The Hindu Business Line : Markets in for a parched summer

NO, I am not contradicting the Met office mandarins who have announced a 98 per cent normal monsoon last week after going through their numbers several times over before sticking their bruised neck out. Nor I am commenting on the monsoons per se.

What I am saying is irrespective of what kind of a precipitation we have later in the rainy season, the markets generally do not do well in the April-June quarter. And looking at the current macro-economic data, there is no reason why history should not repeat itself in the Chinese year of the rooster.

A study of the past 15 years, 1990-2004 reveals that among the four quarters, the April-June period (Q2) is the worst performing quarter. The average returns in the Sensex in the second quarter have been 1.20 per cent as against 9.80 per cent in the Q1, 9.5 per cent in Q3 and 1.8 per cent in Q4.

A careful scrutiny revealed that Q1's high average was largely due to one time surge of 124 per cent in 1992, when the Sensex did an Indian rope trick during Harshad Mehta's stock market circus.

While the pure statisticians would disagree, I removed the best and the worst performing years from the 15 year period and took the average of the balance 13 years to arrive at an normalised return of 3.10 per cent for Q1 against earlier average of 9.80 per cent. Other quarters recorded a normalised average of 1.50 per cent, 7.30 per cent and 1.70 per cent. Even after this exercise, Q2 remains at the bottom of the ladder, but Q3 jumps at number one position.

This exercise only establishes Q2 as the worst performing period, but it is possible to earn positive results as eight out of the 15 sessions have reported positive returns. But the probability of the negative earnings in Q2 goes up in those years, where the markets are already down in the first quarter.

Of the seven instances when the Sensex closed lower in Q1, in five of them the Sensex went on to lose further in Q3 as well, which imparts a probability of 71.4 per cent. But does the Sensex fare better in Q3, if it rises in Q1? The probability is lower at 62.5 per cent.

With the Sensex registering a 1.7 per cent decline in Q1 this year, history favours a negative return in the April- June quarter.

Let's turn to the monsoons now. Of the 15-year period under study, 1990-2004, monsoons saw precipitation of 100-110 per cent of the long-term average in eight years. The other seven years saw rainfall ranging from 81 per cent to 96 per cent. The common belief that a good monsoon will ensure a positive market is not supported by data on the ground.

Of the seven years that saw deficient rainfalls, markets went down only thrice in Q3 (July-Sept). In four of the deficient years, the markets actually went up four times in Q3. Similarly of the eight years when the monsoon was normal or above normal, the markets went up five times. The moral of the story is that the irrespective of the monsoons, the markets tend to do well in Q3.

In the US too, a positive co-relationship exists between the first quarter performance and the performance for the rest of the year. In the last 50 years of the broad based S&P 500, there have been 20 instances when the markets have been down from December 31 to April 15. In 14 or 70% of those years, it has gone on to post negative returns for the next 6 six months, that is October 15.

While history is all right, are there signs on the ground that would indicate that history is about to repeat itself?

The first sign is that FII injections are losing their ability to cure the markets. Consider this. For the first quarter, January-March, the FIIs pumped in Rs 16,587 crore, more than in any single year before 2003. And how did the Sensex react? The Sensex was down by 110 points at the end of the quarter.

There are many reasons for this erectile disfunction, the chief amongst them being that good amount of this liquidity circulation is going into the primary markets and preferential offers. And if at all this liquidity reaches the secondary markets, it is going into block deals and add very little of this actual flows into the veins of the Sensex stocks.

With Dr Greenspan ready with his scalpel for the May 3 FOMC meeting to raise the interest rates further by a 0.25 percentage point to 3 per cent, the FII inflows could seriously get affected. A record deficit of $61 billion for February reported last week made the economists lower their estimates for Q2 US GDP from 4 per cent to 3.25 per cent.

Spectre of a slow down reduced the chances of further rise in the US interest rates but lower jobless claims and higher inflation have improved the odds of an interest hike at the February 3rd meeting of the Fed. As the FII inflows dry up, markets will have to ready themselves for parched throats even if the rain gods are benevolent enough to shower their blessings.

The author is Vice-President, Head of Research, Anagram Securities.

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