Sensex, Nifty charts (Mar 27, 2020): short covering rallies after touching 3 year lows

FIIs eased up on their huge selling spree. They were net sellers of equity on the first four trading days, but were net buyers on Fri. Mar 27. Their total net selling was worth Rs 71.65 Billion. DIIs were net sellers of equity on Thu. Mar 26, but were net buyers on the other four days. Their total net buying was worth Rs 43.08 Billion, as per provisional figures.

RBI resorted to out-of-turn interest rate cuts in a desperate bid to stop the economy from sliding further. The Repo rate was cut by 75 bps (0.75%) to 4.4%, which is lower than its previous low of 4.74% in Apr '09. 

The Reverse Repo was cut by 90 bps (0.9%) to 4%. The CRR was cut by 100 bps (1%) to 3%, which is likely to inject Rs 1.4 Trillion into the banking system. The move is expected to encourage banks to lend more.

BSE Sensex index chart pattern

The daily bar chart pattern of Sensex dropped to touch a new 3 year low of 25639 on Tue. Mar 24 before embarking on a sharp and swift short-covering rally. The index touched an intra-day high of 31126 on Fri. Mar 27, but formed a 'reversal day' bar (higher high, lower close).

Sensex is correcting the 11 year gain of some 34000 odd points from the Mar '09 low to the Jan '20 top. A 50% Fibonacci retracement is expected to drop the index to about 25100. Tuesday's low came within 500 points of this critical level. 

Daily technical indicators are in various stages of correcting oversold conditions. MACD turned up inside its oversold zone, but is facing resistance from its falling signal line. RSI has emerged from its oversold zone, but its upward momentum has stalled. Slow stochastic has risen sharply towards its overbought zone, hinting at an end to the short-covering rally.

Sensex corrected 16600 odd points from its Jan 20th top to its Mar 24th low. A 38.2% Fibonacci retracement of the fall can take the index to about 32000. The falling 20 day EMA is at 32200. The zone between 32000-32200 will be a tough resistance to cross for the index.

Small investors with no experience of the 2008 bear market would do well to refrain from chasing the rally. Sensex may fall further before a recovery in the stock market and the economy can happen. It will be a slow grind upward taking several months - may be even a year or two.

NSE Nifty index chart pattern

The weekly bar chart pattern of Nifty bounced up sharply after touching a new 3 year low of 7511, but closed well below its 200 week EMA for the third straight week. The 20 week EMA crossed below its 50 week EMA for the first time in 3 years, and both weekly EMAs are falling. The 200 week EMA is beginning to turn down.

The long-term bullish structure of the chart has been wrecked by bears. FIIs have pulled out more than Rs 580 Billion from their equity holdings during the month, and are expected to continue with their exit strategy.

Weekly technical indicators are looking bearish and oversold. MACD is falling inside its oversold zone. RSI is also falling inside its oversold zone. Slow stochastic has bounced up a bit from the edge of its oversold zone. Last week's short-covering rally should end soon. 

After touching a low of 17.15 on Mon. Mar 23, Nifty's TTM P/E moved up to 19.52, which remains above its long-term average. The breadth indicator NSE TRIN (not shown) dropped sharply into its neutral zone, where it has been treading water. Any further rally may be short-lived.

Bottomline? Sensex and Nifty charts have closed well below their respective 200 week EMAs for the third straight week - signalling the start of long-term bear markets. RBI's desperate interest rate cuts are too little too late to trigger economic growth that has been decimated by the virus lock-down. Small investors should continue with their SIPs, while waiting patiently for the correction to play out.

Nifty chart: a midweek technical update (Dec 07 '16)

FIIs were net sellers of equity on Mon. Dec 5, while DIIs were net buyers. The roles reversed during the next two days, as FIIs turned net buyers and DIIs became net sellers. For the three days, FII net buying was worth only Rs 0.38 Billion and DII net selling was worth only Rs 0.57 Billion.

Nikkei India's Manufacturing PMI for Nov '16 slipped to 52.3 from 54.4 in Oct '16, while the Services PMI for Nov '16 dropped to 46.7 from 54.5 in Oct '16 - thanks mainly to reduced activity following demonetisation of high-value bank notes. (A number below 50 indicates contraction.)

RBI Governor kept interest rates unchanged at today's policy meeting. The stock market had already priced in a 25 bps rate cut. The status quo came as a negative surprise that led to a sell-off during the last hour of trading. However, withdrawal of the 100% incremental CRR from Dec 10 will be positive for banks.

The daily bar chart pattern of Nifty continues to face resistance from its falling 20 day EMA. The index formed a 'reversal day' bar (higher high, lower close) due to a sell-off after the status quo on interest rates and a 50 bps lower GDP projection by the RBI.

All three EMAs are falling, and the index is trading below them - and well below the down trend line - in bear territory.

Daily technical indicators are giving conflicting signals. MACD and RSI remain in bearish zones and are not showing much upward momentum. However, Slow stochastic is rising above its 50% level in bullish zone.

Some more consolidation in the range between 8000 and 8300 is likely before a decisive move can occur. The fact that FIIs have been net buyers of equity during the past two days will raise bullish hopes.

Nifty's TTM P/E has varied between 21.25 and 21.56 during the first 5 trading days in Dec '16 - which is above Nifty's long-term average P/E. The breadth indicator NSE TRIN (not shown) has dropped down after briefly entering its oversold zone - suggesting some sideways consolidation.

Use the dip to slowly accumulate fundamentally strong stocks that have held their ground during the past month despite the chaos following demonetisation of high-value bank notes.

Nifty chart: a midweek update (Jun 08 '16)

A  delayed monsoon and an upside risk to CPI inflation were the probable reasons why the RBI Governor kept repo, reverse repo and CRR rates unchanged during yesterday's policy announcement.

Though the move was widely anticipated by economists and market experts, bulls treated it as 'no news is good news' and went on a buying spree. 

In the three trading days this week, FIIs have been net buyers of equity worth Rs 1050 Crores. DIIs were net sellers of equity worth Rs 440 Crores.

Passenger vehicle sales in May '16 rose 7.6% over May '15, against a YoY growth of 11% in Apr '16. Maruti, Hyundai, M&M, Ford and Renault showed good growth. Honda, Tata Motors, Volkswagen and Nissan showed decline in sales.

The daily closing chart pattern of Nifty shows a 3-step recovery from a 15 months long down trend after formation of a 'double bottom' reversal pattern in Feb '16.

Step 1 was a sharp rally during Mar '16 that faced strong resistance from the 200 day EMA. Step 2 was a 8 weeks long sideways consolidation within a 'symmetrical triangle' pattern.

Step 3 was a sharp upward breakout from the triangle into bull territory, followed by the 'golden cross' of the 50 day EMA above the 200 day EMA that technically confirmed a return to a bull market.

A 'doubting Thomas' may point out that Nifty has gained only 18.7% from its Feb 25 '16 closing low of 6971, whereas a 20% gain is required to confirm a bull market.

Also, the index is yet to close above the long-term resistance level of 8275, though the level was breached intra-day two days in a row.

But these may appear to be nothing more than technical nitpicking. The chart is firmly in the grip of bulls. All three EMAs are rising and the index is trading above them.

Does it mean that the index will continue to rally without a correction? Obviously not. 

All three technical indicators are in their overbought zones following the sharp rally after the upward breakout from the triangle. The breadth indicator, NSE TRIN, has dropped back inside its overbought zone.

A correction or consolidation may be around the corner.

A chart can look overbought for long periods during a bull market. Should you now chase the rally? Prudence requires waiting for a dip to enter/add.

A few market analysts have mentioned substantially lower levels for Nifty due to high valuations and global uncertainties. You should ignore them.

But don't throw caution to the wind. Do not try to short the index. If you decide to buy, pay attention to your asset allocation plan and maintain a suitable stop-loss.

A modern day parable about profligacy and prudence

Once there was a young man who lived in a small village more than two hours by train from the nearest big city. None in his family had ever studied beyond Class 8 in school. But the young man had a dream – to become a lawyer and save his fellow villagers from being exploited by the zamindar.

He pursued his dream and did become a lawyer, and went on to earn a huge fortune. He spent a lot of his earnings in building a school and a college near his native village. He also bought large tracts of land with fruit orchards and lakes. The land was cultivated to grow food grains. Fruits from the orchards were sold in the market. The lakes were used for fish farming. Villagers were employed to look after the property – and shared part of the bountiful produce.

Things were going well for the villagers – who were prospering. The lawyer was happy that he was able to make a difference to the lives of his fellow neighbours – though he spent most of his time in the big city.

But there were dark clouds on the horizon. The lawyer had a son who was a good-for-nothing spendthrift, who spent most of his time with friends and enjoyed the good life. Despite his best efforts, the lawyer could not make his son mend his ways. He was too busy with his legal practice anyway. So he thought of a plan.

He formed a trust, with his childless younger brother as the trustee. His son was to receive a regular allowance per month, but the trustee was the sole authority for sanctioning any additional expenditure. After the lawyer passed away, the trust came into force – much to the chagrin of his son.

He was soon running through his monthly allowance and kept asking for more from his uncle, the trustee. The uncle was initially indulgent, because he felt sorry that the young man had recently lost his father. But he soon realised that his nephew was taking undue advantage of his indulgence. So, he tightened the screws and refused to sanction extra amounts.

The nephew was taken aback, but instead of mending his ways, he brought over his friends and tried to threaten his uncle with dire consequences. But the uncle refused to budge. So he changed tactics and started imploring and cajoling his uncle for more money.

The uncle said he may re-think provided his nephew met certain conditions. First, he would need to get rid of his freeloader friends. Next, he would need to take an active interest in his father’s property in the village – to ensure that the villagers were doing a proper job of maintenance and upkeep as well as to plug the large amount of leakage of produce that was being siphoned off by various middlemen.

The nephew agreed to the conditions and did prevent his friends from hanging around all the time – though he didn’t really get rid of them. The uncle sanctioned some extra allowance as a quid pro quo. But the nephew showed no interest in looking after the village property of his late father, nor in plugging the pilferage.

Next month, the uncle refused to sanction any extra money, and reiterated his conditions. The nephew promised to change, but his uncle said he won’t sanction anything till he actually saw some change on the ground.

And so the stalemate continues at the time of writing. The nephew (read UPA II) may have good intentions to change, but is unwilling or unable to do so because of his friends (the Mulayams and Mamatas). The uncle (read RBI Governor) has put his foot down and said thus far and no further (by keeping repo, reverse repo and CRR unchanged). The 1% cut in the SLR – from 24% to 23% – was just a token gesture to show good intentions by increasing liquidity without affecting the high inflation rate too much.

To cut, or not to cut, that is the question: for the RBI Governor

“Whether 'tis nobler in the mind to suffer
The slings and arrows of (outraged industrialists and analysts),
Or to take arms against a (policy-paralysed government)
And by opposing end them…..” (with due apologies to William Shakespeare).

It wouldn’t be at all surprising if the RBI Governor is thinking like Hamlet prior to the policy announcement on Jun 18 ‘12. On the one hand, the abysmal IIP figure of 0.1% raised hopes of an interest rate cut among various stock market participants, who went on a buying spree. On the other, rising inflation poured cold water on rate cut expectations, and the stock market tanked.

 

What is so great about an interest rate cut, and why are market participants getting swayed by opposing possibilities? There was a greater–than-expected 50 bps (0.5%) repo and reverse repo rate cut in April – what happened after that? The stock market dived in May! Even if there is a 25 bps or 50 bps rate cut in June, it is highly unlikely that the sluggish economic growth engine will suddenly spring back to full speed.

 

Rate cuts tend to have a lag effect on the economy. Only after several rate cuts can one expect the captains of industry to start investing again and revive stalled expansion projects. Also, rate cuts alone can’t stimulate the economy. The government has to play an enabling role by cutting wasteful expenditure on subsidies and populist programmes, and make it easier for entrepreneurs and businessmen to start and expand businesses by reducing red tape and corruption.

 

From one extreme of doling out coal blocks and mining rights to all and sundry after duly lining their own pockets, government mandarins have gone to the other extreme of not sanctioning anything because they are afraid of being put behind bars on graft charges. Where bold policy decisions are the order of the day, senior ministers and opposition members are turning themselves into a laughing stock by their idiotic bickering and posturing over who will become the next President of India.

 

The great Indian growth story is being stymied by self-serving, thick-skinned representatives of the people who think it is their birth-right to loot the country’s resources. And they have the gall to blame the RBI Governor because without growth there will be no new projects, and without new projects the politicians can’t make money!

 

The RBI Governor should stick to his guns and conscience (he seems to be the only one with a conscience) and not succumb to any pressure about cutting interest rates in June. In fact, if inflation continues to rise – which is a good possibility because of the delayed monsoon – he should raise rates.

 

Will that be bad for the stock markets? Sure it will. The market seems to have factored in some sort of a cut – either in the interest rate or the CRR. Leaving rates unchanged may be taken as a negative.

 

Investors should take the motto of the Boy Scouts to heart: Be prepared. A drop below 4700 on the Nifty would provide a good buying opportunity. A spurt to 5200 can be used to sell.

What message did RBI convey with the 50 bps interest rate cut?

In a move that pleasantly surprised the market, RBI’s governor announced a 50 bps (0.5%) cut in the repo and reverse repo rates, while keeping the CRR unchanged. The consensus estimate, after announcement of a slightly lower WPI inflation rate on Monday (Apr 16 ‘12), was a 25 bps cut. The repo and reverse repo rates are back to levels last seen in Jul ‘11.

RBI had made it quite clear through several previous policy announcements and interest rate hikes that controlling inflation was its top priority, even if it curtailed growth. Of late, it had come under a lot of criticism from corporate bigwigs and analysts for being too hawkish, since the rate hikes didn’t help in bringing down inflation by much.

Monetary policy alone can not help moderate inflation in a situation where the country’s current account deficit (currently at 4.3% of GDP) and government’s fiscal deficit (now at 5.9% of GDP) are at unsustainable levels. RBI had pretty much exhausted its policy options. Unless the finance ministry reduced its wasteful expenditure on subsidies and took bold decisions on economic reforms, there wasn’t much the RBI could do. Note the status quo that existed from Nov ‘11 to Mar ‘12 in the chart below:

Q3 GDP figure of 6.1% – down from the heady days of 9-10% growth a few years back – and WPI inflation falling below 7% probably forced the RBI’s hand. They were being made the scapegoat for India’s sliding GDP growth, when the blame should have been laid squarely on an inept and scam-ridden government.

Today’s 50 bps rate cut is a clear message to the finance ministry from the RBI: “We have done more than was expected; now it is your turn.” Unless efforts are made to curtail deficits and bold policy initiatives are taken to attract overseas investments, inflation will start rising again as the base effect of the previous year wears off. The RBI governor has clearly mentioned the possibility in his policy statement. Further rate cuts that are required to stimulate the economy and incentivize capital expenditure by corporate India will then be kept on hold.

The following chart depicts the relation between the repo rate, WPI inflation and industrial production over the past eight quarters:

It is quite clear from the chart that industrial growth has been affected in a high interest regime. Will corporate India jump up and open its purse strings because of the 0.5% lowering of interest rate? Not very likely. That means slow growth will continue for another quarter or two. It is now up to the government to take policy decisions that will be good economics rather than good politics.

The proposed ban on prepayment penalty of floating rate loans will be welcomed by EMI payers. For the stock market, any drop in interest rate is good news. The bulls should come charging with renewed vigour.

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Market celebrates RBI interest rate hike – why?

Should you ignore the Feb ‘12 IIP number?

For the uninitiated, the Index of Industrial Production (IIP) is one of the many indicators that policy makers look at to assess the strength or weakness of the broader economy. So, why should investors ignore the IIP number declared today? The short answer is: The figure is unreliable at best, and fiction at worst.

Am I being harsh? Sure. But how else can I describe an important indicator if the Jan ‘12 number is revised downwards from 6.8% to 1.14%? The reason for the sharp downward revision was an ‘error’ in the calculation of production data for sugar. Production figures from all the sectors don’t always come in on time. A ‘best guess’ is often made for the numbers from the missing sectors. That still doesn’t justify an 83% error!

What about the Feb ‘12 number of 4.1%, which was much lower than the consensus estimate of 6.6%? It is better than the revised Jan ‘12 figure of 1.14%, but who can say whether another ‘error’ won’t crop up after a month? Either way, 4.1% is not worth cheering at all. It shows that industrial growth remains sluggish.

Why did the stock market celebrate a not-so-great number? It was probably on the expectation that next week the RBI will be forced to cut the repo rate after almost three years to help stimulate growth. But the RBI is in the horns of a dilemma.

They have taken a stance that controlling inflation is their top priority. While inflation is no longer in double digits and is expected to fall some more, it is still quite high and may start going up once again as the base effect kicks in. The RBI also expects the government to take worthwhile steps in curtailing its huge deficit, which is partly responsible for causing inflation.

But the government is showing no inclination to cut down wasteful expenditure on populist measures. Instead, the Finance Ministry is desperately trying to generate revenue by milking cash-rich PSUs and by introducing measures that may cut-off FII inflows (which will further compound the deficit problem).

If RBI cuts the repo rate and inflation goes up after a couple of months, they will look like fools. If they don’t cut rates and growth slows down further, they will be made a scapegoat for all ills. They may compromise by reducing the CRR once again to inject more liquidity into the system. Alternatively, they may cut the repo rate by a token 25 bps (0.25%) – which seems to be already priced in by the market.

What could be a positive surprise for the market? A CRR cut and a 25 bps repo rate cut or a repo rate cut of 50 bps. If either of those two events occur, the stock market may trend upwards from its current consolidation range.

Will the budget be a game changer?

This was supposed to be an eventful week that was going to provide a clear direction for the economy and the stock market. Instead, the events that have unfolded so far have left the future of the economy and the stock market in a state of limbo. Will tomorrow’s budget announcement turn out to be a game changer?

Last week’s surprise announcement of a higher-then-expected 75 bps cut in the CRR rate by the RBI turned today’s policy announcement into a non-event. There were some hopes raised by a few experts that the RBI may cut the repo rate by 25 bps to bolster growth. That was a bit unrealistic. The rate cut may happen in Apr ‘12, provided other factors remain unchanged.

What are these other factors? Industrial production is one. The 8.5% growth in the manufacturing IIP was much higher than expectations – even though it was bolstered by some questionable data. Growth at a time of high interest rates and a liquidity crunch surely didn’t call for a interest rate cut.

The fact that WPI inflation rose in Feb ‘12 further forced the hand of the RBI governor. He had made it quite clear that curtailing inflation, even at the cost of sacrificing growth in the near term, is his prime concern. The government’s proclivity for wasteful expenditure and populist measures is stoking the fire of inflation. High cost of oil – which has not been fully passed on to consumers – is another cause of inflation that has been artificially suppressed.

The drama surrounding the announcement of the Rail budget made headlines. Except for the political party to which the rail minister belongs and the leftists who oppose everything, the rail budget was hailed as a progressive and practical one. But if the first hike in fares in more than 8 years is rolled back due to coalition politics imperatives, then the proposed spending on safety features and infrastructure projects will go to the back burner.

In front of this backdrop, we have a geriatric finance minister who is a shrewd politician but hardly a bold and visionary risk taker. What likely rabbits can he pull out of his hat to dramatically change the current political and financial mess in which the government finds itself? A few token measures may perk up the stock market in the short term, but reality will catch up soon enough.

If the budget proposals turn out to be a damp squib – and the odds of that happening are high – the FIIs may decide to reduce their buying and stall the young bull market. In a worst case scenario, they may decide to book profits. There should be no rush to buy any intra-day dip. The stock market won’t go away. It may be prudent to digest the budget proposals over the weekend and decide on the next course of action.

That was the long answer. The short answer is: Highly unlikely.

Did the stock market over-react to the 50 bps CRR cut by RBI?

The short answer to the question is: Yes. The CRR rate cut is good news, but not great news. Great news would have been a cut in the repo and reverse repo rates. Now, the long answer.

Imagine that you are a farmer in central India, and it is the middle of April. With poor access to irrigation facilities, your crop is dependent on the monsoon rains. Your cousin from the nearby town comes to visit you and mentions that it was announced on the TV that monsoon may set in a week early in the middle of June instead of the third week. No doubt, that would be good news. But the rains will still be two months away.

RBI's announcement is somewhat similar. The CRR rate cut is an indication that repo and reverse repo rates may be reduced two months down the road. So, today's high volumes may be a sign of a buying climax.

What is the CRR and what purpose will be achieved by cutting it from 6% to 5.5%? Cash Reserve Ratio (CRR) is a percentage of the total deposits in a bank that has to be maintained as a 'reserve' with the RBI. It is one of the monetary instruments used by the central bank to regulate the money supply in the financial system.

Due to the aggressive interest rate increases by the RBI to contain inflation, growth has started to slow down. In fact, the RBI has now set the GDP growth target for 2011-12 at 7% - down from earlier revised target of 7.6%. Much lower than the glory days of 9-10%. India Inc. have been complaining that growth was being sacrificed to control inflation. Now that inflation rate has finally started to moderate, RBI has taken the first step by increasing the liquidity in the financial system.

How does it work? Let us say, a bank has Rs 10,000 Crores as deposits. A 6% CRR implies that Rs 600 Crores have to be maintained as a 'reserve' with RBI. That means, the bank has access to only Rs 9400 Crores that it can give out as loans. A 50 bps (i.e. 0.5%) cut in the CRR leaves the same bank with access to Rs 9430 Crores to deploy gainfully. On the extra Rs 30 Crores, the bank can expect to generate an additional Rs 3 Crores in profit.

The overall cash infusion into the banking system is expected to be about Rs 32,000 Crores, which can be loaned out to generate a profit of say Rs 3200 Crores. Not a small sum, but not a king's ransom either. Now you know why the bank stocks rose today. But that is the theoretical view point. What is likely to happen in real life?

Is India Inc. going to break down the doors of banks to apply for loans? Highly unlikely. Remember that the interest rates remain just as high as it was two months back, when no one was taking loans and were postponing capital expenditure. Banks are also struggling to contain their NPAs and have become quite rigid in doing due diligence before handing out loans. Add to that the likelihood of the inflation fires getting stoked by the excess liquidity in the system. There is also 'hidden' inflation due to large subsidies.

All in all, definitely not a cause for celebration. The RBI governor clearly put the ball in the government's court by pointing out that fiscal profligacy is one of the major causes of inflation. Unless core inflation falls further, do not expect a cut in the repo or reverse repo rates in a hurry.

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Why did the stock market fall despite a good IIP number?

India’s Nov 2011 IIP (Index of Industrial Production) came in at 5.9% – higher than the consensus estimate – raising hopes of a quick return to the growth path. Considering the Oct 2011 IIP of –5.1%, there was a huge 11% swing month-on-month.

The stock market should have celebrated by spiking higher – specially since both the Sensex and Nifty are in the midst of rallies from their recent bottoms. Instead of doing the obvious by rising, both indices lost ground. Not much, but enough to cause consternation among small investors.

What is going on? Is this just the way Mr Market behaves to separate investors from their hard-earned money?

There can be a few logical explanations, which are mentioned below:

1. Both the Sensex and Nifty are in the midst of prolonged bear markets. Good news tend to get ‘discounted’ quickly and bad news causes renewed selling during bear markets.

2. Infosys – which is generally considered to be one of the bellwethers of the Indian stock market – announced better than expected Q3 results, but disappointing Q4 guidance and got hammered. Its high weightage in both indices caused the fall.

3. Oct 2011 IIP number was unusually low – but one must remember that it was a festival month (Navratri and Diwali), which meant lower production days due to the holidays. Nov 2011 IIP was comparatively much better, but some of the new orders may be due to inventory replenishment. Lower growth usually leads to inventory draw-downs (companies tend to let their existing inventory get depleted almost completely before placing new orders).

4. Technically, both indices retreated after facing twin resistances from their 50 day EMAs and DTLs (refer last Sunday’s post on Sensex and Nifty chart patterns).

5. All of the above.

Stock markets don’t necessarily move according to logic. In the short-term, sentiments can, and often do, overrule the fundamentals. So can a rush of buying or selling by the FIIs. What should small investors do?

Remember an old saying: “Buy the rumour; sell on news.” There is no better example of that maxim than today’s price action in the TTK Prestige counter. The company announced impressive Q3 results, but the stock lost more than 7% after the ‘good news’!

The stock market is in a state of flux. After 14 months of down trend, small investors are becoming impatient to buy in the hope of a trend reversal soon. Please be aware that interest rate is still high. So is inflation – though food inflation has turned negative. Stock markets don’t reverse trend till the first few interest rate cuts happen.

There is a clamour for a CRR rate cut from all corners. If the Nov 2011 IIP figure is the reality, i.e. economic growth is back on track instead of what has been mentioned in point 3 above, then there is no reason for the RBI to cut the CRR – let alone cut the interest rate. A rate cut may stoke the inflation fire.

In other words, there is no need to turn bullish yet. Await Q3 results of the big guns and RBI’s policy announcement on Jan 24. You may miss the absolute bottom by being conservative, but in a bear market it is better to be safe than sorry.

RBI pauses interest rate hikes – why did the stock market dive?

Stock markets and interest rates have a love-hate relationship. Markets love low interest rates, but detest high interest rates. ‘Low’ and ‘high’ are relative terms. As a very rough thumb rule, a Repo rate of 5% or lower can be taken as a ‘low’ rate; 7% or higher can be considered a ‘high’ rate.

In Jul ‘08, the Repo rate (the interest rate payable by commercial banks when they borrow money from the RBI) had peaked at 9% – more than 6 months into the previous bear market that lasted from Jan ‘08 to Mar ‘09. Thereafter, Repo rates and Reverse Repo rates (interest rates payable by RBI when they borrow money from commercial banks) were gradually reduced till the Repo rate hit a low of 4.75% in Apr ‘09.

By Mar ‘09, when the Repo rate was at 5%, the stock market reversed direction and started rising. The ‘lag’ effect of interest rate changes are evident from the above data. Bear markets start well before interest rates hit their peak; bull markets start before interest rates drop to the bottom.

The next increase in the Repo rate came only in Mar ‘10, when it was raised from 4.75% to 5%. The bull market was already a year old by then. Thereafter, 12 more rate increases – the last of them in Oct ‘11 – took the Repo rate to a high of 8.5%. By then, the bear market from the top of Nov ‘10 was almost a year old.

Why do stock markets hate high interest rates? Because the cost of doing business increases for every one, and profits take a hit. Capital expenditure is postponed, which hurts growth and in turn, hurts profits. When earnings decrease, EPS reduces. P/E ratios become higher, which induces selling of stocks and shifting of investments to bank fixed deposits at high rates.

Two months back, RBI last increased the Repo and the Reverse Repo rates by 25 basis points (0.25%). The stock market had expected the hike, but appeared to celebrate the news by moving up. That seemed to go against logic. Stock markets are supposed to hate high interest rates. What may have caused the celebration was a hint by the RBI that they may not raise rates further if inflation rate started to moderate.

Inflation rate has started to drop, though it continues to remain high. Food inflation has fallen quite remarkably – whether due to seasonal reasons or high ‘base effect’ or both. The high interest rates caused GDP growth to slow down and de-growth in IIP (Index of Industrial Production). So, it was no surprise that RBI left the interest rates unchanged, and hinted that rates may be lowered henceforth to spur growth. Instead of celebrating, the stock market dived – again appearing to defy logic.

What happened? Many market players had expected a cut in the CRR (Cash Reserve ratio – the percentage of total deposits that commercial banks have to maintain in cash) to inject more liquidity into the financial system. But a combination of an inflation rate that is still high and a fast depreciating Rupee against the US dollar may have forced RBI’s hand in keeping the CRR in tact. That perhaps caused disappointment that led to the sell-off today.

During a bear market, the slightest bit of ‘bad’ news causes a disproportionate amount of negative sentiment. Even if the news isn’t bad for the long-term but appears to be bad in the short-term gives a good enough reason to sell. The opposite happens in bull markets, when the slightest bit of ‘good’ news sends the stock indices soaring. That is an unlikely occurrence at least for another 6 months. Till interest rates are reduced significantly, the bulls will not return.

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Market celebrates RBI interest rate hike – why?

Market celebrates RBI interest rate hike – why?

RBI increased the repo rate (at which it provides short-duration loans to banks) and the reverse repo rate (at which banks maintain short-duration deposits with the RBI) by 25 basis points each. The repo rate is now 8.5% and the reverse repo rate is now 7.5%. The CRR has been left unchanged at 6%.

With inflation remaining stubbornly high despite 12 rounds of rate increases since Mar 2010, it was widely expected that the RBI will increase the repo and reverse repo rates by 25 bps (0.25%) today. The market should have already discounted the rate hike. Why the buying celebration then? Was there some good news that the market liked?

Apparently, there were three. First, and most important, the RBI governor hinted at inflation rate moderating to 7% by Dec ‘11, in which case there will be no further rate hike at the end of the year. Moderation of inflation and a likely pause in the rate hike cycle was considered ‘good news’ by the market.

Also, for the first time ever, interest rate on savings bank accounts have been de-regulated. That means banks have the freedom to offer any interest rate on savings bank accounts that they deem fit. Last, but not the least, banks have been given the freedom to open branches in Tier-II through Tier-VI towns without prior permission.

Let us look a little more critically at each of these pieces of ‘good news’.

How will inflation suddenly moderate to 7% in less than 2 months when it has remained uncontrollably high for the past 20 months? Will food prices suddenly fall? Will government employees get less salary? Will politicians become honest and stop their looting? The answer is: none of the above.

The moderation will happen due to the ‘base effect’. Inflation was already high in Dec ‘10. So the YoY increase in Dec ‘11 will appear to be less. Actual prices that we pay will remain almost the same as now. There is also a possibility that diesel and kerosene prices will finally be increased if inflation does moderate. So, we may get back to square one.

What about the pause in the rate hike? Well, that won’t help much either. Better than bad isn’t necessarily good. As per RBI’s guidance, the GDP growth rate has been revised down from 8% to 7.6% in year ending Mar 2012. There are already signs of growth slowdown, which will be exacerbated by today’s rate hike. Unless interest rates start heading downwards, stock markets are unlikely to go up.

Is the saving bank interest rate de-regulation good news? Certainly not for banks. Their business has already been hampered by high interest rates – due to which loans have become dearer and term deposit rates have gone up. If interest rate on savings bank accounts is increased, it will be a direct hit on bank bottom lines.

As per the Economic Times, if savings bank interest rate is increased from the current 4% to 5%, then all the banks put together may need to pay out an additional interest of Rs 15,000 Crores, which may reduce the entire banking sector’s profitability by 13%.

Look at it another way. Savings bank account holders will collectively receive an extra Rs 15,000 Crores. What will they do with the sudden inflow? Why, spend most of it. Will that stoke the fires of inflation or not? You tell me!

SBI has the largest percentage of savings bank accounts among all banks (Yes Bank has the fewest) and will be affected the most by an increase in savings bank interest rate. The CMD went on record that SBI will not increase the savings bank interest rate. He also said that de-regulation means rates can also be reduced.

What about opening branches in small towns? It may help in financial inclusion of people living in remote areas where no bank branches exist. But if there was a lot of business potential in Tier-II through Tier-VI towns, banks would have sought permission to open branches there by now. By removing the red-tape of prior permission, the business potential of remote corners of the country is not going to increase overnight. But opening branches will add to the operating costs of banks.

The ‘good news’ doesn’t seem so good, does it? What was the reason for the buying today? It was a combination of short-covering and index management – today being early F&O ‘expiry day’ because of the Diwali holiday. The broader markets didn’t participate much in the rally.

Both the Nifty and the Sensex are poised at the upper end of their respective trading ranges of the past 11 weeks – with the huge gaps caused in Aug ‘11 remaining unfilled. Tread with caution.

The Interest Rate hike was expected – why did the market fall?

As expected, the RBI hiked the repo rate and reverse repo rates by 25 basis points. For the uninitiated, that means a 0.25% rise. The repo rate (the interest rate at which banks borrow short-term funds from the RBI) is now 6.5%, and the reverse repo rate (the interest rate that banks receive for parking short-term funds with the RBI) is now 5.5%. Two other rates – the CRR and SLR – have been left unchanged.

Why was the interest rate hike expected? Primarily because core inflation (non-food) has been rising and 6 rate hikes in 2010 had little effect in cooling off prices. Every one knows that food inflation has almost gone out of control, and the Indian housewife is at her wit’s end trying to put nutritious food on the table within the family budget.

If 6 previous rate hikes haven’t managed to cool off inflation, will the 7th (1st in 2011) fare any better? That is a good question, and the RBI Governor knows it. He took pains to explain to the media that his choices were limited. Inflation needs to be controlled, otherwise high prices of essential commodities will increase input costs for India, Inc. That would dent bottom lines and may slow down expansion and capital expenditure. The severe crack in Hindustan Unilever’s stock price today is a clear example of investor nervousness.

Raising interest costs too much at one go will increase borrowing costs and hurt the growth prospects of companies. The RBI has chosen the middle path of a gradual increase in interest rates. If inflation continues to rise, another round of rate hikes may be inevitable. Already, the RBI Governor has relaxed the target core inflation rate to 7% from the earlier 5.5%. There lies the first clue to the market’s fall today. So far, the RBI and finance ministry officials have been making positive noises about controlling inflation through monetary measures coupled with the ‘base effect’ of higher inflation in the year gone by. This was the first official admission that things haven’t worked as planned.

The second clue is the unambiguous message that the RBI Governor sent to the commercial banks: Curb lending and increase deposit rates. That may be music to the ears of retirees who stay far away from the stock market and depend on fixed income avenues. Fixed deposit rates at banks will hit the double-digit mark soon. What is meat for retirees is poison for stock market investors. The combination of higher interest rate with lending curbs will throw a spanner in the works of India’s growth story.

Rate-sensitive stocks took a beating today, and don’t be surprised if the stock market cracks further after the Republic Day holiday. As small investors, there are a couple of things we should do. One, don’t panic and sell off everything. But if you are in profit in second rung stocks, book some or all of it. Two, prepare for a bigger correction by making a list of fundamentally strong stocks that offer some Margin of Safety. Let the correction play out. The next positive trigger may come from the Budget. Buy then.

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What exactly is the Margin of Safety?

The RBI has increased the Repo and Reverse Repo rates – should investors be concerned?

Many small investors tend to be oblivious about repo rates, reverse repo rates, economic and monetary policies, and the tools that the RBI has at its disposal to control the supply of money (liquidity) in the financial system. But ignorance is not necessarily bliss.

Here is a simple Q&A to try and understand some of the basics:

Q. Why did the RBI raise the repo rate from 5.5% to 5.75% (‘25 basis points’ is another way of saying ‘0.25%’) and the reverse repo rate from 4 to 4.5%?

A. To keep inflation under control. Recent hikes in the repo, reverse repo and CRR rates had failed to contain inflation, and another round of rate hikes became inevitable.

Q. What causes inflation?

A. An excess of liquidity in the financial system.

Q. Why is there excess liquidity in the financial system?

A. Three main reasons:-

1. reduction in the repo and reverse repo rates by the RBI during the downturn in 2008 and 2009
2. continuous inflow of large sums of FII money into the Indian stock markets
3. larger inflow of remittances from NRIs into India (due to the economic downturn in Europe and USA)

Q. Why had the RBI reduced the repo and reverse repo rates in 2008-09?

A. Higher interest rates earlier had led to a slow down in the economy as industries reduced borrowings at high rates and put expansion plans on hold. The reduction in rates helped to stimulate the economy.

Q. Will raising the rates slow down economic growth?

A. Hopefully, not. The CRR rate has been kept unchanged. The Indian economy is almost back on its earlier growth trajectory, so the availability of money at lower interest rates is being curtailed. Companies are expected to finance part of their capital expenditure from internal accruals.

Q. What is the likely effect of the hike in repo and reverse repo rates on small investors?

A. Banks may have no option but to raise lending rates and deposit rates. An increase in lending rates will reduce profitability for those investors who indulge in leveraged buying (i.e. buying stocks with borrowed money).

An increase in deposit rates may lead to a ‘flight to safety’ (i.e. investors may book profits in riskier stock market investments and reinvest the proceeds in safer bank fixed deposits).

Q. Will the stock markets crash because of higher interest rates?

A. A crash is unlikely. The hike in the repo and reverse repo rates were already ‘discounted’ – which means that it was within expected limits. The 50 points rise in the Sensex today is proof that the market players are not unduly concerned.

Q. Should investors buy, sell or hold?

A. That is a tough question, and will depend on individual investors. Interest rate hikes are not conducive to bull markets, as it raises the cost of doing business and affects profitability. So, the upside may get limited. As it is, the Sensex has been trading in a range for 11 months.

If you want to buy, select only fundamentally strong stocks with a track record of flourishing through several bull and bear phases. If you already have such stocks in your portfolio, hold with trailing stop-losses and ride the bull. Book profits in any second or third rung stocks that you may own.

Please remember that as long as the Sensex trades above a rising 200 day EMA, we are in a bull market. So, there is no reason to sell in a panic, or worry about what happened in late 2007. Setting stop-losses will save portfolios from getting destroyed.

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Five more things to avoid in a Bear Market

A lot of investors who joined the party from 2004-2005 and haven't really experienced a bear market bought a lot of stocks during the current downturn - specially after the Sensex breached 12000 and then 10000. They are now realising that just because the market has fallen a lot from its peak it doesn't mean that it can't fall even more.

So here are five more things you should avoid doing in the current market situation.

6.  Don't be swayed by the occasional bullish news. They should be noted and filed in the memory, but no action should be taken yet. Instances include the US bail out, the Chinese bail out, reduction of CRR/SLR/repo rates, slowing of inflation. These may appear to be good news and the market usually reacts positively to them. But you must understand that most of these are actually measures to put some upward impetus to the crashing economy and markets.

7.  Don't blindly trust your stock picking skills. You may have picked some real winners during the bull run. So did every one else. Bull runs lift all stocks - good, bad or ugly - to stratospheric levels. Be very careful in preparing your buy list in a down market. Do some 'paper' trading to see if your chosen scripts are going up, down or remaining static during the brief rallies. After some time you will realise which stocks should remain in your buy list.

8.  Don't assume that past performance will get repeated in future.  Just because certain stocks did very well in the later stages of the bull market doesn't mean that they will do well again when the market turns. Realty and cement stocks come to mind.

9.  Don't confuse inflation and capital protection. At times like these, you may be better off locking your cash into a two year fixed deposit at 10.5% and opt for monthly or quarterly interest. You may think that tax adjusted return will be 7% which will be eaten away by inflation of 9%. But a year hence, the inflation rate may fall below 6% (mostly due to higher base effect) and you will actually gain. Plus your capital will be safe. The periodic cash flow from interest income can be used if some unbelievable buying opportunities come by (like TISCO falling to Rs 100 or Bharti going below Rs 400).

10. Don't do some thing silly on a hunch because you are getting bored. This is a great time to actively learn the importance of patience. If you have targeted some interesting stocks (I'm looking at Maharashtra Seamless and Yes Bank), buy a small quantity and keep actively tracking it. When it breaches a previous low, don't jump in. Wait to see how far down it'll go. When it goes lower, wait some more. Till you see volumes almost disappear. Then buy some more.

What the CRR-SLR-Repo cuts mean for investors

Economics and monetary matters are not my strength areas, but a lot of investors must be wondering how all these different rate cuts may affect them. So here is a 'dummies guide' to the triple rate cut dose.

But first, some of the basics.

The Repo rate is the rate of interest charged by the Reserve Bank of India (RBI) to commercial banks who may need to borrow some short term funds against securities. (The Reverse Repo rate is the rate of interest paid by the RBI to the banks who may park short term funds with it. Usually the RBI pays a lower rate.)

The Cash Reserve Ratio (CRR) is a percentage of the total deposits with commercial banks that they need to keep with the RBI.

The Statutory Liquidity Ratio (SLR) is a percentage of deposits that commercial banks need to invest in government securities.

What purpose is served by such means? It is for the safety and security of the funds available in the banking system (which in turn helps investors like you and me). It is also for controlling the supply of money (or liquidity) in the country's financial system.

The Foreign Institutional Investors (FIIs) were lured by the growth prospects of the Indian economy and brought in huge funds (by Indian standards) to purchase shares of Indian companies. Indians working overseas also channeled money back to the country for investments because of the comparatively higher interest rates.

As demand for products and services kept rising, capacities got stretched, and prices were hiked. Industries went in for capacity expansion availing cheaper overseas funds. With higher production the GDP kept rising, attracting more foreign funds.

The increased liquidity - mainly from overseas - and higher prices caused inflation to rise. Initially the government kept ignoring the rising inflation rate till it hit double digits. To curtail inflation, the RBI squeezed the supply of money by gradually increasing the CRR, SLR and Repo rates.

Unfortunately, the sub-prime crisis in the USA hit the world's financial system like a whirlwind. Many of the FIIs who had lost heavily in the sub-prime derivatives markets, started to sell aggressively in the Indian share market.

The outflow of foreign money caused two problems. First, it caused a reduction in liquidity - which had already been tightened by RBI's policies. Second, it caused a fall in the value of the Rupee - which the RBI tried to stem by buying foreign currency, further reducing liquidity.

The banks started feeling the pinch and started offering higher interest rates for deposits and, therefore, charging higher interest rates to borrowers.  Industry found the easy-money taps getting closed - both in India and overseas, and started slowing down their growth plans.

Speculators who borrow money to invest felt the cost of doing business was too high and started selling off. This compounded the selling pressure already exerted by the FIIs. The downward spiral in the stock market got exacerbated when small investors also started selling off.

The several rate cuts over the past couple of months is the RBI's and governments rather belated effort to inject liquidity in the market so that banks can resume lending. Hopefully that will lead to rejuvenating the growth plans of industries and eventually lead to reduction of interest rates.

That would be the first indication that the stock markets are ready to stop falling and starting their next upward journey.