The difference between Sep 2007 and Jan 2008, and the case for PSU banks

Yesterday, Bernanke hinted at aggressive policy action.

Bill Gross - the bond king at Pimco - argues for 3% Fed rate. His argument is that real Fed rates touch 1% in a slowdown/recession. Core US inflation is 2%, which gives a Fed rate of 3%.

This seems likely now. Fed is at 4.25% today. 50bps is likely on Jan 30. June interest rate futures are pricing in a 3.2% Fed rate.

Despite aggressive Fed cuts now, US will go through a slowdown/recession. If it hits exporters like China and causes their stock markets to correct, will it have rub off effects on our own markets? Or like in Sep 2007, if Fed eases by 50bps, the India momentum trade will take another leg up.

There is a difference between now and Sep. In Sep, it was a financial crisis. Now, it is turning into an economic one.

In Sep 1998, Fed cut during a financial crisis - LTCM. In late 1999, Fed cut in a technological crisis - Y2K. Both times markets went up.

In Jan 2001, Fed cut, and still markets crashed. Because that time, it was an economic slowdown.

The case for PSU Banks

Two scenarios are possible from here:

a) A new momentum grips the Indian markets. Banks are going to be one of the beneficiaries, this includes PSU banks.

b) If economic slowdown worries hit emerging markets like China, India wont be immune. But then, RBI will cut rates - after all this is an election year. This will cushion the interest rate sensitive sectors - real estate, banking. Real estate and pvt sector banks stocks are a bubble, so they might still deflate. But PSU banks are relatively cheap.

So, I think PSU banks are the safest way to play momentum.