tax concessions on housing to promote domestic growth as housing is an attractive hedge against inflation, is not imported and contributes to local spending compared to imported gold. Savings by investment in housing add to the profit pool since to firms that saving is also spending. That policy reform brookes no delay.


Lastly, our slow down has been caused by growth hitting supply side capacity constraints caused by paucity of Government investment in areas of infrastructure that it insists on controlling. It isn’t lack of demand: latent or otherwise. Our inflation level reflects the friction of capacity constraints in agriculture and infrastructure that need supply side policy changes rather than tighter money and higher interest rates. Government must address the root cause of inflation which is underinvestment in agriculture and infrastructure.–-where-do-they-come-from-where-do-they-go.html



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Market Notes 31st Aug., 2011

September 1, 2011 1 comment



Nikkei started its run to the bottom in December 1989 from a high of 38,882.  It made its first low of 14,300 in June, 1995 after a full five part impulse wave down.  This low failed to pierce an earlier low at more or less the same level in 1992 after which, the Nikkei tried to rally meeting with a resistance at 23,000 which it has never pierced since. Wave III of the down move on the Nikkei starting June, 1996 made a lower low at 7,500 in May 2003 before rallying to lower high of 17,300 in April, 2006. Wave V, the last of the impulse waves down, commenced in Mid February, 2007 from a level of 18,200 and continues.  Wave 3 of the last wave down, made a new low of 6940 in October 2008 which has been tested 2 times since in wave 5 of Wave V and in those tests Nikkei held well above 6940.  The last major low, in the 9,500 area was in March this year which is currently being retested.

Taking into account the wave count over the last 24 years of correction, the probability of the 9,500 area being breached is pretty low. While Nikkei hasn’t made new highs as the world markets peaked in 2008, its ebb and flow has been fairly well correlated to that of the rest of the world markets.  Nikkei is one major index that gives signals a bottom formation in equity markets may not be too far off.  On the Nikkei itself, some sort of a confirmation of this should be in evidence by end of September this year.


Dollar Index:

The Dollar Index slide was examined in notes of 8/17 here  .  The index is currently testing the last low 72.85 made in April this year.  Nothing in the market action, including the near certainty of QE3, has induced the $ to make a lower low against its trading partners so far.  A breach looks unlikely and the prognosis in the medium term of 6 months to a year remains the same.  Note, this upward bias in the $ is against its trading partners.  It doesn’t mean the $, together with the currencies of its trading partners, will not depreciate against gold or a clutch of other physical commodities.  Dollar debasement can well continue even as the currency trends upwards against its trading partners.



HG Copper is interestingly poised in the 4.23 area, having rallied as expected.  This area on the long term chart is the “break out” level beyond which much higher highs for the metal are possible. Despite a margin squeeze on bulls by the Chinese Govt., the metal has held firm.  A break out in the near term is unlikely.  That typically takes to 3 or 4 attempts.  But the metal shows little indication of the weakness that one would expect in the prevailing doom and gloom evident in equity markets.



CBT Corn has been in a major bull market from November, 2005 starting from a level of 188 [5000 Bushels contract.]  It is currently testing its all time high area of 760 and is well positioned for a break out.  Chinese appetite for corn to feed pigs is relentless.  That the price has held high despite a weakness in crude prices points to tightness in the underlying physical market. On a break out, corn prices can go anywhere on the charts.  Again, that is not likely to happen at the next attempt to take out the previous top.  A breakout could take time but the trend remains bullish.


S&P 500:

The 1150 area on the S&P 500 represents the mid-way point between the low and high on the index for the last 20 years of the last bull markets.  Interesting then, that the Index is moving back and forth around this level indicating the bulls and bears are evenly matched at the mid-point.  By my reckoning, S&P500 is in the middle of its Wave 3 down that started in April, and is likely to come back to retest the recent low 1100 at least a couple of times between now and March 2012.  The bear rallies from 1100 could be sharp.  But the main trend on the index continues to be bearish.


Shanghai Composite:

The prognosis on the Shanghai Composite remains the same.  It is in a down trend that appears destined to retest the recent lows around 2300-2350 levels sometime before the end of November. Two interesting things stand out.  Firstly the index broke its long term trend line running up from 1990 in August this year. Significantly that comes at the fag end of a multi-year bear market; a sort of last hurrah by the bears.  Secondly, there is a sort of triangle between this long term trend line and one dropped from the top of the last bull market.  With the breach of the lower trend line, prices have fallen out of this triangle.  That smells of a typical bear trap.  All in all, the Shanghai Composite is nearing a bottom around 2300 end November.



Moves on the Sensex conform to what was detailed in the notes .  By my wave count we are currently in the sub-wave 4 up of the impulse wave down from 20,600 starting April this year.  The index should come back to retest 15,500 area once again but Wave5s are prone to failure frequently.  I would be looking at individual blue-chips and prices at which to buy them between now and mid-November.  Not all stocks bottom at the same time.  Some would have bottomed out already.  Tough to call a bottom so the maneuver is not without some downside risk.  However, many investors miss the bus by waiting for the lows to be repeated.  Markets these days don’t give a second opportunity to buy or sell.

NB: These notes are just personal musings on the world market trends as a sort of reminder to me on what I thought of them at a particular point in time. They are not predictions and none should rely on them for any investment decisions.

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