Prudence Dictates Caution

Updated: Sep 22 2003, 05:30am hrs
Just as investors were getting used to a secular bull run and rushing off to invest in equity mutual funds, the capital market has tripped them up. Stock price indices spike up one day and zip down the next with seemingly no pattern to their volatile movement. The sensex shrugs off a Supreme Court decision stalling the sale of oil companies on one day and then collapses a 101 points the next. What does this indicate Has the rally fizzled out, or are the bulls merely gathering their breath for another onslaught on stock indices There are no clear answers. What is, however, clear is that the days of a daily appreciation of 60 points plus in the sensex are over. What is also clear is that after pumping in a couple of hundred crore rupees or more per day in Indian stocks, foreign investors are finally taking out profits. For two days last week, FII investment was negative; that is, they sold more shares than they bought. And although net sales were less than Rs 100 crore on each day, its a signal for prudent investors to turn cautious. They have to recognise that the sensex is already up over 45 per cent since April, in line with business and economic fundamentals and it cannot maintain the pace of appreciation without a significant price correction.

An interesting development that has not been adequately analysed in this rally, is the impact of derivatives trading on the volatility of stock prices. Derivatives trading turnover in India is already more than twice that of the cash market. For instance, the National Stock Exchange, which accounts for most of the derivatives trading in the country, showed an equity turnover of Rs 4,722 crore while its derivatives volume was a huge Rs 9,878 crore. On several days, the NSEs derivatives volume has been above Rs 10,000 crore. However, the cash market turnover comes from 800 scrips traded everyday, while the massive derivatives turnover is from just 41 scrips with an option of three or more contracts each. This would explain the high level of interest in the segment. Some analysts believe that although derivatives have allowed market operators to speculate with lower risks and to hedge their cash market positions more effectively, it has also increased market volatility in leading market favourites. They also believe that the impact of positive and negative market developments tend to be magnified by the derivatives trade, because they have a higher weightage in leading stock indices. It is not clear if this would be borne out by statistical testing. But so far, derivatives trading has proved a highly positive development, by providing better and safer opportunities for speculation.