Monday, March 5, 2012

Uncertainty over market rally as intra-day trades increase

The stock market rally this year has led to a jump in trading volumes on Indian bourses, but the proportion of delivery-based trades has been lower than in the previous year due to increased intra-day trades, indicating uncertainty over the current rally.

Moreover, although the long-term outlook for Indian equities appears marginally better now, compared with two months ago, uncertainty on events such as election results, the national budget later this month, and the direction of crude oil prices, which touched an 11-month high on Thursday, might make the markets volatile in the coming weeks, analysts said.

Riding on the back of easing liquidity in the West, foreign institutional investors (FIIs) have pumped in $7.4 billion net of sales in Indian equities so far this year, pushing the 30-stock Sensex index on BSE up 14%. The rise in the broader market has been sharper,with the BSE-500 index rising 18%.

The rally has led to increased trading interest, fuelling a jump in trading volumes. Average daily trading volumes reached a 16-month high of 1.38 billion in February.

This year, nearly 1.17 billion shares have been traded per session, 33% higher than the previous year, when average trading volumes had dipped to a five-year low of 872 million shares. Due to a weakening economy and policy uncertainties, institutional and retail investors largely stayed away from Indian markets in 2011 and the Sensex slumped 25%.

The drop in volumes had become a major worry for Indian regulators. When Securities and Exchange Board of India (Sebi) chairman U.K. Sinha in late December met various market participants including top mutual funds, FIIs, brokerages and investment banks, the drop in trading volumes dominated the meetings.

The Reserve Bank of India (RBI), in its financial stability report in December, flagged off the drop in cash volumes and the rising share of derivatives in the total turnover as a key risk to financial stability in the Indian equity markets.

A rise in global risk appetite since then has led to a surge in volumes, but trading has been dominated by day-traders. The average proportion of delivery-based trades fell to a 19-month low of 38.1% in January and rose only marginally last month. Delivery-based trades as a proportion of total volumes averaged 41.5% in 2011.

“The proportion of delivery-based trades has fallen as day-trading has become more common,” said Yogesh Radke, head of quantitative research at Edelweiss Securities Ltd.

The current trend is in contrast to the equity rally in 2010, when rising volumes were accompanied by a rising share of delivery-based trades. The average proportion of delivery-based trades had risen by 2 percentage points to 42% in the August-November period of 2010 over the first seven months of that year. The Sensex had rallied by 9.3% over the same period on the back of foreign inflows worth $18.5 billion, net of sales.

This year’s rally has been led by improved global liquidity, and lingering concerns on fundamentals have made many averse to taking long-term bets, analysts said. The recent rally is unlike the 2010 rally, when there was greater institutional participation and conviction in the strength of the bull run, said Radke.

“Economic growth is likely to bottom out in the current quarter, and the overall outlook appears marginally better compared to a few months back, but uncertainties on corporate earnings and over events such as the Union budget still remain,” said Prasun Gajri, chief investment officer at HDFC Standard Life Insurance Co. Ltd that manages around Rs.25,600 crore worth of assets.

India’s economic growth slid to a three-year low of 6.1% in the December quarter. The consensus earnings estimate for Sensex firms for the next fiscal year has dropped 13% since the start of fiscal 2012 to around Rs.1,298 a share, and it will be a while before the upgrade cycle starts, analysts said.

While the second round of monetary easing by the European Central Bank is expected to lend support to risk appetite globally, concerns over rising crude oil prices that adversely impact India’s fiscal and current account deficits, and uncertainties over the upcoming Union budget and the direction of RBI’s monetary policy could keep markets on tenterhooks in the coming weeks.

The fall in inflation and recent policy initiatives by the Prime Minister’s Office are grounds for optimism, but the current valuations appear to have priced in most of the positives and “March could see newsflow-driven volatility due to election results, RBI policy and budget”, Manishi Raychaudhuri, head of research at BNP Paribas Securities India Pvt. Ltd, wrote in a 1 March note to clients.

The Sensex trades at 14 times its estimated earnings for the next fiscal year.

Gajri of HDFC Life agreed that there are near-term uncertainties, but said current valuations appear reasonable from a long-term perspective.


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