India Sensex - Be careful of speculative interest !

It appears that speculation has played a significant role in recent Sensex run-ups. Sharp price rise in some recent high performing stocks have not been backed by adequate delivery based volumes. For example, Reliance Capital, Essar Oil, Reliance Natural Resources Limited and Ispat Industries have attracted lower than average delivery based volumes. Reliance Capital had only 9% delivery based interest on Friday indicating that 91% of the transactions were speculative !

Longer term retail investors need to be wary of such run-ups and be willing to ride out volatility.

Infosys, TCS and Wipro stocks - drags !

India based technology companies like Infosys, TCS and Wipro are facing a serious challenge. From being hyped as darlings of the markets, they are now facing a situation where their stock prices have declined significantly while the Sensex has gone up significantly over the last year.

For example, stock prices on 1 Dec 2006 and 1 Dec 2007 for various scrips are as follows:

1. Infosys: Declined from Rs 2193.75 to Rs 1604.05, a decline of 26.8%
2. TCS: Declined from Rs 1186.80 to Rs 1013.95. decline of 14.5%
3. Wipro: Declined from Rs 600.90 to Rs 460.30, decline of 23.4% !

All this when the Sensex has gone up by 39.8%, despite having these three as part of the index.

India Sensex vs NIFTY

BSE's Sensex and NSE's NIFTY both are designed to track the Indian stock market. While the two indices are closely co-related (better than 0.9), there are some differences in the way the indices are calculated.

NIFTY takes the full market capitalization of a company and divides it by the total market capitalization for all the stocks it tracks (50) to give the index weighting for the stock. Sensex on the other hand uses free-float as the measure. Free-float is defined as that amount of stock of the company (and associated market cap) that is not held with the promoters. The free-float method is often seen as a better reflection for trading purposes as it reflects only the amount of shares available for trading of a particular company.

Other key differences are as follows:

• Sensex is overweight on financial services and auto stocks compared to NIFTY
• NIFTY is overweight on oil, gas and refining; telecom, metals and power compared to Sensex
• NIFTY has greater depth in derivatives.

It is important to understand these differences when you are trying to make sense of index movements, especially in the volatile Indian stock market.

India Sensex hurting !

Sensex pundits now talk of structural problems, given the dive in the Indian stock market. This was the same bunch talking the Sensex to further highs past 20,000. If you had invested in the index at 20,000, you would be poorer by 7.86% in a very short period of time !

Experts and market analysts are taken aback by today's industrial production growth figures that puts Sept 2007 growth at 6%+ down from 12%+ same time last year. Increasing loan rates, squeezed credibility and higher rupee seem to be weighing heavily on growth indicators - effects of these actions should not be a surprise to anyone!

Sensex is most likely up for a period of volatility. You need to maintain a longer term value-driven view to have the stomach to take this churn. Its like buying a house - you don't check prices every day and don't look to sell quickly. When you buy shares, you are effectively buying ownership into the company - a commitment that is best given some time to bear fruit. If you have selected the company right and bought at appropriate price/value, you could be in for sustainable value creation.

India Sensex volatility - mutual funds vs fii

India mutual fund companies and foreign institutional investors (FII) appear to have been betting in opposite directions for most of the recent Sensex growth.

ETIG data highlights this trend:

• When Sensex jumped from 14,000 to 15,000, FII sold shares (net sales) worth 2372.10 crores while Indian mutual fund companies bought shares worth Rs 2891 crores
• Between 15000 and 16000, FII bought shares worth Rs 7307 crores while Indian mutual funds bought only Rs 667 crores
• When Sensex moved from 16000 to 18000, FII bought shares worth Rs 24,372.3 crores while mutual fund companies sold (net sales) Rs 2182.21 crores
• Between 18000 and 19000, FII bought Rs 7378.2 crores worth shares while mutual funds sold (net sales) Rs 966.2 crores worth of shares
• Finally, when Sensex jumped from 19000 to 20000, FII sold (net sales) Rs 1281.1 crores worth of shares while Indian mutual funds bought shares worth Rs 1515 crores.

Question arises as to why two groups of well researched/informed institutional investors have bet on opposite sides in a stock market that has grown to dizzying heights in a matter of months.

It appears, that mutual funds companies in India expected a correction in Sensex when the US sub-prime crisis hit in August - therefore they preferred to lower exposure. While some market commentators expected FII money running away from the US sub-prime mess to come to emerging markets, the relative deluge in to India surprised many a mutual fund pundit ! Domestic mutual funds, who were cashed up, now appear to want to get into the market so as to meet performance hurdles. Interestingly, FII money in the latest run up, seems to be going the other way.

All said and done, while an investor may be able to make some money purely playing momentum, longer term players would be better off considering fundamentals of the company closely while trying to leverage momentum plays. However, if leading institutional investors see fundamentals of blue chips in India so differently, what chance does a retail investor have ?

Sensex reaches 20,000 – where is gravity ?

Sensex reached 20000 yesterday (29 October). Only a few weeks ago, we were cheering while being sceptical of the 17000 level ! The following factors seem to have driven the market to this new all time high:

• FII (Foreign Institutional Investors) have 18 months to unwind their participatory note (PN) positions. This has led to many of them staying in the market and not withdrawing in a deluge as was thought
• Domestic Institutional Investors (DII) seem to have got into the buying act this time around
• Corporate earnings continue to be strong
• Sensex PE ratio on a six month forward basis is around 21 times and on a 12 month forward basis is around 19 times. Bulls continue to feel that these are acceptable numbers given runaway valuations in China and expected economic and corporate growth in India. In fact, the famous Indian investor Rakesh Jhunjhunwala who is bullish for the longer term, has expressed little surprise at Sensex reaching this summit.

India market cap is at $ 1.55 trillion while China is at $ 3.6 trillion. This now makes India no. 9 in terms of global market capitalization rankings. This market is now one of the top wealth creators in the world: Sensex has returned 60%+ on a year to date basis. Only China is way ahead at 200% +. While we should rejoice at such wealth creation during the festive Diwali season, some pundits suggest caution. They highlight that:

• 60%+ of the 991 point rise in Sensex between October 15th and 29th has been driven by three stocks: Larsen and Toubro (gained by 25% in this period !), ICICI Bank and Reliance Industries
• If you add the next three top gainers i.e. HDFC, Tata Steel and HDFC Bank, you can account for 80% of the recent rise in Sensex
• Bharti Airtel, Infosys and Reliance Energy, who were the drivers of another recent rally, declined by 213.13 points in this period
• FII may unwind as they get closer to the 18 month deadline. Question remains on who would take up the slack in such a case.

Given the meteoric rise of the Sensex, retail investors seem to be jumping in so as to not miss the action. Do remember though, a retreat of Sensex from 20000 to 19000 would mean a drop in value of 5%, if your portfolio mirrors the index. A 20% drop in value would need the Sensex to be closer to 16,000. This comes back to what you are willing to lose – if 20% is your tolerance, your ability to bet on this rising tide would be that much higher.

Sensex crash: SEBI initiates probe, while some retail investors appear to be back !

SEBI is said to be probing the role of various parties, especially top foreign portfolio investors, in the Sensex collapse of 17 October 2007. The stock market (BSE) crashed by 1700 points within minutes of market opening on the back of relatively small volumes. The regulator seems to suspect that trades may have been done at way off market prices with some of the same investors coming in to buy securities at lower prices when markets reopened after the hour trade was halted for. Issuers of Participatory Notes (PN) seem to be under scrutiny.

Meanwhile, some reports suggest that retail investors did not appear to be hurt very badly in the Sensex crash as many may have booked profits at the high levels. Dealers also feel that investors were hurt more by the US subprime led stock market fall in August than this particular crash. In fact, BSE data seems to suggest that retail investors may have bought Rs 1871.22 crores in last three trading sessions end of last week.

It remains anyone's guess how all this will play out in the short term. Volatility can create both significant gain and severe pain - all depends on your risk appetite !

Sensex crash today - could it be a steadying influence ?

SEBI introduced a paper on Tuesday that seeks to restrict Offshore Derivative Instruments' (Participatory Notes) involvement in the Indian stock market. The regulator's philosophy behind this move seems to be to slow the recent deluge of foreign capital flows into the stock market that sent the Sensex to a record high of 19000.

Participatory Notes (PN) have been popular with foreign investors who are not registered as Foreign Institutional Investors (FII) in India and therefore cannot invest directly in Indian capital markets. They get the required exposure by buying offshore derivatives that are issued by financial services players operating in India. Risk of these derivatives are then hedged using India exchange traded derivatives.

This structure appears to have created a four fold problem for the regulator:

1. Ultimate investor identity may not be clearly known as they are investing through offshore derivatives where the risk can be further laid off
2. Facilitates much larger flow of foreign funds than envisaged by registered FII route
3. Money can leave as quickly as it came creating significant volatility in Sensex and NIFTY
4. Foreign inflows have also led to the strengthening of the rupee vs the dollar creating discomfort in some government circles.

Essentially, the SEBI paper suggests that Offshore Derivative Instrument exposure which have underlying as Indian exchange traded derivatives unwind positions over the next 18 months. This sent the market into a major selling spree resulting in loss of 1000 points in early trading - triggers were hit and markets were suspended for an hour. Trading has resumed and some of the loss seems to have been recovered though Sensex is still in the red by about 800 points at the time of this post. Market analysts expect that there could be further unwinding of positions and therefore market volatility could continue for some time.

The government has clarified that it does not plan to ban Participatory Notes but is seeking to moderate capital inflows. The government continues to encourage investments by registered Foreign Institutional Investors (FII) and is seeking to reduce the complexity of registering as a FII.

Can the retail investor now hope for more realistic pricing ?

Risk appetite for individual investors in India

Exuberance in stock markets (Sensex), of the type seen recently in India, often leads to individual investors behaving in one of two ways:

• Investing with the herd
• Never finding the right level to enter the market !

Both these outcomes have the potential to be painful for individual investors. When you invest with the herd, you are never really sure if you are picking ‘yesterday’s’ good news and therefore buying at close to peak. On the other hand, if you stay out of a rising market for too long, you are likely to miss out on significant gains. What should an investor do in such a case ?

It comes back to thinking of investment as a long term game and building a diversified asset portfolio that meets your risk appetite as you go through different life stages.

A popular yardstick to understand one’s risk appetite for equities is to measure it as ‘100 – your age’. For example, if you are 40, this yardstick suggests that you can have approximately 60% of your asset allocation in equities. In our opinion this yardstick need not be correct for many investors. Risk appetite is a personal matter and it can vary based on an individual’s situation and age.

Some believe that it is better to have an investment strategy built around how much you are willing to lose as opposed to how much you would ideally like to make. Risk appetite could then be defined as how much of value you would be ready to lose over short /medium term (up to 3 years). If the answer is 40 to 50%, then you obviously have a high risk appetite and are investing for the longer term (e.g. 10 years). In such a case, a relatively higher proportion of riskier assets that can outrun inflation by a significant amount could make sense. Investments in stocks, particularly in emerging technologies, mid caps, etc could give you the upside in such situations.

However, if you are willing to lose no more than say 10 to 15% of your investments’ value over the short/medium term, then you can be classified as a risk averse investor who could be better off with more ‘secure’ investments like bank deposits, etc.

If you have the heart to lose between 15 to 40% of your investment value over the short/medium term, you could be classified as a moderate risk investor. In such cases, your portfolio could contain balanced mutual funds that diversify your risks and have about 65% of their assets in equity, the rest being in ‘safer’ instruments.

Please recognise that the investment percentages talked about above are primarily for liquid assets – i.e. do not include property which typically forms a large portion of many investors’ portfolios. Also, the risk appetite percentages of 10-15%, 15-40% and 40-50% are indicative.

We will talk about what a typical portfolio might look like for these three investor classes in a subsequent article.

Indian stock market index Sensex at 17000 - however, you wonder why your portfolio is not following suit !

The T20 world cup has been won, people are ecstatic and roads in Mumbai have been suitably jammed at this afternoon's victory parade. Investment gurus think there is a rising tide of good cheer what with the world cup and Sensex at 17,000. Some of the braver ones talk of 19,000 !

You must be feeling rich if you have stayed with the stock market roller coaster over the last few years. On the other hand, you may be surprised that your portfolio does not necessarily reflect the full impact of this wonderful turn of events.

Some observations, based on market commentators' views:

1. There is a view that foreign institutional investors (FII) are throwing money at emerging markets like India to get away from the sub-prime mortgage mess and lowering interest rates in the US. As we have seen before, this flood can come and go at reasonably short notice ...

2. Rally has been led by large cap stocks this time around. Good for you if you were mirroring the large caps in your portfolio. However, the last rally was mid cap based ! Even better, if you had both sectors covered - if not, you are probably hurting in some areas ...

3. Some suggestion that markets show an overbought position ...

4. Let us get to the 'other hand' of this story. Bulls mention corporate earnings continue to grow robustly, inflation (as measured officially) has been reined in and therefore an ongoing growth in the stock market cannot be ruled out (remember the pundits who talk of 19000) ...

If like many of us, you also cannot time the markets, then a few thoughts for you:

1. Invest on fundamentals of the companies

2. Stay with them for a reasonably long period if you like the firms' business, their management strength and growth story

3. Ride short term price gyrations - provided the firms continue to do well

4. Remain diversified in your portfolio mix.

If you are a novice in stock markets, then consider hiring a professional portfolio manager and / or devour analyst reports regularly so that you can take measured actions.

Good luck !