The run-up in the Sensex and indeed in all emerging market stocks after the rate cut by the US Federal Reserve is being compared with what happened to the Nasdaq after the rate cuts in late 1998. Well, here’s a chart comparing the run-up in the Sensex after the 50 basis point cut in the Fed funds rate on 18 September to what happened to the Nasdaq after the 25 basis point rate cut on 15 October 1998. The day of the rate cut has been taken as day zero on the chart and the chart maps the rise of both the indices from a base of 100. The numbers on the x-axis denote the number of days after the rate cuts. Notice how similar the movement of the Sensex has been to that of the Nasdaq in 1998.

There is, of course, a difference. The 15 October rate cut in 1998 was actually the second one, the first being in a 25 basis point cut on 29 September. However, that initial cut didn’t really have much of an impact on the market, and the Fed soon went in for another 25 basis point cut on 15 October, following that up with a similar cut on 17 November.

In contrast, in 2007, the initial rate cut on 18 September was of 50 basis points. It could be argued, however, that the chart plots the remarkable similarity between the rally on the Nasdaq nine years ago after a (cumulative) 50 basis point rate cut and the rally in the Sensex after a similar rate cut this year.

Why are the two rallies so similar? The reason could be because the liquidity unleashed by the Fed rate cut rushed into tech stocks listed on the Nasdaq nine years ago, while liquidity has flowed into emerging markets this time. If that line of reasoning is true and Monday’s Nasdaq bubble is indeed being reincarnated in today’s emerging markets or in the Sensex, then, going by the chart, the current rally has a lot of steam left in it. And if stocks move into bubble territory, valuations go for a toss. At the peak of the bubble in early 2000, the Nasdaq traded at a price-earnings multiple of around 200.

One last point—the Nasdaq rally was fuelled by total rate cuts of 75 basis points, the last one coming on 17 November 1998. Fed funds futures are currently showing a 42% chance of another 25 basis point rate cut at the Fed Open Markets Committee meeting at the end of this month.

Nifty Midcap 50

So we have another mid-cap index, with the National Stock Exchange (NSE) launching the Nifty Midcap 50 last week. But this one’s different. NSE has ensured that the index is made up of not only liquid stocks, but also those that are already part of the derivatives segment. In fact, the primary purpose of the new index is that derivatives contracts could be launched on it. NSE’s CNX Midcap index, comprising 100 stocks, was already doing a good job of disseminating information on how mid-cap stocks perform. It’s no wonder derivatives contracts on the Nifty Midcap 50 would be available in less than two weeks from the launch of the index.

NSE’s resolve in providing new indices for derivatives market participants is commendable, especially since the experience with futures and options on the Nifty Junior and the CNX 100 have so far been disappointing. But it typically takes time before trading in new products takes off, and NSE is doing its part by offering incentives to traders.

If the daily average turnover of a trading member exceeds Rs10 crore in the futures market of any of the three new indices, transaction fees are waived. If the turnover exceeds Rs20 crore, there would be some waivers on trades done in the popular Nifty series. Given such a structure, it would even make sense for trading members to act as market makers by offering two-way quotes.

From a trader’s point of view, the Nifty Junior and the Nifty Midcap 50 offer trading opportunities that are distinct from those offered by the Nifty, given the difference in the beta of these indices.

The CNX 100 offers a superior hedge for a diversified portfolio. Market participants have been asking for new products in the derivatives space for some time now. NSE is gradually doing its part—it’s up to the market to make the most of the new opportunities.

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