'This rally will end only when couple of European banks go bust'

Santosh Nairmoneycontrol.comThe ongoing rally in equity markets globally has its roots in the banking crisis in the West and will end with a banking crisis in the West, feels Saurabh Mukherjea, CEO, Institutional Equities, Ambit Capital“It is not about valuations any longer; the rally will end only when a couple of banks in Europe go bust,” he said in a free-wheeling chat with moneycontrol.com. Emerging markets have been on a tear for over a month now, powered by a gush of liquidity from exchange traded funds as well as by money moving out of European markets.Global investors have shrugged off concerns over Brexit, assured that further monetary easing by central banks should be able to fix any complications arising out of Brexit.But the stress tests by the European Banking Authority (EBA) on 51 lenders from across the EU, revealed chinks in banks in Italy, Ireland, Spain and Austria. “It is not only the banks in Italy and Portugal that could blow up; some very sound European banks too look pretty vulnerable,” Mukherjea said, adding, “…unfortunately it is hard to time that.”The problem according to Mukherjea is that two developments—negative interest rates and negative inflation-- are striking at the heart of the premise that the entire banking system is built on.“If interest rates are negative, why would banks want to lend? If inflation is negative, the cost of your loans (to borrowers) will keep rising and borrowers then have a greater incentive to default,” said Mukherjea.A report on CNBC.com says there are still close to 1 trillion euros (USD 1.12 trillion) worth of non-performing loans (NPLs) on euro zone banks' balance sheets, making them highly vulnerable in the case of a crisis. Also, the results of the latest stress tests on leading European Union banks have been diluted by the omission of risks such as the effect of negative interest rates and Brexit, reports Reuters.Some market analysts are worried at the blind faith the investing community seems to be having in central banks to fix any problem. Others are questioning the behaviour of central banks.“Central banks have crushed yields everywhere," Sanjeev Prasad of Kotak Institutional Equities told CNBC-TV18 on Monday, "...destroyed the concept of risk in a way and the whole message which is there from central banks is do whatever you feel like, we are there to protect the appreciation in stock prices or any asset prices for that matter.” “So people are just partying based on the macro inputs which one is getting from the central banks,” he said.Many stock market experts have warned about expensive valuations and that a steep correction was likely when valuations reverted to mean.But Mukherjea feels the rally will go on till a banking crisis surfaces.“Valuations have a meaning when there is a cost attached to money; they are meaningless in a world with negative interest rates. If money is free, valuations can be anything,” said Mukherjea.And he feels that the limits to the ability of monetary policies will be tested before long.“There is this feeling that central banks can keep printing money and all will be well with the world. But when banks default, the limits to monetary policy will become obvious,” he said.Also read: Fund managers' Catch 22: Doomed if you buy, doomed if you don't