F&O data signals rise in volatility, be cautious

Tuesday was not a great day for our market. It turned volatile and closed virtually at the lows of the day. The Nifty ended just above 5,900 level, but it was not a big dent to the market. Today, one need not worry too much about the global cues because they are flat, but it appears that Nifty may also start flattish, maybe with a mildly negative bias like the rest of Asia, said CNBC-TV18's managing editor Udayan Mukherjee.

Also read: Relax! India will outperform by year-end: Credit Suisse

Below is the verbatim transcript of Udayan Mukherjee’s comments

Our market had a fantastic rally last week; so given the ferocity of the rally and that the global markets too looked a bit extended on their way up, a bit of pull back was on the cards. However, the big question now is whether this is just a pullback or are these first signs of some kind of a U-turn for our market, something that the global investors might already have been preparing for in the Futures and Options market.

However, since we have not seen enough damage on the screen to conclude that the market has turned from last week’s rally, it may just be a pull back. The market might have legs on the way up particularly if global markets move higher. I don’t think the bears will be very confident after yesterday’s move to press large scale shorts, but the germ of suspicion and some caution would have been planted in the minds of the bulls,  especially after the price action of the last couple of sessions.

Foreign institutional investors (FIIs) have bought Rs 6,000 crore of Nifty Options and that is phenomenal buying. If one looks at yesterday’s strike prices on Puts, then one can see that the FIIs have largely been buying only Puts. They started buying from 5500 all the way to 5700 and especially around 5600 huge amount of Put buying happened

Although the market has not corrected too much the volatility index (VIX) has gone up quite significantly if one compared it to where it was on last Friday.

So, I think something in the environment is telling people that volatility is on the rise and that people should be extremely cautious. Just the sequence of events should make one a little wary because we had a 5 percent rally and just on back of that rally, we had the FIIs selling Nifty Futures and buying huge amount of protection for them through Puts and that usually does not happen in markets where FIIs are sniffing momentum.

Even in the cash market, the domestic institutional investor (DII) selling is overwhelming the foreign institutional buying, although part of it could a preparation for the paper which is coming up. However, the internals are once again suggesting some caution for the market and that too is making the market nervous. So, it would be a mistake right now to just look at the one Rs 700-800 crore plus figure on the cash market and conclude that we are in a very benign liquidity momentum spiral. We were in that situation last week but this week there have been some red flags which have popped up.

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Today, I hope the Nifty does not trade too much below 5900 because the longer we spend below 5900, the more nervous the long traders will become especially since yesterday’s price action was not encouraging. One also needs to watch the midcap action very closely today, because sometimes at such crucial points, the breadth of the market gives an indication of whether the markets is about to break down or that it is just a pull back after which the last leg of this upmove can resume.

If the market is very vulnerable and scared of a downside opening up, you will probably see the midcaps and smallcaps coming off quite significantly, even if the Nifty dithers in this 5900 zone. So, the breadth is going to be important.

Since yesterday the volumes were higher than the day before, so on the down tick volumes actually went up. Therefore even the volume action would be quite important to watch out for today.

As yet there is no way of knowing whether this market is just giving you a pull back to about 5850-5900, before the global markets and liquidity picks it up once again to take it to 6000 plus. Although there is no fundamental reason per se for that to happen, but liquidity and global market action can certainly achieve that.

However, there is a lot of caution which has come in the last couple of days from the Futures and Options action and one can read that in both ways. One can ask with apprehension why FIIs are getting so skeptical with their Put Option buying or one could say, if the market is so well hedged already, with FIIs having bought so many Put Options, would there be such a downside risk to this market? I am not sure of which is the right way to read it but staying a bit on the cautious side for now may not be unwarranted.

With regards to the monetary policy, it is a tough call on whether the Reserve Bank of India (RBI) moves next week or not and I don’t think it’s a done deal particularly given double digit consumer price inflation (CPI) which has been running for some time. The RBI might take a judgement call to wait and do it in the annual policy in April or it may do a token of 25 basis points and then start to get cautious.

However, it is important to take on board some of the commentary which is coming in; Dr Rangarajan from the Prime Minister’s Economic Advisory Council (PMEAC) who generally speaks in very bullish tones is talking about stagflation kind of environment. That is what he said last evening. That seems to be India’s big problem that the growth is low and will probably remain fairly low for some time and we have not really seen the death of inflation, although one might want to believe otherwise. In fact, once this government’s precipitous cut in planned expenditure for Q3 and Q4 goes down, and the fisc becomes loose again going into next year, there might be some challenging times for the inflation numbers once again.

So, I would hesitate to celebrate the death of inflation already. The Reserve Bank probably will have to keep that in mind as well, even if it thinks that the government has done enough to deserve a 25 basis point cut. Inflation is still too high for comfort particularly the consumer level, and growth is still stumbling. One can talk about targets of 6-7-8 percent growth numbers but the current evidence is not suggesting that we are in for a V-shaped recovery in growth. The macro still remains very challenging.

When you get Rs 1,000 crore of FII flows every day, then you look at every data point with rose tinted glasses and talk about 8-9-10 percent growth. However, once the global flows start disappointing, that is when you start fretting about current account deficit and the currency, and then some of those growth assumptions will begin to look quite low. So, right now we are in the phase of illusion of global liquidity, which leads us one way or the other but the data on the ground still remains very challenging.