Who wrote this article?

Deepak Shenoy, Capitalmind's research team.

Macronomics: The Mystery of Low Volume New Highs in the Markets

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Macronomics

Our weekly Macro Newsletter will feature a great story on the macro picture each week. What is Macro, though? While you could have a hundred definitions, Macro in the Capital Mind definition is all that is not Micro - that is, when you have gone beyond the individual stock or security, you have gone into macro territory.

This week, we’ll talk about how the “new all time high” on the Nifty, and the background scene around volumes.

The Mystery Around Volumes at All Time Highs

The Sensex hit a new all time high just before Diwali. [level-capmind-pro]The Nifty hasn’t yet closed at an all time high but it’s very very close. However, you might have noticed that hardly anyone around you is talking about stocks. The ‘paanwala’ quotient - where the tiny shop in the corner would be telling you which stock he’s bought - is absent this time around.

Volumes for a Nifty 6300 - nearly the highest ever - are the lowest this time around. Here’s a look at the Nifty versus average daily volumes (monthwise) since 1999.

Note: The green bars are the total volume traded on the NSE - meaning not just Nifty stocks, but all stocks put together.

There are three distinct periods in which the Nifty crossed 6000.

Jan 2008: Before the big crash, the Nifty soared to the 6,000 levels for a brief period before crashing over 50% through the Lehman crisis.Volumes were, on average, between 18,000 cr. and 20,000 cr. per day in this period.
Oct 2010: Again stocks went back up to this all-time-high level, but the volumes were lower - around 17,000 cr. per day. This period wasn’t big on euphoria either.
Oct 2013: Volume in the month averaged a meager Rs. 11,398 cr. per day in the cash market.

Volume To Nifty Ratio at 10 year low

Another way to look at it would be a Volume-To-Nifty ratio - where the volume in crore rupees is compared with the Value of the Nifty.

At 1.6, the Volume-to-Nifty ratio is the lowest since 2001 (we did briefly go under it in 2006). What is scary is that this volume is actually spread across many more stocks now:

(The drop in numbers recently is probably because of the moving of illiquid scrips to periodic call auctions, where the lack of liquidity in such auctions results in them not getting traded at all)

Where has volume gone?

It’s likely that volume has gone to the derivatives markets. Here’s a look:

Most of the volume seems to be in the options market. But then Options aren’t really indicative of real volume.

Let me explain. Volume as mentioned in the options volume above is the total ‘exposure’ of the option. It means if I pay Rs. 100 as premium for a 6,000 call option on the Nifty (whose lot size is 50), then I will be paying Rs. 5,000.

However, what NSE decides is that turnover is actually the total exposure - that is (6,000 strike + 100 premium) multiplied by 50 lot size, and records my Rs. 5,000 transaction as Rs. 305,000 instead! Towards expiry you could have a Nifty contract trade as low as Rs. 0.05, so the multiplier becomes worse - a Rs. 2.5 trade will be shown as Rs. 300,000.

This means options volumes are unreliable. But they can’t just be ignored.

It must be noted here that an investor may be able to create a** synthetic long and short position using options**.

Note: If you buy a call option and write a put option at the same strike price, you will technically be long that stock. Effectively buying a 6,200 call for Rs. 60 and selling a 6,200 put for Rs. 30 means you are long at 6,230. If the stock goes up you stand to make just as much as buying the future at Rs. 6230. In that context, option volume may still mean there are “synthetic” long and short positions in place.

Institutional investors might prefer the synthetic short or long route in options, because it masks their real purpose, and also because it is a much more efficient mechanism to deploy cash. Buying securities gives you a 2% dividend yield. A synthetic option position will need you to put in a fraction of your exposure in real cash (like a future) but unlike a future, will not have any mark-to-market payouts. Which means they can earn interest on the margin for the period of the trade, and market short term yields are 8% to 9%.

(If you’d like to know more about this, mail [email protected] - I will address it in a future article).

But for the moment, if we were to ignore the options positions, and take just futures, here’s where we stand:

The blue circles correspond to the past times that the Nifty was around the 6,300 mark. What this tells you is that even if you consider the futures markets, the positions add up to far lower than the earlier times we were at the 6000+ levels (2008 and 2010).

Impact

With volumes this low, it’s very difficult to say what the ruling is on the sustainability of the move. Basically the rally could be extended using relatively little money (since volumes are low) or we could see an abrupt move down due to some relatively little selling.

Two major things could happen

**Foreign investors **- who have pumped in a large amount of money in the last two months (15,000 cr. in October alone) could start to pare down their buying. Just that will be enough to take down the market substantially.
The retail investor will get active again, and shore up the domestic end of the buy side

Foreign investors are unlikely to quit easily, and if they do, the first impact may not be on stocks, it may be visible on the currency. So as long as the currency remains at the 61/62 levels, you can be reasonably sure that foreign investors aren’t leaving in droves.

The return of the retail investor is also unlikely in a period of high inflation. When your expenses go up - as they are today, with inflation showing up in expenses that you and I make - you tend to invest lesser. But retail investors are like sheep - appeal to our greed and we’ll probably chase the momentum right at the top.

What I will watch for is a liquidity change in the markets. It could be a US taper, an FII exit or the return of the retail investor. However, this time around, the volumes are so low that one wonders just how they can go any lower! In 2008, we saw liquidity hit badly after the Reliance Power IPO (which sucked out money from the market). In 2010, foreign investors began to exit.

With the lack of volume and lack of euphoria, it’s difficult to say that we will see a big crash from here. Midcaps and banks are not even close to their all time highs. But we have seen a long, slow, sustained crash in 2010-11, when again the market had lower volumes and a higher index.

If one were to take a calculated risk - with one eye on liquidity - that would be my bet, of a slower medium term decline, given the headwinds of inflation, high government spending, general reform paralysis and large scams.

Disclaimer

Nothing in this newsletter is financial advice and should not be construed as such. Please do not take trading decisions based solely on the matter above; if you do, it is entirely at your own risk without any liability to Capital Mind. This is educational or informational matter only, and is provided as an opinion.

Disclosure: The authors at Capital Mind have positions in the market and some of them may support or contradict the material given above, or may involve a direction derived from independent analysis.

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