Sensex Seesaw

At a time when money was supposed to have flown in torrents into the capital market, stock prices have hardly budged. And instead of confidence, there is diffidence, confusion, fear and desperate attempts to explain why stock prices are refusing to maintain a shining trajectory.

This year began with worries about whether the market would be able to absorb the large portfolio investment that was projected to flow into India. Foreign institutional investors FIIs had pumped in 7 billion into Indian stocks in 2003. They were supposed to double their investment in 2004. There were fears of a speculative bubble if this new money were to chase scarce investment opportunities. Investment bankers were urging the government to hasten the disinvestment of PSUs in order to soak up the inflow of dollars and expand the basket of good stock in the market.

Not any more.

Suddently leading investment bankers are struggling to explain the viciously volatile market behaviour. It began on January 6, but the sharp increase in volatility was especially obvious after the finance minister announced his 8216;mini-budget8217; on January 9.

Normally, the market should have ended on a euphoric new high. Instead the benchmark Bombay Stock Exchange Sensex touched an all-time high of 6249.60, dropped to a low of 6096.68 on the same day and finally closed at a sedate 6119.59 8212; an intra-day movement of 152 points.

That was just the beginning. Since then, it has been day after day of fierce plunges and sharp upward peaks that have exerted a downward pressure on prices in January, ignoring extremely significant bullish developments.

After all, the rupee is stronger, Fitch and Moody8217;s have upgraded India8217;s credit rating, most leading companies have announced excellent corporate results and the mini-Exim Policy has loosened the import regime and reduced duties. All this is in addition to Jaswant Singh8217;s 8216;mini-budget8217;.

But the market remains unimpressed.

Although the overall sentiment continues to remain bullish, the inexplicable daily mood swings are forcing brokers, investment bankers and fund managers to find a variety of excuses for the market8217;s strange behaviour.

For several days, the volatility was attributed to the alleged confusion over the status of Participatory Notes PN. These are derivative instruments issued to overseas investors, who are not eligible to invest in the market and represent a basket of underlying securities.

PNs issued to unregulated entities are considered a problem because they provide an entry to hot money, Indian black money stashed abroad, and international hedge funds whose investment strategy of swooping in on market asymmetry to make quick money sometimes tends to destabilise markets.

However, the PN issue resolved itself a few days ago with the Securities and Exchange Board of India SEBI choosing not to impose any significant curbs on their investment. Although a section of the business media exaggerated the PN effect, FII operations over the past fortnight do not indicate any serious panic over this issue.

In fact, FIIs have been net buyers of equity on most days of the past fortnight see graphic irrespective of whether the Sensex had risen or fallen. But the impact of their huge buying and selling operations in inducing market volatility probably needs further study.

Especially since SEBI8217;s permission for PNs to be issued to regulated entities from around the world still leaves it clueless about their beneficial ownership and exposes the market to the dangers of fickle hedge fund investment.

Another explanation for the steep intra-day spikes was that large operators were forced to unwind leveraged positions to make margin payments.

Leveraged trading on the stock market is usually funded with a margin payment of 25 to 40 per cent of the ruling market price. However, when prices fall sharply, jittery financiers ask borrowers to top up margin payments with additional funds or to reduce their exposure by selling a part of their holding.

The sharper the fall in prices, the more indiscriminate are the sales meant for margin payments.

Anecdotal evidence suggests that such sales indeed depressed prices even further on bad days. But that still does not explain the schizophrenic 8216;8216;up one hour, down the next8217;8217; kind of movement.

In normal situations, a 70 to 80 point movement of the Sensex is considered significant. But since January 6, the intra-day peak and dip of the Sensex have been a frightening 200 points-plus almost everyday. And on January 22, when the Sensex fell sharply to 5,593, the intra-day movement was a phenomenal 285 points see graphic.

Traders have often attributed the high volatility to FII activity in the derivatives segment. They claimed that FIIs were not merely hedging off their cash market investments against the derivatives trades, but were going short in the futures market, thereby causing turbulence in the cash segment as well.

While it is indeed true that FIIs have been short on the derivatives segment, the regulators have not found evidence of manipulation.

Yet if there is one factor that differentiates the present bull run from the past, it is the explosive growth of the derivatives market.

Even in the bull run of 2000, the National Stock Exchange NSE had generated trading volumes of over Rs 5,000 crore per day in the cash market, and for a while the combined turnover of the NSE and the BSE had touched Rs 10,000 crore.

Take a look at trading volumes. NSE8217;s daily turnover in the cash market is over Rs 5,000 crore, but volumes in the derivatives segment have been thrice as high at an incredible Rs 15,000 crore plus everyday.

These volumes reflect higher activity by investors, especially day traders, who are forced to operate in shorter time segments. But do these high volumes also make it easier to hide market manipulation?

Possibly. But there are no sure answers yet. Stock exchange sources confirm that FIIs have indeed been extremely active in the specific time intervals when the market has violently gyrated. What remains unclear is whether these FIIs represent genuine foreign institutional investment or are fronts for Indian money.

ALSO unclear is whether dozens of FIIs, or at least their sub-accounts, could be acting in concert to induce volatility and create short-term profit opportunities for themselves. In India, market kingpins over the past few decades have been known to operate through dozens of brokerage firms across four or five bourses. Is it then inconceivable that the trading of a score or more sub-accounts are controlled by a single group?

Only the regulator or the stock exchanges are in a position to find out. But even if their analysis does detect suspicious trading patterns, it will still be a difficult task to track beneficial ownership or prove that the manipulators were acting in concert.

What can the regulator do in these circumstances to maintain investor confidence? It can put more information out in the public domain; for instance the trading operations of insurance companies and Unit Trust of India. It can also hasten FII registration and hope that fresh portfolio investment will make manipulation more difficult. Thirdly, it can ignore criticism of vested interests and remain vigilant about the quality of FII money.

Dalal Street Talk: Hang on in there

In the run-up to the elections, some amount of volatility is expected. But the underlying fundamentals are strong. Retail investors should keep in mind three things: First, stay away from little-known, little-researched companies with rosy results. Second, if buying stocks of a top company, set a target and don8217;t get nervous over intra-day drops. And finally, if you don8217;t have the wherewithal to play the market, go in for a mutual fund with a dividend option.

Krishnamurthy Vijayan
CEO, JM Mutual Fund

AT any extreme point, volatility will come. With time the definition of volatility keeps changing. Earlier it was a movement of 50-100 points, now it is between 100-200 points. One hundred points on a 3000 index is 3 per cent and even 200 points on 6000 is 3 per cent. With such a large number of players, huge amount of money and high index levels, this movement is not a cause of concern. Investors need not worry about the ups and downs of the market. Instead, they must take the opportunity to invest in good quality stocks.

Motilal Oswal
Chairman, Motilal Oswal Securities

THE volatility is mainly because of the large open positions in the derivative market which have come down in the last few days. The rumour on foreign funds not being able to participate in the market is not playing such a large role in market sentiment. It8217;s the arbitrage position between cash and futures which is playing a large role.

Anup Bagchi
COO, ICICI Direct

FROM 2500 to 6000 is quite a journey. In fact each point that the market covered during its climb was a journey in itself. So, although volatility is an issue, it is all very momentary. The market will consolidate at the 6200 level, and will remain there for the next 12 months. All the fundamentals 8212; the corporate results, government decisions 8212; are moving in the right direction, so I don8217;t see the markets falling anytime soon. I8217;d advise investors to look at a 12-15 month horizon now.

NK Sharma
CEO, IL038;FS Mutual Fund

WELL, this is pre-election time, new sops are being announced everyday, corporate results are out, more results are expected8230; as a result of all this, the market is behaving erratically. But once the elections are over and we have a stable government, this will stop8230; the market will settle down to more realistic levels. For the average investor, I will always advise investment through mutual funds. Don8217;t put all your money in equities. There should be a 80:20 break, 80 in fixed and 20 in equities. Book profit and then recycle it back to the 80:20 formula.

S K Mitra
MD, Birla Sunlife Mutual Fund

The volatility may continue for some time because the market has not yet been able to digest the huge gains made in the last 12 months. There is also the ripple effect of the international markets. Once the market is able to come to terms with the gains, we will see more stability. The misunderstanding about the entire PN issue had also added to the choppiness.
But I foresee the market maintaining the same high levels, simply because our economy is doing well. As far as investors are concerned, the next three years are looking great. But, yes, equity will outperform any other investment tool.

Shailendra Bhandari
CEO, Centurion Bank

Compiled by Arundhati Bakshi-Dighe and Shefali Anand

RED RAG

What led the bull charge in the markets? These could be the factors:

8226; Participatory Notes: A potential source of international hot money, the first suspect when the market behaves erratically

8226; FIIs: Net buyers of equity on most days of the past month, their contribution to the volatility is still open to speculation. It8217;s unclear if they represented genuine foreign investments or were fronts for Indian money

8226; Large operators: Under pressure of falling prices, they could have downloaded part of their holdings to make margin payments. The rule is: The sharper the fall, the more indiscriminate the sales. This doesn8217;t explain the spikes, though

8226; Collusion among FIIs and large players: Short-term profits could have induced FIIs or their sub-accounts to tie up. But it will be difficult to prove they were acting in concert

MONEY TALKS
HEDGE FUNDS

Operating as sub-accounts of FIIs registered with the SEBI, they are purely speculative in nature, using hot money for investments. Hedge funds currently have 1 billion invested in India through participatory notes issued by FIIs. While funds originating in the US are regulated there, many funds registered in tax havens are not monitored anywhere. They are not regulated in India.

Despite being called so, there is no real hedging involved in these funds: they are opportunists who want to make a fast buck. Their modus operandi is unique: They invest and pull out funds fast, using all kinds of high-risk methods. The returns 8212; and the losses 8212; can be very high.

PARTICIPATORY NOTES

PNs are basically contract notes issued by FIIs operating in India for amounts mobilised by foreign investors who do not want to invest directly or are barred from doing so. Such investors 8212; genuine investors or Indian corporates or residents with funds parked abroad 8212; can ask FIIs to put in money in specific shares. But the SEBI or anybody in India would have no idea about the identity of such investors.

Studying the PN route recently, SEBI discovered that 31 overseas corporate bodies floated by Indians had invested in India through PNs issued by four FIIs. It told the Finance Ministry, 8216;8216;Many FIIs were not willing to part with details because of the confidentiality clause it has with the investors.8217;8217;

SEBI estimates nearly 5 billion 8212; almost 25 per cent of the total FII investments 8212; has entered India through the PN route.

George Mathew