The Hindu Business Line : Sensex's dubious distinction during meltdowns

The steep fall witnessed in the Indian equity markets since February 9 has global linkages and shares many similarities with the fall that was witnessed in May 2006. The most remarkable one is, that in both the instances, the Sensex was the top loser among the major global indices.

In the period between May 9, 2006 and June 14, 2006, the Sensex lost over 28 per cent. Other BRIC countries such as Brazil and Russia followed Sensex closely as major losers though China escaped unscathed. China's Shanghai SE Composite index scored handsome gains on both the occasions. The stock markets in the developed markets were relatively less affected in May and June.

If we study the fall in the other global indices in the period between February 22 and March 5, we notice that Sensex has the dubious distinction of being the top loser once more with a 12.5 per cent fall. Russia was again a close second and DJIA was the least affected among the indices that we tracked.

Though the Sensex had been moving down since the middle of February, the sharp crack came on February 28 when it moved in tandem with the other global markets and crashed due to the imposition of regulatory controls on trading in China. The May 2006 crash too came about due to crash in base metal prices in international markets and concerns about drying up of global liquidity.

Though many peripheral reasons can be attributed to both these falls, the basic reason remains the overstretched nature of the equity markets world-wide due to a sharp rally in stock prices in the run-up to the crash. The Indian markets recorded net FII outflows in both these periods.

A parallel can also be drawn in the mood that was prevalent in the Indian markets in the period preceding these falls. Investors were getting overtly complacent. The small investors were beginning to get active, buoyed by the run-up witnessed in the mid-cap and small-cap stocks. Signs of over heating was evident by the renewal of interest in the penny stocks and stocks that had been in the wilderness for many years.

The sharp fall in the Indian equity prices on these two occasions can be partly attributed to the overheated derivative segment.

F&O scenario

The open interest on the NSE on both the occasions were at an all-time high. The open interest on the NSE on February 22 was Rs 65,000 crore. The open interest on May 9, 2006 was Rs 52,000 crore.

The presence of a large number of retail participants in the derivative segment makes our markets relatively more vulnerable as they do not have the deep pockets to be able to withstand losses and to carry forward loss-making positions. There are also leveraged positions in the cash segment of the BSE and the NSE. When there is a sharp fall in stock prices, brokers dump the shares at market price in order to recoup their margins causing further erosion in stock prices.

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