Retail hopes ride high, smart money waits. What's next for markets after budget?

Last week, I wrote that the coming weeks would be crucial for the markets. There are still enough pending news triggers in the pipeline to influence sentiments significantly enough to provide some surprises.

The US Fed kept rates unchanged along expected lines. The cost of funds will probably rise further before they ease. At the time of writing this piece, the budget was a minor trigger for the markets. The new Income Tax Act is yet to be announced, and the fine print of the budget is yet to be dissected. The tax exemption threshold being raised is a welcome step, though the real benefit accruing to a tax payer needs to be examined under a microscope.

Two things about the budget and its possible fallout caught my attention. Firstly, higher credit availability to the agriculture and MSME (micro, small and medium enterprises) sectors. These sectors fall under priority sector lending (PSL) regulations. Every banker must lend at least 40% of his entire loan book to the PSL segment. The noteworthy point is that this is a segment with a higher-than-average delinquency ratio, and is also politically sensitive. That means markets can get worried about the prospects of banking and financial sector stocks.

These stocks command a whopping 34.60% weightage in the broad-based Nifty50. This swing sector can sway the broader markets, and if sentiments turn nervous, the market can erode further.

The second noteworthy point is the estimated gross borrowings of ₹14.82 trillion, out of which ₹11.54 trillion would be from dated securities. Some portion of the borrowings would be met from small savings schemes and other public savings. Since the government intends to raise a substantial amount of money from the money market, can the Reserve Bank of India’s monetary policy committee really cut rates aggressively next week? Keeping rates elevated while borrowing more from the markets will mean a weakening rupee and “imported inflation." This would impact banking and financial stocks which are heavyweights in the indices.

So far, statistical data seems to suggest that retail hopes are riding high, and smart money has not enhanced its exposure yet. Budgets usually witness a few days of number-crunching and reading the fine print, before markets settle down. In this case, the new Income Tax Act is yet to be known, and RBI’s interest rate decision is awaited.

In terms of action, public sector undertakings (particularly banks), power, infrastructure, defence, logistics and energy stocks should witness larger-than-average two-way moves. Industrial metals are showing signs of profit-taking on commodity exchanges, which may drag stock prices of metal and mining stocks. Bullion shows safe-haven buying due to flight of capital, and will see buying on dips. My hypothesis of oil and gas markets being oversupplied was validated by the price action in the past week.

Fixed income investors should await clarity from the MPC meeting outcome on 7 February before deploying any fresh amounts in gilt funds or sovereign bonds.

I would suggest trading light and maintaining tail risk hedges on all trades.

A tutorial video on tail risk (Hacienda) hedges is here.

Rear View Mirror

Let us assess what happened last week, so we can guesstimate what to expect in the coming week.

The rally was led by the banking sector which was fuelled by hopes of personal income tax cuts in the budget and an RBI rate cut next week. The rupee fell again versus the US dollar and that capped the upmove. Indian 10-year bond yields eased and that boosted banking stocks. The market-wide position limit (MWPL) fell routinely on expiry.

NSE gained in market capitalization, and that hints at retail buying. US indices were a mixed bag, but were largely nervous, and that capped gains in our markets. It was primarily the budget that triggered optimism in the retail camp.

Retail Risk Appetite

I use a simple yet highly accurate yardstick for measuring the conviction levels of retail traders – where are they deploying money. I measure what percentage of the turnover was contributed by the lower and higher risk instruments.

If they trade more of futures which require sizable capital, their risk appetite is higher. Within the futures space, index futures are less volatile compared to stock futures. A higher footprint in stock futures shows higher aggression levels. Ditto for stock and index options.

Last week, this is what their footprint looked like (the numbers are average of all trading days of the week) –

The capital-intensive, high-volatility futures segment saw increased turnover contribution. Part of it is due to expiry as traders close trades in the expiring series and initiate the same in the next monthly series. That witnesses dual turnover. Robust rollover itself is a sign of conviction.

In the relatively lower-risk options segment, index options saw turnover contribution fall drastically. This is the lowest-risk segment in the derivatives space. Stock options turnover rose as traders preferred to roll over their trades. Overall, I saw derivatives traders display higher risk appetite, though the expiry was also a reason.

Matryoshka Analysis

Let us peel layer after layer of statistical data to arrive at the core message of the markets.

The first chart I share is the NSE advance-decline ratio. After the price itself, this indicator is the fastest (leading) indicator of which way winds are blowing. This simple yet accurate indicator computes the ratio of the number of rising stocks compared to falling stocks. As long as gaining stocks outnumber the losers, bulls are dominant. This metric is a gauge of the risk appetite of ‘one marshmallow’ traders. These are pure intraday traders.

The Nifty clocked gains after a fortnight of losses, and the advance-decline ratio rose to 1.77 (prior week 0.76). With 177 gainers for every 100 losers, intraday bulls were clearly on the front foot and dominated over the bears. Follow-up buying will be required to maintain the upthrust.

A tutorial video on the Marshmallow theory in trading is here.

The second chart I share is on market wide position limits (MWPL). This measures the amount of exposure utilized by traders in the derivatives space as a component of the total exposure allowed by the regulator. This metric is a gauge of the risk appetite of ‘two marshmallow’ traders. These are deep-pocketed, high-conviction traders who roll over their trades to the next session/s.

The usual post-expiry decline in MWPL saw a fall in the reading to 25.46% (prior month 24.45%). The higher reading indicates higher rollover of positions and hope-based activity. Should follow-up support be seen, all is well. Any nervousness can result in some crowded exit like phenomenon.

A dedicated tutorial video on how to interpret MWPL data in more ways than one is available here.

The third chart I share is my in-house indicator ‘impetus.’ It measures the force in any price move.

Last week, both indices clocked gains and the impetus readings were higher too. That tells us there was forceful buying in the indices. Part of the reason is the expiry of the January derivatives, due to which dual turnover was logged - which means follow-up buying assumes significance as per this study too.

For a sustainable upthrust, prices and impetus readings must rise in tandem.

The final chart I share is my in-house indicator ‘LWTD.’ It computes lift, weight, thrust and drag encountered by any security. These are four forces that any powered aircraft faces during flight; so, applying it to traded securities helps a trader estimate prevalent sentiments.

The Nifty clocked strong gains last week, and the LWTD reading jumped to 0.39 (prior week -0.71). That tells us declines are likely to see fresh buying and/or short-covering support. Should this hypothesis be proved correct, declines may be shallow, failing which a crowded exit can occur.

A tutorial video on interpreting the LWTD indicator is here.

Nifty’s Verdict

Last week, we saw the bearish triangle which needed a confirmatory sustained trade below the 22,875 level to confirm bearishness. Bulls managed to save the day and defended that threshold. The 23,425 level that needed to be overcome was also achieved on a closing basis.

The price is still below its 25-week moving average (blue line) which is a proxy for the six-month average holding on cost of a retail trader. Should bulls push the price above this average and keep it sustainably higher, a phase of bear covering and fresh buying may be triggered.

The round number of 24,000 assumes importance as a threshold to be crossed to display strength. On the flip side, trading below the 23,250 level opens the possibility of fresh declines.

Your Call to Action:

Watch the 24,000 level as a near-term hurdle. If the Nifty stays above this level on a sustained closing basis, markets may witness short-covering and fresh buying. On the flip side, staying below the 23,250 opens the door to fresh declines.

Last week, I estimated ranges between 50,025 – 46,700 and 23,725 – 22,475 on the Bank Nifty and Nifty respectively. Both indices traded within the specified support levels.

This week, I estimate ranges between 51,400 – 47,775 and 24,175 – 22,850 on the Bank Nifty and Nifty respectively.

Trade with strict stop losses. Avoid trading counters with spreads wider than eight ticks.

Have a profitable week.

Vijay L. Bhambwani

Vijay is the CEO of www.Bsplindia.com a proprietary trading firm. He tweets at @vijaybhambwani.