The great bear squeeze that changed the market direction

PALAK SHAH Mumbai | Updated on November 01, 2019

The markets, which fell to multi-year lows in 2019, have made a strong comeback

The year 2019 was witness to a large bear squeeze in the domestic stock market. Fears of some unknown event hitting India's economic juggernaut, has hung like an oppressive miasma in the air, throughout the year. And yet, foreign portfolio investors (FPIs) were forced to cover around 1.44 lakh index futures contracts of short positions in the equity derivative segment in just two months -- September and October.

In sheer value terms, the short-covering is a record of sorts, with bearish bets worth more than $1.5 billion being covered by FPIs in index futures alone, experts told BusinessLine.

A bear squeeze can change the market direction suddenly, as traders are compelled to cover their short positions in a fast-changing scenario. When bears are cornered, the indices start moving up rapidly, instead of crashing under the weight of short positions. This is what happened with the benchmark indices, the Sensex and Nifty. Both hit multi-year lows, after crashing around 15 per cent from their lifetime peaks. In September, in just two trading sessions, the indices jumped 8 per cent. Overall, while the Sensex has managed to hit a new peak, the Nifty index is within striking distance of record levels.

In the cash market in October alone, the top 50 listed companies in the Nifty index churned out a total volume of more than 14 billion shares, the highest since the launch of the National Stock Exchange (NSE) in 1994. Sentiment in the domestic stock market hit a nadir this year, in a throw-back to the 2008 financial crises, when a fear of the unknown gripped the streets after the fall of Lehman Brothers in the US.

Impact of the NBFC crisis

In 2019, it was the crises of non-banking financial companies (NBFCs), the darlings of the stock markets, which caused sentiments to fall. Their business model of lending at high interest rates, that was a strength for several years, suddenly became their weakness, as a few large corporate houses defaulted on their debt. The debt market fiasco of IL&FS and DHFL caused a panic and had a domino effect.

The 2019 crash was different in that a majority of small and mid-cap stocks led the crash. History shows that it is always the benchmark indices that have crashed severely, with the small and mid-cap stocks replicating the fall with a lag effect. Yet, while the Sensex and Nifty were down by only around 15 per cent, it was a 70-80 per cent crash in most small and mid-cap counters that put the fear of God among Indian retail and mutual fund loving investors.

Much of the blame for this should go to an over-enthusiastic SEBI, which led a crackdown of sorts on the price rise in small and mid-cap stocks. The SEBI diktat asking mutual funds to restructure their small and mid-cap schemes was akin to putting a lid on investments in this segment. Also, vague norms relating to circuit filters on small and mid-cap stocks, almost drove investors away from them. FPIs ended up selling stocks worth Rs 4.5 billion in just a few weeks before September on a dooms day prediction, and creating near record levels of short positions.

“The crash in small and mid-cap stocks was so severe, it spread gloom in India, even when the global financial markets appeared resilient. Be it small traders or large fund managers, everyone was reacting to bits and pieces of bad news in the economy or corporate houses. Most of them believed sentiments would translate into a severe crash in the Nifty and Bank Nifty, akin to small and mid-cap stocks. The indices played along, but only up to a certain level. When smart money understood that short-sellers were overshooting their limits, it was the end of the game for the bears,” said Rohit Srivastava, chief strategist and founder, Indiacharts.

On Thursday, when the Sensex touched a new lifetime high after decisively crossing the 40,000-mark, there was utter disbelief and not to mention still present fear in the air. Srivastava says he had been negative on the markets for more than a year and wrote about it in his weekly reports, too, but changed his tone in September.

Central banks change course

"All the ingredients of a market crash, including the sagging GDP print, which hit a low of 5 per cent for the first time in over six years, miscalculations on various counts by the new Finance Minister Nirmala Sitharaman in her maiden budget presentation this year and noise around corporate profits seemed like cacophony. The fact that global central banks were changing their course from liquidity tightening to easing was enough to put all other negative factors to rest. Markets are still some way from matching the power of central banks that control money supply and, hence, the bull and bear cycle," says Srivastava.

Shaktikanta Das, the former bureaucrat who was appointed Reserve Bank of India Chairman, has never hid his dovish stance. He has cut key interest rates by 25 basis points twice this year and by 37 basis points once. Jerome Powell, the US Federal Reserve Chairman, although he has seemed hawkish, has cut interest rates by 25 basis points three times this year. Importantly, for the first time in more than a decade, the Fed has started cutting interest rates and even commenced enhancing its balance-sheet.

Central banks and Europe and China were easing and Japan has been talking the markets up by threatening to cut, which it will certainly do aggressively when the situation looks grim. It is taking a cautious stance now, to keep the dollar under check. Fear and aggressive buying by Russia, which is trying to move away from the US dollar, took gold to new highs, but that rally seems to have been halted for now. In fact, the position in US gold futures suggest the bulls could have peaked out for now.

Corporate tax rate cut

In India, the GDP may take time to improve, but the markets always move on forward basis. The first short-covering trigger came from Sitharaman, who embarked upon a course correction journey after her Budget misadventure in July this year. After nearly two decades, India cut its effective corporate tax from 35 per cent (even more for certain companies) to 25 per cent (effectively even less for certain companies). If that was not enough, Sitharaman signalled she would do more for markets and even rolled back incremental tax on FPIs. The positive impact of corporate tax cuts is already evident in the profits of some banks and companies in the September quarter results, and brokerage reports have suggested the next two quarters could show the full impact of this.

"Fear still lurks in the market. There is talk that the fiscal deficit could rise due to tax cuts and other measures by the government. But then, it would be a different ball game if the government decides to let the fiscal deficit rise a little, to achieve something more. Anyways, the fiscal deficit was way higher during the previous government. It will not be surprising if the Modi government, too, chooses to dare the rating agencies with elevated fiscal deficit numbers. But a further strong rally from here cannot be ruled out if the government walks the talk on market-friendly tax measures, including rationalising capital gains tax, securities transaction tax and doing away with dividend distribution tax, as is being reported in the media," said Rahul Arora, CEO, Institutional Equities, Nirmal Bang.

Lone voices say they still fear bank NPAs, but are clueless when they see that provisioning is not rising and major bad loans were out in the public domain. RBI has opened its liquidity tap, but it is still stuck in banks, which are conservative in lending, Rashesh Shah, Chairman and CEO, Edelweiss Group, told BusinessLine in an interview in October.

Abhiram Eleswarapu, Head of India Equity Research, Analyst at BNP Paribas, told BusinessLine in an interview earlier that he believed the Sensex could touch 43,000 next year, due to the corporate tax cuts, everything else remaining constant.

Experts say it would be tragic if individual tax payers are subjected to a 30 per cent tax rate when corporates were paying 25 per cent. News reports suggest the government is working on it and a package to boost the demand side of the economy could be unveiled, with the only threat being the rise in the fiscal deficit, which Arora says the government may allow for a while.

The story does not end here. Markets are also watching every move of India’s largest company by market cap, Reliance Industries (RIL). It recently announced that its telecom arm, Jio, would be made completely debt-free in a restructuring exercise. Mukesh Ambani, RIL promoter, has already announced that the Saudi state-owned company Aramco, the world's largest oil conglomerate, was keen on buying a stake in his oil assets. The markets are keenly awaiting this, and would cheer like never before when the news is confirmed.

Published on November 01, 2019

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