During this year, 2011 Jan – Aug
2001, market has been trading in the range of 5170 – 6100 with a downward bias.
During past few weeks, global
markets experienced two major events – S&P downgrade of US sovereign rating
and fear of Europe contagion with Italy getting added to PIGS (Portugal,
Ireland, Greece, and Spain) economic problems. Also, QE2 has come to an end in
the US. These factors pushed all global markets down. Some bearish analysts
have attributed this to market pricing in the recession.
This led to Indian markets breaking
the trading range. In the past two days, markets lost 4% and went below 4800
before closing at 4845 on Friday. Now this is significant for following reasons:
·
Market has breached the key support
area of 5150 – 5200, which was tested multiple times this year, has been broken
decisively.
·
Also, the uptrend that has been in
force since Aug 2009 has been broken signaling that down trend that started
after reaching the high of 6330 in 2010 November has gained strength
Due
to these technical factors combined with weak global scenario, the probability
that markets entering a prolonged bear market has increased.
The key market levels that we need to
watch out for are:
1. NIFTY 4750, which if it is broken, could lead to market
testing 4200 levels.
2. NIFTY 5200, if broken on upside, signals the end of the down
trend and the market will turn bullish
Following are the possible scenarios
going forward:
Scenario 1: Markets could go up to 5050 – 5150 and resume further down
slide with increased vigor
Probability: High
Rationale: Global headwinds – First, US market getting into recession
as current government and congress fail to take steps to stimulate the economy.
Second, European leadership fails to find satisfactory solution to Europe union
fiscal problems.
Scenario 2: Markets could go up to 5050 – 5150 and continue to climb
up.
Probability: Medium
Rationale: Technical – NIFTY 4750 is a strong support area and market
could bounce from the current levels. Macro economic factors: First, US market
slows down and markets feel it wouldn’t get into recession based jobs data,
housing data, and manufacturing data in the next two weeks point to improved
economy. Second, Federal Reserve and Ben Bernanke could come out with
aggressive monetary policy to shore up the stock market with QE3 or some other
policy decision this Friday.
Scenario 3: Markets get into sideways consolidation
Probability: Low
Rationale: Markets may not find clear signals either from the data or
policy decisions to take a decisive direction.We anticipate markets to remain
volatile for next few weeks and it will take some time to determine which of
these scenarios is going to pan out…
Strategy:
1)
Equity Portfolio:
a. Deploy the cash in the portfolio to increase equity exposure
i.e., buy stocks as long as the market is below 5050.
b. When market recovers to 5050 -5150 levels, re-balance the
portfolio by
i.
Reducing exposure to interest rates
sensitive sectors such as Banks, Capital Goods and export dependent sectors
such as IT
ii.
Increase exposure to defensive
sectors such as Oil and Gas, FMCG, and Pharma sectors. Also, we reduce exposure
to Midcap stocks.
2)
Collar Strategy: We wait for the markets to pull up a bit, to 5000 – 5150,
and then sell NIFTY Call Options and use the premium collected to buy put
options. If the market falls, the put options will increase in value and we use
the gains to buy stocks. If the markets do not fall as anticipated, the current
portfolio will gain in value and offset the potential lose in selling call
options. Also, we use stop loss mechanism to mitigate the potential hit on
short calls.
Also, if the market goes below,
4700, reduce equity exposure by 50% and use the cash to
buy stocks at lower levels, continue with this strategy as long as the
markets are in down trend. The major benefit of this strategy is, we continue
to buy more shares at lower prices, and the portfolio will lose relatively
smaller value compared to the market.
If the markets continue with the
sideways consolidation, even then we will continue with this strategy.
3) Reverse Spread Strategy: In
this strategy, sell Call options at lower strike price and use the premium
collected to buy more options at higher strike price. For example, we will sell
5200 Call options and buy 1.5 times more 5300 call options. If the market
continues to climb up sharply, then this strategy will lead to profits. We
employ this strategy only if the markets show strength and trade above 5200
level.
These strategies will allow us to
take advantage of the volatility and enhance portfolio returns in the long run.
