The difference between the Sensex high and low was a whopping 480 points on Thursday, and the benchmark index closed 2.8% off the day’s high.
The trigger for the crash: France’s biggest bank, BNP Paribas, announcing that it was “temporarily” suspending redemptions on three of its funds because it was impossible to value their asset-backed securities.
Banks are so used to valuing these securities on whatever their fancy models tell them that marking them to market is proving to be a very distressing exercise. As a result, banks in Europe have become so reluctant to lend that the European Central Bank had to take the extremely unusual step of injecting billions of euros into the market at 4%, after overnight rates went up to a four-year peak of 4.7%.
The volatility in the Sensex mirrors that in the Dow on Wednesday. The DJIA started off the session around 50 points up, continued in the range of 50-100 points up for most of the session, moved up slowly in the middle of the session to almost 300 points above the previous day’s close, before plunging 250 points or so on rumours of problems at Goldman Sachs and then moving up another 150 points in the last half-hour of trading.
The message is simple: Although markets have trended up in the last few days, they’ve also been very nervous. The volatility is the result of a battle royale between the bulls and bears in markets worldwide.
The bulls believe that the credit worries are a storm in a teacup and the markets will bounce back after every dip, as has happened every time in the last four years.
After the European Central Bank’s stepping in on Thursday, that’s a bit difficult to believe. The bears believe “this time it’s different” and the problems in the credit markets will be long-drawn and will spill over into other asset classes. The strength of the bulls seems to show that at least in the equity markets, there’s still a lot ofliquidity.
But BNP Paribas’ statement says that the decision to freeze the funds arose out of a “complete evaporation of liquidity”, indicating that the situation is very different in the credit market.
There’s still plenty of money on the sidelines in the Indian equity markets. However, open interest remains high, magnifying both the rise as well as the fall in the markets. “So far, trading volumes have remained high, but as every attempt at a comeback fails, market players will slowly get discouraged and volumes should start to fall,” says Ajit Surana, managing director of Dimensional Securities. It’s likely that more funds will be hit as they try to mark their portfolios to market and every time that happens, the markets will totter.
The credit market for Indian companies has already been affected, with reports that Tata Steel may have to offer a higher rate of interest on part of the refinancing package for Corus. At the same time, there’s still a lot of liquidity for the right kind of issues, seen from Chinese real-estate broker E-house’s initial public offering being subscribed 15 times, despite being priced at 28.8 times 2007 earnings.
In the Indian market, it’s worth noting that despite the carnage, the BSE Capital Goods index is at a higher level than what it was on 19 July, when the Sensex first closed above 15,500. That’s because fund managers are now positioning the capital goods sector as a defensive one, because of the visibility of earnings.
Will the action by the European Central Bank soothe the markets? It should certainly have a calming effect on the credit market, but, as a hedge fund manager put it, “It also raises the obvious question—just how bad is this problem for the central bank to have to step in?”
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