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Exactly a decade ago, during the second week of July 2007, S&P downgraded US$7.3 billion of securities sold in 2005 and 2006. A few weeks later, Moody’s Investor Service slashes ratings on 691 securities from 2006, originally worth US$19.4 billion. Some 78 of the bonds had Moody’s top rating of Aaa. The securities were backed by second lien mortgages that included piggyback mortgages. Moody’s stated that the cause for the downgrades was the dramatically poor overall performance of such loans and rising default rates. Fitch also downgraded subprime bonds sold by Barclays, Merrill Lynch and Credit Suisse.
 
This was beginning of, what would become a global financial crisis in no time. The crisis which would annihilate some of the leading financial institutions like Lehman Brothers and Merrill Lynch, threaten the solvency of some of the most powerful empires in history, namely Portugal, Italy, Greece and Spain (Inappropriately clubbed under acronym PIGS), lead to erosion of trillions of dollars from global wealth, cause millions of job losses, imperil the unity of European Union, and push the world into a prolonged period of low growth.
 
Surprisingly, the stock markets did not react to the crisis immediately. After a small jerk in July 2007, stock markets across the world rose dramatically. Except for Chinese equities that corrected in October 2007, most markets rose sharply till January 2008. This was perhaps the sharpest bear market rally, in our view. And then came the inevitable crash. From last week of January to March 2009 was one of the worst periods in decades in terms of stock returns.
 
The challenging times call for tough measures. But that was not to happen in this case. The central bankers across the world got united to bail the world out of this crisis through an "unconventional method" - quantitative easing, an euphemism for printing more money.
 
"Whatever it takes" was the new paradigm. The mints across the world ran overtime. Centrals banks printed enough money to buy all the junk available on street, bail out profligate governments & errant banks, and splurge concessions on consumers to boost consumption.
 
To their credit, the gigantic effort did help in unfreezing the global markets, stabilizing the global financial system, forced a certain degree of fiscal discipline amongst the profligate government, pull out the global economy from recession (that was widely feared to snowball into a worldwide depression, worst that the 1930 episode)
 
The strategy however created a New Normal in the global economics. Something that was not there in the economic text so books.
 
The unprecedented monetary and economic stimulus failed to bring the inflation back. The commodity producers continue to struggle. The economic growth potential for most developed economies scaled down materially. The investment demand therefore seems unlikely in foreseeable future. The bond yields remain close to their lows, despite talks of imminent talk of policy reversal. Reflation and bond correction are two trades that have deceived millions of traders following old text books
 
....to be continued next week
Silkrose Fiscal Serviecs LLP & Adroit Research Team 
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Disclaimer: SilkRose Fiscal Services LLP (SFSL) is NOT registered with SEBI as Advisor. The updates are purely a view point / public domain news and there is no assurity on the returns. Hence all the members are requested to apply their prudence and consult their financial advisor before acting on any of the recommendations by the company. SFSL is not responsible of any losses incurred (if any) by acting on the updates. All news shared by SFSL is meant for free view and the company does not earn revenues from sharing any public domain information.

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