Intelligentguess

The Indian Stock markets traded weak on Wednesday, May 23. The weakness was led by banking sector stocks.

These stocks were weak on rumors floating around in the marketplace that the Reserve Bank of India (RBI) may hike the cash reserve ratio (CRR) – the proportion of deposits that commercial banks have to set aside as a statutory pre-emption. Banks do not earn any interest on these pre-empted funds.

The trigger for the story seems to be the large inflow (in excess of INR 200 bn) expected into the system due to the maturity of a government bond (11.90% - 2007).

Step back to a few weeks ago (I forget the exact date). Bank stocks were on fire (with most of them gaining by as much as 5% on that day). And the story that led to that move was that the RBI was contemplating a cut in the CRR. Ironically, overnight money rates on that day were ridiculously low (less than 0.50% per annum). Precisely the kind of conditions that preclude any cut in the reserve ratio.

However, strange are the ways of the marketplace – the rumor was allowed to perpetuate for the whole day. By the evening, when it was pretty clear that a CRR reduction was never going to be in sight, the story promptly switched to a possible reduction in the statutory liquidity ratio (SLR) – the proportion of deposits that commercial banks have to compulsorily invest in government securities. The SLR story was more credible, I should add.

Coming back to present day moves, what puzzles me is how marketmen react to a piece of information (the upcoming bond redemption) that is known for ages. Weren’t markets supposed to discount all publicly available information (the efficient market hypothesis)? Or is it, that the stock markets are getting around to the RBI Governor Y V Reddy’s penchant for springing surprises.

A CRR cut when overnight money rates were ruling at Japanesque levels – that would have been the coup de grace!

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So, the US Fed has, expectedly, decided to keep policy rates on hold. It also appears that the Fed is unlikely to raise rates in the near future too.

It would be interesting to watch the reaction from other major central banks in the days and weeks to come. Personally, I feel that other central banks are unlikely to ape the move. Their decisions are likely to be based almost entirely on local considerations. Having said that, policy rates still seem to be (at least for most major markets) at or close to their near term peaks. The same seems to hold true of the Indian markets too.

Talking about Indian markets, Wednesday’s trading session was a study in contrasts. Overnight money rates crashed on abundant liquidity. Rates in the collateralized CBLO segment fell sharply to near zero, while call money rates were in the range of 2%-2.5% at close. This led many (money) market participants to speculate that the central bank (RBI) might react with some harsh measures, including possible a hike in the cash reserve ratio (CRR) - a method of prempting bank funds. Knowing RBI’s penchant for surprising markets, nobody is ruling out anything nowadays.

In contrast, the equity markets seemed to have taken this penchant to the other extreme. Their were rumors of a reduction in CRR leading to a rally in banking stocks. The Bombay Stock Exchange’s bank index gained approximately 1.5% on the day.

Money rates have opened at 1% levels in the CBLO segment and 2% levels in the call money segment on Thursday. Given these conditions it’s difficult to forsee a reduction in the cash reserve ratio

Personally, I’m inclined to go along with the money market mandarins.

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Analysis of Market Indices

Have an alternate thought process ? Would be glad to hear about it

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The Economist writes

According to Goldman Sachs, the latest jump in the Vix (a measure of stockmarket volatility) took it eight standard deviations from its average. If conventional models are correct, such an event should not have happened in the history of the known universe. Then again, the move in energy prices that caused the collapse last year of Amaranth, the hedge fund, was a nine standard-deviation event.

For clarity sake, the movement in the Vix index (spoken about above) during the last three months is as below:

Hmmm…… Two seemingly impossible events within a span of three months. Tells us something about our modelling skills. 

No wonder, the Sage of Omaha continues to rule the world of investments.

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India’s central bank, the Reserve Bank of India (RBI),  today, hiked the Cash Reserve Ratio for Indian banks by 50 basis points (0.50%) in a bid to rein in money market liquidity (Press release here). 

The CRR is the amount of cash (expressed as a percentage of net demand and time liabilities - deposits to a layman) that banks have to keep as clear cash balances with the RBI. Banks do not earn any interest on these balances. This hike is to be implemented in two stages of 0.25% each with effect from Feb 17, 2007 and March 3, 2007.  The total amount of cash that would be impounded by this is estimated to be INR 140 bn.

This move is in line with RBI’s stated stance of reining in inflationary expectations, and also its willingness to use all tools at its disposal at any point in time. What comes as a bit of a surprise to some, though not seasoned marketmen, is that this comes within a fortnight of the release of the last quarterly review of the monetary policy. However, to marketmen, there were enough indications that some such move was in the offing, given the easing that we have witnessed  in the liquidity situation in the money markets during the last week or so.

More importantly, the direct move of impounding cash, is a strong message to banks to curb unrestrained lending, especially to red hot sectors like commercial real estate and capital markets. A related impact of the central bank’s  move would be a rise in costs for banks which they would most likely pass on to their customers. Indian corporates and consumers therfore have to brace up to more hikes in lending rates

The immediate impact on the bond markets is clearly bearish, though the market may find some support since bank’s statutory investment in government bonds are running very close to the minimum 25% (of net demand and time liabilities again) that they need to maintain. We would therefore not be witness to a bout of unrestrained sales as would normally have been the case in such a situation otherwise. Further, many marketmen were expecting some such move, which may limit the damage to some extent.

Money market rates are  expected to firm up in sympathy with the RBI move. Bank stocks are also expected to open in the red when trading opens on the National Stock Exchange of India  and the Bombay Stock Exchange. 

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The purpose of this note is not to force down any complex technical analysis / direction views. The simple visuals - allows you to conclude.

The study deliberately uses the Indian BSE-30 index versus the SP 500 ( the Indian NSE-50 was too much in line)

Visual I

In May 2004 the markets dropped (”crash” in Indian markets). ( BSE dropped from 6500 area to 4200 area while SP-500 had dropped from 1160 to 1065). Post the market drop - we can clearly see the SP-500 lending ( leading ? ) direction when the markets turned around.

Visual II ( since July 2006 )

Since July 2006 - both the Sensex and the SP-500 have been tracking each other.

Visual III ( S & P 500 movements since 1997 )

Conclude

• Pretty clear  that S&P 500 leads BSE-30 on market turns / direction
• In a rising market S&P  500 has too many resistances - and could rise slower than BSE-30
• However in a market thats falling  - S&P 500 would fall harder and longer initially - compared to BSE-30
• A lateral thinking solution for the short/ medium term- without having a view/bias towards the direction of market  - could be - “BUY” BSE ( or Nifty- NSE) and “Sell” S&P 500. ( i.e make a spread trade using one markets momentum against another)

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