Bonds, Equities and the Broader Economy...

Real or inflation adjusted bond yields and interest rate are important from the investment view... The bonds are paying inflation premium and term premium too which make up higher nominal bond yields, higher inflation expectations are also responsible for higher nominal bond yields...

But, now, inflation has increased which has reduced real bond yields and real interest rate, which could increase demand... Nonetheless, higher inflation expectations have increased bond yields expectations and lowered bond price expectations and more investment in the equities and the production and the inventories... Higher bond yields and expectations mean that the economy has expectations of a bounce back in demand and spending...

The RBI has used a flexible inflation targeting of 4% with a band of 2% on the either side which means the RBI could remain neutral between 2-6% and inflation lower than 2% attracts rate cuts and above 6% rate hikes... This time it must avoid rate hikes upto 6% and remain neutral, but higher inflation means hold on further rate cuts since real interest rate has gone below 1%...

Low and stable real interest rate and higher inflation expectations could increase spending in the economy... End of the rate cut cycle might increase demand and spending...

The RBI may adopt a neutral approach, open to work both ways since inflation is close to its medium term target of 4 - 6%...

Higher food and oil prices get transmitted into the higher cost of living or wage cost and higher cost of borrowing or interest cost and higher price level or inflation means lower savings and investment and consumption... Lower GDP...

The RBI does not control bond yields and wages, they are market determined, though only indirectly... which also decide demand and spending in the economy...

Oil prices are doomed to see a big correction with a downward bias... EVs have changed the market share equation; oil prices are unable to make a comeback (higher prices) despite of supply cuts...

Market share depends on competitiveness and increasing productivity which means lower prices and higher demand and supply or quantity and prices and profits and expectations... Though prices are volatile and move between high and low...

Whatever investors do in terms keeping in the mind rational expectations would be self-reinforcing and self-fulfilling... If they expect or the market hopes that prices would increase, higher demand or lower supply would increase prices and vice versa... Nonetheless, if they increase demand at low prices and increase supply at high prices that would narrow the volatility in the market...

Lowest interest rate means that it would not go down, bond price also would not increase and not profitable in the short run, which means that recession or slowdown or low growth and prices and expectations have reached the bottom so people increase investment in assets or inventories or stocks which have a higher price expectations...

During slowdown bond prices go up that have an inverse relationship with the broader economy and lower interest rate and bond yields... Higher bond yields expectations or lower bond price expectations due to increase in demand and prices and interest rate could increase selloff in the bond market in the short run an further increase bond yields or lower bond prices and increase allocation to the other asset class that have higher price expectations during recovery with an accommodative money and demand supply policy...

The Govt is planning to change base year for growth… The change in the base year after adopting the inflation targeting framework looks reasonable... From that viewpoint 2015-16 is quite normal low inflation, below 4%, and high growth rate, above 8%... and could serve as the base year.... Near 4% average inflation is good to keep the inflation target framework…

Investors must take into account P/B ratio which must be below 2 which shows that the stock is not too overvalued and the possibility of correction is low, nonetheless people must invest slowly if they are investing short term on more correction in the stock...

Secondly, high P/E ratio above 20- could help getting higher returns... P/E ratio shows that the stock has given high returns in the past... Consistency in returns and growth brighten expectations....

Long term investors in good companies need not to worry... 10 years time is a good time horizon for investment... Mutual Funds choose stocks carefully and the risk is diversified...