I write at Yahoo: The School Of Hard Knocks

Many of us desire to make money from the stock markets, because it doesn't seem to take a lot of skill. After all, like a casino, all you need is one good trade. That's what we read about — the success stories of investing talk about how Warren Buffett bought into Coke, or Rakesh Jhunjhunwala bought Titan, or Paulson shorted sub-prime mortgages or such.

While these investors — and many others — have benefited from the huge success of a few stocks, there are thousands, even millions, of other investors who lost much of their money chasing performance. And not just speculating, but even with deep, well researched analysis. A stock that seemed like a steal three years ago is still a steal; they have higher profits, and a lower stock price. In another ten years, they might still have the same stock price. The "value trap" attracts people who think luck plays no role in investing, that all it takes is good analysis.  Value traps are lessons you don't learn about in books; real life teaches you instead.

I attend the School of Hard Knocks, and every time I think I'm close to graduating, I fail the next test. Here are four mistakes I've made and hopefully, learnt from.

Chasing Highs and Lows

On twitter, when I mention that a stock has fallen 10%, I get a quick response — "Is it time to buy?" Usually, it is not — it's a warning sign. But what we like is to have "caught the low" — bought it when the stock was at the bottom. This is unlikely to happen — you may catch a bottom once or twice, but it's like a falling knife that'll slice through you. When Satyam fell rapidly from over 200 to 80 in December 2008, I had decided to pick up a few shares, assuming that it was just a "margin call" or something. The news about Mr. Raju's announcement waltzed in a few minutes later, that he had lied about the company's financials all along. I sold the stock — intra-day — at Rs. 65 or so. It still languishes around those levels three years later. What I thought was a "low" at Rs. 80 went all the way to Rs. 20.

I want to sell the highs too. I held a share called Reliance Petroleum Limited (RPL) which was bought in its IPO at Rs. 60. The stock went to Rs. 240 and I decided to sell. Yet, I felt those pangs of regret as the stock went to Rs. 300. Even with a very good profit — 300% in less than two years — I felt bad that I couldn't make some more?

For the record, I have picked highs and lows; I have bought at the high and sold at the low more often than the other way around.

The Desire to "know".

A friend who had $1,000 in currency asked me if it was a good time to convert to rupees. I said I had no idea. He laughed, and asked me why I was in the finance business if I didn't know. But I honestly didn't know if:

a)      He should care where the rupee or dollar would go, in a one-off transaction, not being a trader

b)      The dollar would move further up — and therefore my friend could get a few more rupees for his dollars

c)       Any prediction would be to simply assuage my friend's need for an answer.

We all wish we could know, which is why astrology is so popular. But we don't.  The markets have asymmetrical information; different participants know different things. An investor may be aware of a problem that you and I don't — and if he sells heavily, the stock collapses; with the information we have, the stock looks attractive, but is it?

I've been trapped enough times thinking that I know more than the market — but more often than not, I've been the ignorant one. In the face of the knowledge that one doesn't really know, what's the right action? Not invest or trade? That would be pointless, because investing or trading, even with incomplete information, can lead to substantially higher returns.

Now I prefer to act another way. I expect this stock to go up. But if it comes down to X, I'll sell, assuming something happened that I didn't know. This is called a "stop loss", but it's more of a "stop the pain of not admitting my ignorance".

The Revenge Trade

And just when I've admitted I was wrong, the stock stops falling and goes back up to new highs. This short-circuits my brain, and I feel like the universe has just conspired against me.

The desire for revenge has made me jump back into a stock, only to watch the temporary move reverse and again come back to hurt me. Usually, such a trade has no logic; it's just a strong feeling that losses in one stock must be recovered from the same stock.

In the school of hard knocks, revenge is an F.

The Perspective: Percentages and Absolutes

Consider the proposal where if you invest Rs. 20,000 in certain (80CCF) bonds, you don't get taxed on that amount. With all sorts of calculations, you hear that you're really investing Rs. 14,000 (since you would have paid Rs. 6,000 as tax on that money, in the highest marginal tax bracket) And then, you get back Rs. 26,000 in five years, making your return 13.2%.

While the 13% is attractive, the entire exercise allows you to earn Rs. 12,000 in five years (assuming the 6,000 in tax saving, and 6,000 in interest).That's Rs. 2,400 per year, or Rs. 200 per month. When you are earning more than Rs. 8 lakhs per year — that's at the highest tax bracket — the amount saved is significantly lower than the joy you feel by hearing "13%".

I have bought stock options for Rs. 100, which tripled in one day. I was overjoyed — 200% in one day. Now let's see: 365 days in a year, 200% a day — that makes me…very stupid. The point here is not just that I can't find such trades every day (and I'll lose my shirt on many of them), it's also that the amount I can invest in options has to necessarily be small, because you can lose 100%. If I invest just 2% of my portfolio on a single trade, and I double my money, the real profit on my total portfolio is just 2%. Nothing to write home about.

Absolutes and percentages both matter; when you get a high percentage return on a single trade, the school of hard knocks tells you to evaluate the overall return on your portfolio instead. You don't appreciate a car that has a great steering wheel if its engine misfires, its headlamps don't work and the seat is uncomfortable. You don't praise one good trade if you have three equal (or worse!) bad ones burning your portfolio.

Perhaps you invested five years ago, when the India story was going strong and they told you, like they told me, that India was the next big thing. Five years have gone, India's GDP and per capita income have doubled, car sales have quadrupled, and yet, markets have returned a miserable 4% per annum, just about beating the savings deposit rate. India's stock market behaves very differently from the rest of India, we learn, as we pass through another year in the school of hard knocks.

There’s been some brouhaha about a new feature at Cleartrip which tells you how many seats are left (at the mentioned price) when you search for tickets.

A post on moocube called “The Cleartrip Hurry Algorithm” started doing the rounds of the Indian web, with the author accusing Cleartrip of trying to make people “hurry” to buy a ticket by conveniently cloaking the “(at the mentioned price)” in the visual interface. You get to see something like:

and the moocube blog writer believes that gives the false impression that the plane is nearly full – his subsequent searches with more passengers indicates the flight isn’t full at all.

Hrush Bhatt, co-founder at Cleartrip, pitched in very quickly with an explanation. Airline ticket pricing is “bucketed” – up to a certain number of seats, you get a certain price, and then onwards a higher price will apply. The interface therefore means there are “n” seats left at this price, not that the plane’s filling up. In fact if you “hover” over this red box you see the missing “at this price”.

The interface, admits Bhatt, is not really conveying the right impression, and others claim in the comments that a lie is a lie. The intentions are not malafide, though, because in some cases you may search for 1 ticket and get a “5 seats left” – indicating that even this bucket isn’t full; a strategy that would be inconsistent if the intent was to intentionally mislead a customer. But it’s best to convey the right image, and it looks like they’ll address that soon. Sadly, Bhatt also tried to malign the author of the post, calling him a liar for not mention

What I learn from this:

• As a business owner, you have to respond to detailed accusations like the moocube post. And fast. But you mustn’t respond to haters and trolls – and they will litter the comments of any negative feedback post anyhow.
• You must admit your mistakes but avoid looking arrogant. People are irrational, they will accept the strategy of “hurry, buy now” from a real estate agent who pretends that a project is sold out when it’s not, or from a movie hall that says “nearly sold out” but you find it empty walking in. But not from you, the website that sells plane tickets. That’s how people are. You don’t call them out for lying when they accuse you of lying – it’s counterproductive.
• Don’t let an episode like this make you think “I shouldn’t do this”. We’ll all make mistakes, the idea is how well we respond to them. Cleartrip gets a lot of publicity for both having done a rush job and for hurrying to clear it up. That’s better than no publicity. In a service business you get recognized for action; and sometimes it’s better to have to apologise than to endlessly argue about whether you should do it at all. [Yes, caveats apply, but you know what I’m saying, no?]
• What the heck is with the “scratched out” numbers – 35,255 for one image, 72,403 in the other? I suppose one might make the argument that those are not fares anyone is expected to pay, but will people take offense to that next? [I doubt it, because that’s less highlighted in comparison]

I personally don’t book on Cleartrip because I get better prices directly from the airlines, where refunds or rescheduling is cheaper as well. (I used to be able to allocate seats, but the silly DGCA has removed that privilege) But I think they have a nice interface and are out there running a good business in a field that is ridiculously competitive.

To end an off-topic post, here’s Seinfeld on airline travel:

The Securities and Exchange Board of India, the market regulator, has upped the minimum investment in Portfolio Management Services (PMS) to Rs. 25 lakh. The earlier minimum was Rs. 5 lakh. This applies immediately for new clients; for existing ones, additional investments need to top up to at least Rs. 25 lakh.

Many brokerages and independent managers offer PMS products, where a manager trades the stock markets, and the Rs. 5 lakh minimum was supposed to deter people who couldn’t really afford to lose that money. (I’m not sure how the higher limit helps, but I suppose it does deter the less well-to-do from losing their shirts)

The unfortunate problem with PMS products has been their overall misuse. There are good PMS products, mind you, and many are offered by smaller, boutique investment advisors; these are usually not available to the masses (reference-only). But the vast majority of what you hear are abused in many ways:

• High fees+Brokerage: typical models use a 2 and 20 – 2% as management fees and 20% of the profits (above a hurdle rate). Typically, when offered by brokers, they also charge a hefty brokerage and churn portfolios.
• Ditching the product when they can’t make hurdle rates. In 2008, a large fund abruptly stopped the PMS service after losing 30%, simply because they would now need to make that back, and then a profit, before they could charge the profit share fees.
• PMS pooling: Funds were placed in a pool account and then traded. Then profits and losses were assigned to clients. This was supposed to be appropriately assigned, but in practice, there were “favoured” PMS accounts which got allocated more of the profits (and lower losses). This was stopped by SEBI by banning pooling, by making segregation into individual demat accounts compulsory. But the practice continues when it comes to derivatives (where there is no demat).
• Misselling: A customer was duped in a Kotak PMS (Moneylife) with a dud product that was dressed up and mis-sold.
• Bad performance: Many products tend to perform much worse than regular mutual funds or indexes. Much of this is attributed to risk taking, but it’s because the high commission structure – PMS companies will pay advisors 2% to 5% upfront for getting them money – requires a higher return to compensate.

While the Rs. 25 lakh minimum doesn’t do much about the above abuse, it helps raise the bar – hopefully, people at that level will read more about the abuse and ask tough questions before they invest. However, noting how high-barrier investment products have been abused around the world (like a Norwegian town being sold US subprime securities), I wouldn’t hold my breath.

The RBI has provided rates that banks used to give for one year deposits, all the way back to 1976. Here’s a plot of the “high” rates today (9.25 to 10%).

Much of the 90s was a 10 to 12% rate, and I remember that many bonds (IDBI etc.) offered 12%-14% to retail buyers. (We still own some 17 year bonds at 14% or so, which mature in 2016. )

When you invest in a fixed deposit, the interest you receive is taxed as income. At the highest tax bracket, you pay 30% on that interest. That means a bank FD that gives you 10% really only gives you 7%. Even if you a a longer term investor in the FD, you pay interest every year. (And the bank deducts 10% as TDS before you even see it)

The government has allowed certain entities to give you tax free interest; if you are an investor for the long term, 10 to 15 years, in certain infrastructure companies. Two of them have already issued bonds (PFC and NHAI) and if you missed those, you can subscribe to the next two coming up from Jan 27: HUDCO and IRFC.

* Retail applications are for individuals, for under Rs. 5 lakh, and the higher interest rate is only for the first allotment. Any sale of the security will drop the interest down to the “Others” level.

The bonds will list on the NSE and BSE, and if you can’t get in now, you can buy them off the exchange. (PFC and NHAI bonds will list soon) and the interest will still be tax free. However, in the above two issues, the “coupon” rate paid on the bond will drop, for retail investors.

Since the bond interest is tax free, this is equivalent to a high interest yielding fixed deposit based on the tax bracket you are in. That is, if you had an interest rate of 30% at your highest tax bracket, a coupon rate of 8.35% means an equivalent FD of 12.08%.

But this is a silly comparison. There is no liquidity – of course the bonds are listed but there’s no guarantee that there will be someone willing to buy. Even if there is, the price someone may be willing to pay could be far lesser – in terms of effective yield – than the price you want (An FD can always be returned early with no loss of principal and perhaps a little penalty on the interest) This is like a 15 year FD.

You needn’t invest in an FD to get a similar return, of course. If you’re thinking of exiting in a few years, you may be better off with a longer term FMP, where the post tax returns are around 9-10% nowadays. These mutual funds lock you in similarly, and are listed, but the interest is not taxed till maturity; they tend to yield between 9-11% (this is the rate for long term commercial bonds nowadays) and the fact that you get an indexation benefit will make much of the gain non-taxable.

(A 9% return with inflation at 8% means only the excess 1% is chargeable to tax – even at the highest bracket you’ll make 8.70%)

The comparison, for those who are thinking of this bond as a 1 to 5 year investment, is better off with a similar tenure FMP, or if you choose to be a little creative, with a bond fund.

I strongly believe that we have overcomplicated our options. Thinking in terms of “you can’t compare this with a gilt fund” etc. are simply skirting the issue. People like to think in terms of “debt” versus “equity”, and then long versus short term. FD is debt, as is a bond fund, as is a HUDCO bond. If interest rates fall, a bond fund and the HUDCO bond will increase in market price, but nothing changes with the FD. If you are in for more than five years, and believe that interest rates will fall to below current levels, the HUDCO or IRFC bond is a good idea.

If you’re in for less than five years, consider a longer term FMP or a bond fund instead.

If you’re retired, these bonds are fabulous, because they give you cash flow on which you need to pay no taxes. And for fifteen years!

And finally if you’re a short term investor with the idea that you’ll speculate on these bonds, the trade will clear itself when the PFC/NHAI bonds list either Friday or Monday. Wait to see if there’s a listing gain available.

At Yahoo, I write on the Irrelevance Of The Sensex:

In a recent trader meet, a speaker asked on stage where the market closed last. Answers were "4714" and other figures around the 4700 number, but the speaker was looking for another answer. It dawned on us soon that he was looking for the Sensex, which none of us knew even to the closest one thousand. It was around 15,700, said the speaker, dismayed at the total lack of awareness because his slide said "Sensex: The Index The World Tracks".

To a certain extent, that remains true. People do talk about the Sensex. "I'll be a buyer below 16,000", you hear. Newspapers and TV channels cheer the appearance of "20,000", a number only associated with the Sensex.

But the irrelevance is mostly to the trading community. Volumes have deserted the Bombay Stock Exchange, for the "better" deal at the National Stock Exchange (NSE). Looking at the "cash" turnover, the gap between the two exchanges has widened from 2000 onwards.

What has changed since 2000? For one, the derivatives market has flourished on the NSE, with volumes far exceeding the cash markets. NSE started futures on the Nifty in 2000, following up with stock futures and options later. BSE, while having started at the same time with derivatives that replaced the "badla" system, has only recently promoted them. Given that the cash and futures markets are closely related — traders can arbitrage the two markets — it is no wonder that NSE still has four times the volumes of the BSE in cash. Higher volumes means you can buy at a lower "impact" cost due to the presence of more sellers; even those that track the Sensex will buy on the NSE.

But the BSE existed a long time before the NSE. The term Sensex was coined in 1986, but the BSE has existed for over 135 years. There are more stocks listed on the BSE than on the NSE, which was established in 1994. Yet, the BSE lost the battle!

To an extent there were regulatory restrictions — NSE could easily provide terminals nationwide, while BSE only allowed to a slew of sub-brokers, which added to delays and costs.

But the BSE wasn't competitive. Broker cartels were common. Trades were only settled every fortnight, with small defaults and payment crises common. In 1995, the exchange was closed for three days after a default of Rs. 18 crore on a single scrip. The early days involved little technology; brokers would send their agents to the trading pit, when they signalled trades to each other using hand signals and shouting — the "open outcry" model. As an investor, you told your broker to buy a share, and miraculously, you would be given the highest price of the day, and there was really no way for you to verify.

The NSE started with "screen" trading, where all trades would happen in an automated method that matched the best buyer with the best seller, and they offered verifiability where you could check trades and prices. There was a clearing corporation to limit default risk, and NSDL set up to do dematerialized settlement instead of paper. Also, the NSE wasn't managed by brokers; it was owned by institutions and managed professionally, which led to less conflict of interest. From here on, the NSE gained favour even though BSE followed through with similar technology and practices.

The issue is trust: the BSE appears to favour its own. In 2006, a dealing arm of a broker sold eleven lakh shares of Tulip IT Services at a price of Rs. 0.25, on the day of its first listing, with the price having settled at Rs. 185 towards the end of the day. He claimed a typing mistake, costing over Rs. 12 crore — now if this were you or me, we would be asked to suck it up. But the BSE did something dramatic: It decided that all orders executed at less than Rs. 96 would be deemed to have executed at Rs. 171, the average price of the day. What then of the person who thought he got a deal at 0.25 and sold at Rs. 100? He now gets a loss of Rs. 71 instead. This is blatantly unfair — and a loss of Rs. 12 crore is not huge; the seller should have borne it, or the exchange should have covered for it, but it can't be foisted on other traders who participated and assumed that the price they were seeing was correct. (Indeed, an instance of "manipulation" where someone placed a rogue order for Tulip at Rs. 1 per share has been penalized by SEBI)

An ex-BSE-president Anand Rathi had asked for data about who was trading what — information that would benefit him as a broker, and which eventually caused him to resign. Since then, brokers have been removed from senior positions in the exchange, and the management team is now professional staff including a suave CEO. Technology has been upgraded, and there is now complete electronic order matching and verification.

But this hasn't stemmed the rot. Recently, a glitch in algorithmic trading caused the futures market to crash during "mahurat" trading, a special short session held on Diwali for traditional reasons. The decision, once the glitch was found, was to annul all trades in derivatives on that day. What then, if you took on a counter-trade in the cash segment or in the NSE derivatives market? You're left with an open position for no fault of yours.

And the point isn't that there was a genuine issue; the point is that in a fair market, you would assume that:

a) The "rogue" trader should have been penalized to the highest extent possible.
b) There would be much more transparency about what went wrong, how they plan to avoid it in future, and going forward, what the process for "annulment of trades" is.

We have none of this, and if you asked a market participant today, he wouldn't expect it either, because it's the BSE.

Sure, we know the BSE and the Sensex because of the past, but if things are to change, they need to attract investor and trader volumes. For that, there needs to be faith that the exchange will treat investors fairly and not resort to knee jerk reactions like cancelling all trades. Sadly, every incident that undermines trust will result in the Sensex being only an over glorified number, the real money will continue to be in the Nifty.

The Reserve Bank of India has cut the Cash Reserve Ratio (CRR) for banks, as a percentage of deposits, to 5.5% from the earlier 6%.

This is, they say, to manage the liquidity situation, where banks have been borrowing a lot (1.2 lakh cr. last) from the repo window; this is much more than the usual figures of 40-60,000 cr.

The repo rate remains at 8.5% and the reverse repo at 7.5%.

Banks are up more than 3% over this move, which gives them some headroom in terms of having to borrow less from the repo window. Analysts have said that the increase in 32,000 cr. of “reserve” money in the hand of banks will result in a multiplier effect (lend and take that money as a deposit, lend again, and so on). A multiplier of 5 will result in credit growth of 160,000 cr. which is huge.

But I doubt that, because NPAs are growing as well. In the last couple of quarters, NPAs have gone up 0.5% (till September), and another 0.5% will negate the entire impact of the CRR cut.

More importantly, the sectors in trouble are priority sector (mostly SMEs?) and Agriculture, where defaults are running at 5%. And the above chart is not including the massive restructuring of the Air India debt, the upcoming issue with Kingfisher, the large debt of GTL and then the many infra projects that are currently in limbo. (Since the chart is only till September).

Liquidity easing may just be a front – the real impact of the CRR cut will be that banks will have the cash to provision against more defaults. It is unlikely to create more lending. Recently, credit growth has dipped below deposit growth – another chart from RBI – for the first time since early 2010.

These are interesting times, no doubt. Combine it with a thorn in Greece that is threatening Europe and we find that things are much in flux.

Two things are expected of the RBI today, in their monetary policy statement. One, that it will not raise interest rates – a stance taken already in end November in their mid quarter review – or actually cut rates. Second, that it will effect a cut on the Cash Reserve Ratio (CRR) from the current 6%.

Given the Macroeconomic statement yesterday, it doesn’t seem like both are likely.

on Inflation:

While growth outlook weakens, inflation risks remain

• The Growth outlook has weakened as a result of adverse global and domestic factors. However, inflation and expectations of inflation remain high and upside risks emanate from exchange rate pass-through, revisions in administered prices and higher-than-expected government revenue spending. Consequently, monetary actions will need to strike a balance between risks to growth and inflation.

• Growth in 2011-12 is moderating more than was expected earlier. The business climate has weakened. The slack in investment and net external demand may keep the pace of recovery slow in 2012-13.

• While in the short run, moderating inflation will provide some space for monetary policy to address growth concerns, in the absence of structural measures to address supply bottlenecks, this will be, at best, a temporary respite. In addition, the expansionary fiscal stance has emerged as an upside risk to inflation.

And later

Inflation is trending down, but upside risks remains significant

• Inflation is moderating led by sharp decline in food inflation and is broadly in line with the 7 per cent projection for March 2012.

• Primary food inflation declined sharply reflecting seasonal fall in vegetable prices and high base. However, as protein inflation continues due to structural demand-supply imbalances, the decline is expected to be short-lived.

• Inflation in non-food manufactured products remains persistently high, reflecting input cost pressures, partly resulting from the rupee depreciation that has offset the impact of softer global prices of some commodities.

• Upside risks to inflation persist from insufficient supply responses, exchange rate pass-through, suppressed inflation and an expansionary fiscal stance.

When you hear language like this you don’t think “repo rate cut”. You think, “wait and watch”. The language for repo rate cut is - “Growth has moderated significantly while inflation risks are benign”.

On Liquidity – that it is too tight will mean that they will cut CRR:

Monetary growth keeps pace even as money market liquidity tightens

• Money market liquidity tightened   significantly   since   November 2011 partly due to dollar sales by RBI. However, monetary growth has kept pace with projections, on account of a rising money multiplier. The liquidity stress was handled by the Reserve Bank by injecting liquidity through open market operations, including repos under the LAF.

• Credit growth slowed below the indicative projection due to demand as well as supply side factors. Demand for credit weakened in response to slack in real   activity. Supply also slowed down with rising risk aversion stemming from deteriorating macroeconomic conditions and rising non-performing loans.

(Emphasis mine)

What they mean is that liquidity is tight not just due to the economic tightening but due to the selling of the dollar by the RBI (which takes rupees out of the system). We don’t know the extent of that selling yet. Therefore, the OMO auctions – where the RBI pays rupees and buys government bonds – is essentially replacing that lost liquidity, and until they fully replace it RBI won’t really know how bad the situation really is on the liquidity front.

Overall, the CRR cut may not happen (such things are never temporary) until the RBI is reasonably sure that the liquidity issue is beyond what the RBI is doing by intervening in the forex market.

I may be wrong. We’ll know in 15 minutes.

The week ended Jan 20^th has seen the market up more than 9% for the month, in a recovery that is as stunning as it was unexpected. With 2011 going down more than 24%, January has pleasantly surprised on the upside. In a tweetup with market commentators in Bangalore, I suggested that the lows weren’t yet in because of the lack of panic – and one of the members responded that the panic season is over, and this was the lull before a big upmove.

Now bear market rallies of 10% and20% are hardly unknown. In the last year alone, we have had two such rallies. Is this currently that kind of a rally? Will it fizzle out right now, or stick around?

The answer can be in the fundamentals or the technicals. So look at the

Fundamentals

To put it mildly, we’re not in great shape. Seventy two companies have revealed results (till Saturday) and the situation is like this:

While revenues are up 33%, the increase in expenses have matched that, and profits are up just 0.01%. This, despite a stellar performance by banks, which seem to not be recording any of the high NPAs that are usually associated with a slowdown in the growth of the economy as witnessed recently.

The problem started in September. Q2 profits, after all companies had revealed results, showed a dip of over 30% in net profit. (This is after ignoring the one time huge profit made in September 2010 by Piramal Healthcare when it sold a division to Abbott, an entry that would have made the dip seem much worse).

This is now exacerbated by macro factors.

1) The Fiscal Deficit is wider by over 1% now, as tax collections have just not met targets. Essentially we haven’t been able to make that 100,000 cr. that was made the year earlier in the 3G/BWA auctions. This means that the government will try to cut spending to keep the deficit down and to reduce further borrowing.

2) Liquidity in the Banking system is very tight. Over 150,000 cr. is borrowed overnight in the repo window nowadays. While this slackening is good to bring down demand and inflation, it does have a negative impact on growth in the medium term.

3) Europe continues to be in a mess. The situation in Greece gets worse every week, as they negotiate with borrowers to take a huge haircut on their bonds – some say as much as 68% - and roll over existing debt to something that will be paid out over the next few years instead. This has the additional requirement of needing to be “voluntary” in nature, which will not trigger credit default swaps (a trigger means the banks – the sellers of the CDS – will have to pay; and they simply can’t afford it). The failure of these talks – or subsequent ones – can lead to Greece leaving the Euro, with not only disastrous consequences of itself, but with scars on banks across the world. Worse, the world will shift to Portugal and Ireland, which will demand a sweet deal (if further attepts to save Greece are taken) or threaten to leave the Euro together. We would be naïve to think that India is not affected –it will be.

4) There is no government action. With public policy going down the route of populism in the face of big election months, and the government unwilling to sit down and make tough decisions, the uncertainty that has given investors jitters persists. Unless there is a strong leadership change, I doubt the feeling of “what are we doing?” will go away.

Positive notes:

1) Inflation seems to be easing. With a sub-8% print for December, inflation seems to be looking better. This has ramifications for interest rates, which are expected to come down in the year once inflation has moderated. High rates have caused interest costs to rise and dampen profits and growth.

2) The rupee has recovered. To nearly Rs. 50 from Rs. 54 to a dollar, and much of it is through the RBI action of selling dollars. Also it seems foreign investors have put in over 6,000 crore into equities in January.

3) Growth isn’t stunted. The Purchasing Manager’s Index (PMI) and the Index of Industrial Production (IIP) have both shown strong growth figures, even if I don’t trust the IIP that much.

4) The economy is still strong. While we focus on numbers like 8% or 7%, the nominal growth of the economy is over 15%; our GDP has doubled since 2006. The momentum that this kind of growth creates will ensure we don’t stop suddenly; just inertia will have us grow enough to be the envy of western economies. However, if we do slow down, then starting the process again will take many years (again, inertia comes against you).

5) Finally, valuations are low. With the markets reaching lows of 4500 on the Nifty, the valuations at 16 to 18 P/E are much better than the 20+ P/E ratios we have lived with in the last five years. Even then, one has to be worried: EPS growth has come down to 10%.

Technicals

Now on to the technicals. Prices tell you a lot, and it looks like the resistance on the upside is at the 5100 level. The 200 DMA is still higher though in this move the Nifty has moved above everything else. The MACD – discussed earlier in the Chronicles – still shows that we have some more to go before we either consolidate or reverse.

Long time readers will also notice the W bottoms and M-Tops. The recent was a nice little W-bottom with a higher low, but if you had followed B-Bands the strategy of w-bottoms has not always led to a rally. In fact there have been many instances of one getting stopped out recently. (which is why it’s so important to stick with a system – one big win is greater than a few small losses!)

The other thing we’ve spoken about – the number of stocks above moving averages – is a very useful sentiment indicator. The indicator needs to dip downwards before a reversal in the index, and it’s currently at a very high level (though has not yet turned).

The distance from the 20 DMA has also reached new highs, as the bounce has been vicious and fast.

On the bearish side, we have a McClellan oscillator that’s at one extreme. This signals a reversal but is not usually the only indicator (you have to confirm this with other indicators).

So technically speaking we may have a little more to go here, before we can say if sentiment is changing. Remember that technical analysis is not about prediction, it’s about working the probabilities and the expected returns on each alternative.

Where am I? I’ve been out of the trade for longer than I’ve wanted, but it looks to me like the real money is in the short side. That is, we have reached a level where it is unlikely to go up a lot, but is likely to go down a lot. The only thing that prevents me from taking a large position is that too many people are expecting the market to fall.

I mean that. When a substantial majority is on one side of the trade, the markets usually go the other way. It was apparent – in hindsight perhaps, but I had tweeted about this in mid-December – how everyone was bearish (including me!). The expectations were only between a) will we fall a lot? Or b) will we fall a little. That, and the warning sign in the tweetup meet in Bangalore – where I was told that sentiment is rock bottom – should have forewarned me. It still seems that way – that most stock market participants continue to be bearish, including me. But this may be the beginning of a huge rally, with a few stops in between.

But slowly, things will align together if that is so – imagine that Europe resolves itself at least for the next two years, there is a recovery in China, our interest rates go down, inflation soothes itself, the government decides to go with some good reforms…all this, together, is unthinkable today, but it could be small, tiny moves that eventually lead the way. My point: I doubt it, but if these signs come along, I’m not going to fight them.

IPOs have gone down massively in the recent past (see IPOs largely suck in 2010-11) and a large number of them have gone down over 80% from listing prices. Many are small issues, manipulated up on the first day, attracting investors, only to later slump to levels hitherto unheard of. SEBI now has announced norms to curb misuse of the listing day freedom.

To plug the high volatility, all new listings will have circuit limits from day one (currently, there’s no circuit). A new listing post IPO will have an auction similar to the pre-trade auction for one hour, where you can enter limit or market orders which won’t get executed until the end of the auction hour. The best price is then found by matching orders and the “equilibrium” price is used as the open for the subsequent part of the day (with appropriate circuits in place).

And then, for IPOs of less than 250 crore, the stock trades in “Trade for Trade” segment – meaning, you pay 100% margin for all buys, and you can’t sell unless you own the stock (no intraday short sells). Trade-for-trade applies for the first 10 days, only for IPOs less than 250 cr. 

While this is a good step, what it will really do is to move the manipulation to the first day AFTER the curbs are removed. However, the signal that SEBI is watching may just be enough for operators to stop the rampant abuse of the system that is currently happening. I think we simply need more IPOs, from the likes of Indigo airlines to Flipkart to Tata Capital, to fuel capital markets (and interest back into IPOs). I really don’t get the concept of selling IPO stock at a huge premium – it’s better to conservatively place stock and then make the big money on a follow on issue a year later. Sadly, we are all greedy pigs.