Irrational exuberance strikes investors again?

Who is the most powerful human being alive on this planet? No, it is not george Bush, Hugo Chavez or Mahmoud Ahmadinejad. All those who wield political power can safely be excluded, as it is being repeatedly proven that they are making themselves more and more ineffective and irrelevant. In this fast globalising world where money does all the real talking, it must be the moneybags who have all the power.

But the trouble is there are too many mega-billionaires these days and there is no clear leader. Our own K P Singh of DLF saw his net worth jump by as much as $4.5 billion in a single day this week, which must be the biggest ever wealth addition in a day anywhere in the world!

Besides, except for some eggheads like Bill Gates and Warren Buffet, all the mega-rich are likely to keep most of their money for their own progeny. As long as President Bush continues to swear by democracy, that is definitely not the politically correct thing to do. In a democratic world, the wider you distribute the spoils, the more influence and power you are perceived to wield.

Then the most powerful should be a person who can create immense wealth with a flourish of his pen to ensure that the benefits are distributed widely, or democratically.

Oh, that is definitely Ben Bernanke — the most powerful central banker in the world until last month and, after the big stock market rally we have seen over the last two weeks, the most powerful human alive. Period.

All it took is a US Fed Rate cut for global markets to brush aside concerns over an economic slowdown and inflation on record oil and other commodity prices and the billions lost by banks in last month''s credit crisis.

All major global indices have scaled record highs and some like China and India are galloping without pause. Trillions of dollars have been added to that often chimerical commodity called ''investor'' wealth'' in a matter of days. One can hardly believe that global investors — yes the Chinese are often an exception — the bravehearts that they are, were trembling just last month on fears of a global credit squeeze.

Is it so simple?
If a 50 basis points cut in the Fed rate could save the global economy from the biggest crisis since the Great American Depression, as the big boys form Wall Street said last month, then Ben Bernanke must have been crazy not to have done it in August instead of leaving the rate unchanged. Why did he wait until September after hapless hedge funds and traders in exotic derivatives were driven out of business? Why did he let markets go through the pain, fleeting though it turned out to be?

It has now been officially disclosed that Ben talked to Bob Rubin, President Clinton''s treasury secretary and now one of the top shots Citigroup, and other Wall Street heavyweights before delivering the markets from annihilation.

So, did Wall Street bully Ben into dropping his more hawkish stand on inflation within a matter of two weeks?

The truth is, Ben Bernanke did what any sensible central banker would do when faced with demand slowdown in the economy. Size of a rate cut is always debatable, but it is well accepted that such measures should surprise if monetary policy is to be effective. A full-blown crisis in the financial markets and tight liquidity would have worsened the already weak outlook for the US economy.

Nobody likes a recession, not even central bankers, especially ahead of a presidential election. As a columnist said in the Financial Times yesterday, "in democracies bad stuff is outlawed" if politicians want to be re-elected.

But a large interest rate cut is like giving first aid to an accident victim, which in this case is the US economy. First aid is delivered without knowing or checking the full extent of injuries and it is often difficult to predict whether the patient''s condition will improve. All that is known is that the victim is injured and will take some time to recover.

If the economy is weak, with increasing risks of it turning even weaker, and emergency support has been given in the form of an interest rate cut, why are markets so bullish? Strange as it may sound, but it is because conditions may get even worse and more rate cuts may follow!

Rate cuts bring the omnipotent force called liquidity into the markets and everyone will be happy and more prosperous. Declining corporate performance in a weak economy and soaring stock valuations be damned.

But, can Ben also spring a nasty surprise?
What if Ben Bernanke decides that financial markets have partied enough, and decides to focus more on his pet peeve — inflation? Then he may hike interest rates or keep them steady and the markets will be in for a huge disappointment. We all know what happens when markets are disappointed, especially when the indices are at lifetime highs — investors panic.

But Ben has to keep cutting interest rates as the US economy is still weak and inflation is under control, doesn''t he? Yes, the US economy is weak and can slip further. The housing bust is not yet over and can pull down consumer spending in a big way. Going by the house price futures on the Chicago Mercantile Exchange, average house prices in major US cities may slip another 10 per cent by 2011. That will be the biggest decline in history. If that happens Ben will have no choice but to do what Greenspan did after the internet bubble burst - keep cutting interest rates until the economy revives.

That sounds simple. But, Ben also has to deal with a monster called inflation. When Greenspan started his rescue mission earlier this decade, crude oil was averaging $20 per barrel. Prices of most other major commodities were at historic lows. Greenspan also didn''t have to worry much about the proliferation of complex financial derivatives that can worsen any potential crisis. Bernanke doesn''t have any of these props. He must keep an eye on prices while steering policy in an increasingly complex environment.

The emerging ''emerging market'' bubble
Emerging markets have been the biggest winners over the last couple of weeks as overseas funds flew in droves. Even before last month''s meltdown, or correction as many call it, there were many who said valuations were highly stretched. While the correction was on they were gloating in TV interviews claiming, "I said so". After two weeks, there are pessimists no more. Nobody is worried about valuations or declining margins anymore. And price-earning multiples have shot up even higher, it is nearly 25 for BSE Sensex stocks and — believe it or not — over 50 for the Shanghai Composite Index stocks. One more to China!

This exuberance is driven by only one factor - currency. Most global fund managers are now convinced of one thing - the only way forward for the US dollar is down. The possibility of Asian central banks dumping the dollar, triggering a sharp down move in its value, has increased - if you ask them. When that happens, Asian currencies will gain most. So funds are flowing into Asian equities and fund managers are dreaming of the day when the US dollar collapses.

Even if the decline is more calibrated, they will still make their money. If the rupee appreciates by another 10 per cent by March next year as predicted, foreign investors would have made 10 per cent even if the Indian indices remain at these levels. That is sufficient for many of these investors. After all, fund managers may have to make only around 10 or 15 per cent to beat their benchmark indices next year and take home their fat bonuses.

But, all these may not be as simple and straightforward as most of us assume. The US government will come under increasing pressure to defend the dollar. Cheaper currency will make life even more difficult for the US consumer, who are used to a diet of Chinese goods and Middle East oil. Trade partners like Europe has already demanded that the US support its currency more actively. With the real prospect of a Democrat US president by next year, the greenback may even stage a pullback rally.

By the time that happens, if it happens, it is quite possible that emerging market stocks would have rallied some more. But, most of these markets already appear like oversized. Bubbles they may not yet be, but bloated they definitely are.