Short Call: Debt knell for AMCs? Bharat Electronics, copper prices, crude options

The turmoil in the US banking sector could to soon spare the US Federal Reserve of the unpopular move of hiking interest rates.

I am an options trader, and I don't understand options. How do you want a regulator to understand them? ~ Nassim Nicholas Taleb

SGX Nifty futures are indicating an upbeat start to the week, but traders and investors are not convinced that the market can sustain at higher levels. Rather, the question people are asking each other is: how low can the Nifty go. For now, 16,800 is viewed a strong support level. The government’s proposal to hike securities transaction tax on STT has left traders fuming, but veteran brokers say any adverse impact on trading volumes is likely to be short lived.

"Higher STT on options is like sin tax. You can increase tax on cigarettes and alcohol, but people still won't stop smoking or drinking. Similarly, derivatives trading has become an addiction for many retail players. The Big Boys of the game will figure out a way, while the small fry will grumble and keep trading away,” the head of a stock broking firm told Short Call.

And yes, the next traders need to be mindful the next time they brag on social media how easy it is to make money through selling options. The tax man is watching.

The fine print

Shares of the already beleaguered asset management companies took a further pounding on Friday following the amendments to taxation on debt mutual funds, bringing them on par with bank fixed deposits. The market may be overreacting to the estimated hit to profits.

From a CLSA report:

“Liquid MFs of Rs 6.6trn will not be impacted materially as they are anyways a short term product and there is no material change in tax attractiveness. Revenue contribution from non-liquid debt products is 11-14%. Bulk of the revenue/profitability for AMCs accrues from equity AUMs; non-liquid debt AUMs are neither higher growth nor higher profitability segments.”

Industry officials are expecting a deluge into debt funds this week as wealthy investors try to beat the March 31 deadline to take advantage of the tax and indexation benefits.

Finger pointing

Senior officials at mutual funds are furious at the proposed changes to debt fund taxation, and privately say this is the result of lobbying by banks who see a risk to their deposit growth because of the growing popularity of debt mutual funds. That may or may not be true. But how much can banks actually benefit from the move, considering that bank deposits are anyway 22.5 times debt fund assets. Also, the move won’t hurt profits of asset management companies much for the reasons mentioned above. MF bosses though have a couple of good points to make on why the government should not have tinkered with the taxation rules.

“If something goes wrong with mutual fund schemes, they don’t have to be bailed out using taxpayers money. Not so with banks, which do require government intervention in some form. Second, how can you strengthen the bond market, if you make debt funds unattractive for investors. Only MFs can take on duration risk and credit risk; banks won’t do that,” a senior fund manager told Short Call.

Discounted story

Bharat Electronics post market hours Friday said that it had won orders worth Rs 4,300 crore from the Army and the Navy. The stock is almost skirting bear zone considering that it is down 20 percent from the peak of Rs 115 seen in September. Hindustan Aeronautics stock has fared better than BEL, but it too has not done much in the last six months. Bulging defence order book is among the better stories in the market right now, but investors already appear to have priced in the order books for FY24 as well. That said, news of order wins in the days ahead are unlikely to set the stocks on fire

Rising copper

Copper prices broke past $9000 a tonne last week and is expected to keep rising for a while. Top metals trading firm Trafigura sees copper hitting $12,000 per tonne this year, breaking the previous record high of $10,845 per tonne seen in March 2022. China’s refined copper production in the first two months of 2023 rose 10.6% to 1.95 million tonnes year-on-year, according to data from the National Bureau of Statistics. The world’s refined copper market had a 103,000 tonnes surplus in January, compared with a 10,000 tonnes surplus the previous month, website mining.com reported, quoting the International Copper Study Group (ICSG)

Why it matters?

The price of copper reflects the health of the global economy due to its widespread applications across sectors such as power generation and transmission, construction, factory equipment and electronics.

Cost of banking stress

The turmoil in the US banking sector could to soon spare the US Federal Reserve of the unpopular move of hiking interest rates. But that does not really change the big picture.

From Bloomberg:

“At his press conference after Wednesday’s 25-basis-point move, Powell suggested that tighter financial conditions might be “the equivalent of a rate hike, or perhaps more than that” — quickly adding a caveat: the assessment can’t currently be made “with any precision whatsoever.”

That hasn’t stopped economists on Wall Street and elsewhere from trying. Using SHOK — Bloomberg’s model of the US economy— in-house US chief economist Anna Wong calculates that the banking stress seen so far is likely equal to a 50-basis-point increase in interest rates. Other estimates run as high as 150 basis points.”

Time for new playbook

Traders and investors betting on the possibility of central banks cutting rates in the foreseeable future could be setting themselves for disappointment, according to investment management firm BlackRock.

From the BlackRock newsletter:

As the cracks emerged, market expectations for peak rates plummeted. The reason: hopes that central banks will come to the rescue and cut rates, as they did in the past. That’s the old playbook –and it no longer works. Central banks are set to keep fighting stubbornly higher inflation, and use other tools to safeguard financial stability. Our conclusion: Investors need a new investment playbook and to stay nimble in this new market regime.

Quotable

“Our fight against inflation is not over; there’s certainly no mistaking that price pressures are strong and broad-based. If we are to tame this stubborn inflation, we will have to be even more stubborn.” Bundesbank President Joachim Nagel to Financial Times

Options and crude oil

The recent slide in oil prices was caused more due to the dynamics in the derivatives market than because of a change of outlook on demand and supply, according to a report in the Wall Street Journal. Oil prices plunged as traders who sold put options on oil were forced to unload futures as prices neared levels that would have caused losses on the options contracts. And now the pendulum could swing the other way.

“Now, many expect similar dynamics could add momentum to any rebound if the economic outlook improves—leading to more expensive oil that could increase the cost of gasoline and diesel later this year. Chinese refiners have recently snapped up supertanker shipments of oil in a sign that China’s long-awaited recovery from pandemic lockdowns is finally beginning to take hold.”

(With contribution from Shailaja Mohapatra)