Premium: Three Macro Charts That Could Trigger Action

Note: this is an archive of Capital Mind Premium, posted on November 7, 2013.

Folks, an early note for Capital Mind Premium readers, on interesting developments in the macro space. Three important charts might help here.

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1. Bond Yields have been inching up.

At this point the 10 year bond is at 8.85% and that is the highest we’ve seen since September 23.

This level has been a warning sign for the RBI and the government. The 9% level is considered dangerous. However, this impression may have changed as there is a new RBI governor, and he has raised the repo rate twice to tame inflation, which should indicate that yields must rise. But this is simply territory that has created fear in the past, so we should be wary.

2. The Dollar is inching up

Further the dollar has appreciated against the rupee to the 62.6 level, last seen only in end September.

Note: This is despite all the action since then. More than $15 billion has come in through the FCNR borrowing window, and that money has been used to pay the biggest market players - PSU Oil Refiners - through oil swaps.

A large impact on the market has been taken away - oil refiners used to hit the markets for their purchases (between $5 and $10 billion a month) which is now absent.

3. Our proprietary market indicator is showing a market move down.

Our proprietary indicator that uses Stocks above Moving Averages, points to a downward trend in the near future. The indicator takes all Nifty stocks above their 20 day moving averages [A] and those below [B], and charts A minus B, smoothed in with a 5 day mean.

The Red line will oscillate from +50 to -50. The transition downwards is usually a signal for a market breaking down, and when it goes up from below -30 the market tends to follow. This isn’t foolproof - in the sense that there have been failures. Look at the most recent time when the indicator fell to 10 and then rebounded big time.

However, this indicator gives you a feeling of where the market - which moves in both directions - changes its direction. A typical correction would be around 10%, and we’re already about 2% below the peak.

Impact

The first two seem to tell us there is potentially some action coming along, to reduce the impact of the dollar rising or bond yields hardening. There’s not much more they can do about NRIs pumping money through the FCNR swap (which will not affect the dollar market anyhow, as it’s an off-market transaction). The oil-PSU-refiner swap has to be unwound soon. Banks are already restricted from playing in the forex and

It could be a rate hike, if inflation moves up. (Data comes in on the 12th to 15th) Rate hikes are bad for banks and the markets, and till now they have largely absorbed the impact. But banks are now beginning to increase lending rates, which means further rate hikes in the market will be transferred to consumers and corporates.

There could be another move to** cull liquidity**, as that has eased considerably, so much so that banks actually reduced their overnight borrowings from RBI recently (usually they would max it to the limit, because it has been the cheapest source of funding). If liquidity is tightened by increasing short term rates, banks will be hurt. The last time around, Yes bank stock fell nearly 60% in a short time.

Additionally if short term rates are increased, your investments in liquid and ultra-short-term funds could be impacted. Recently short-term yields on T-Bills (government secured) have fallen to 8.7%, from the 11% we had seen in July. This has made ultra short term funds outperform since then. However, a move that will increase short term yield could hit the NAV of such funds. The effect will be temporary, but if you need money in the near term, you might consider putting some of it in a bank fixed deposit instead.

Or, there may be measures that work in favour of banks and the markets. We don’t know what, but some new thing - like announcing the list of the next banks, opening up some regulatory layer, or something to that effect might calm markets down. That would take markets up. (Hey no one ever told us this stuff was so difficult!)

Opportunity: The market seems poised for action, and while things point downwards, they might move rapidly up as well. I would play this through a purchase of a straddle. If you buy a call and a put option on the BankNifty at 11,000, it will cost Rs. 650. If the Bank Nifty were to move 6% in either direction, the trade will end up with a profit. (It might take a smaller move, as there will still be time value in each option) The Bank Nifty is more volatile than the Nifty - indeed, it’s fallen more than 2% today, so a 6% move is not unthinkable.

Another way to protect a portfolio is to buy out-of-the-money puts on the Nifty. However, your portfolio may differ substantially from the Nifty, and your stocks could fall more more, nullifying the protection bought.

The impact of these charts is to let us know about outliers - data that has reached an edge case where something is likely to happen. A rising bond yield, a falling currency (the rupee) and overbought indicators in the markets are telling us there is some drama left to come.

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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