Stay away from 'Operator driven stocks'

As the year 2010 draws to a close, our stock markets are gaining strength, and are likely to test the previous highs in the next couple of weeks. But, there is a word of caution for the retail investors not to be carried away by the euphoria, and desist from investing in 'operator driven stocks' based on hearsay. Some investors may have been lucky to have made money in these stocks provided they offloaded them in the last bull run, but most investors have burnt their fingers by investing in these stocks. SEBI has cracked its whip on the activities of these operators a.k.a manipulators on several occasions, but their activities are not fully curbed. The last leg of the bull run is best used by these operators to jack up the prices of their favourite stocks. This month SEBI order pulled up the promoters of companies like Welspun Corp., Murli Industries, Ackruti city, and Brushman India for allegedly rigging the stocks of their companies in collusion with some dubious operators.

How does one identify an 'Operator driven stock':

• Sharp price movements in both directions - These stocks generally swing between locking consistent upper circuits to getting frozen at lower circuits. It is very difficult to get out if you have purchased the stock at a higher level.
• Small market cap. - This enables the operators to manipulate the price with limited funds deployed. The penny stocks are often recommended by unscrupulous publications through SMS and mails, as the cost of the same is low. This helps in creating volumes in these stocks.
• High PE multiples - These stocks often quote at very ridiculous PE multiples, which are often justified by the news flow regarding order book of the company, although the company may lack the execution capability. Investors must check the PE multiple of the industry, small cap stocks normally would not sustain a higher PE multiple as compared to the industry leaders.
• New listings - During the bull run some dubious companies are able to demand high premiums for their IPOs which are manipulated in the early days of listing. More than 50% of the companies that came out with new issues during 2010 are quoting at heavy discount to their offer price.

It is not going to be easy to make money on the equity markets in 2011. Retail investors are advised to stick to large cap stocks with good track record of performance and reliable managements. Investment in mid and small cap stocks are advisable only after thorough research, keeping in view the above factors.

Revolution in Insurance industry: Buying insurance through Demat account

Soon insurance policies shall be available online through demat accounts. This is likely to revolutionise the entire insurance industry. A 12-member committee of the Life Insurance Council constituted to look into this issue is expected to submit its recommendations to IRDA next month, according to S.B. Mathur, the council’s secretary general.

A number of customers buy insurance without knowing enough about the commissions paid and terms of risk cover, leading to mis-selling, a phenomenon that has led to an unnaturally high rate of lapsed policies. One of the key benefits of a demat form for insurance will be the ready disclosure of all policy-related information, including commissions and fees paid to the company, exact benefits offered, premium payment and renewal-related dates, and terms and conditions of risks covered. The acceptance of these recommendations by IRDA would serve as a great service to the large number of policy holders, and would make the cost of an insurance policy attractive. This will also help the insurance industry tap the latent demand for insurance by the price conscious customers who are deterred from taking out a policy due to the lack of transparency surrounding the insurance policies sold, or rather mis-sold by the insurance agents/ advisers.

The other notable advantages of the insurance in demat form are:

• Implementation of Know Your Customer (KYC) and Anti- money laundering guidelines would become easy and transparent
• The administrative cost for insurance companies shall be cut down drastically
• Customers shall have the advantage of single point transaction for insurance
• Helping further expansion of the insurance industry.

Hopefully the procedural changes shall be in place for the new system within one month. The first quarter of next calender year should see this welcome transition, which is a big step forward by IRDA, after the abolition of entry load on Mutual fund schemes implemented by SEBI last year.

Is the Bull run over for equity markets?

Continuing from my last post on behavioral finance, the recent fall in the equity markets confirms the fickleness of human mind, when it comes to taking decision about our finances. Retail investors who were all gung-ho on the markets around Diwali, are now panicking and asking the question whether bull run is over on the markets? To answer this question I shall rely on the three different approaches to analyse the future of the markets:

• Fundamental Analysis: We all knew around Diwali that the markets were over stretched on fundamentals, and excess liquidity was driving the momentum stocks. So once the liquidity crunch was observed, after the unearthing of a series of scams, the momentum stocks in the realty and infra sectors were the worst performers. These stocks were beaten down to such ridiculous levels that quite a few of them are looking attractive at current levels. The positive GDP numbers announced today are pointing to the fact that the worst is over for the markets from the fundamental point of view, at least for now. The markets can expect some positive news flow from the international markets also in the days to come.
• Technical Analysis: The unabated run of our equity markets from the Nifty level of 4800 to 6300 did call for a technical correction. The markets have retraced around 40% of the above rise, which is close to the 38.2% retracement level held sacred by technical analysts. The bounce back on the markets was widely anticipated from the 5700 levels on the Nifty, and the markets have obliged. Given the oversold position of the markets the bounce back could be ferocious. The beaten down sectors shall be at the fore front of the rally. The technical correction seen by the markets is good for the long term health of the markets. 
• Astro Analysis: While analysing the markets I would like to give equal weight age to the astrological angle as the other two factors. Human behaviour is determined by the confluence of planetary configurations, and stock market behavior is no exception. As I am no expert in this area I would like to quote what the famous astrologer Lachman Das Madan had said in October: "Within a period of about one month from 6th November 2010 financial institutions, members of security forces, business people, diplomats, youth, sports people etc. are likely to be accused of corruption and illegal activities and actions are likely to be initiated against them". You can analyse the correctness of this astro prediction. The unearthing of scams one after another was influenced by the planetary configurations. The malefic affect of the planets now seems to be diminishing, hence we can soon expect business as usual in the markets.

In view of the above I would like to conclude that the Nifty and Sensex are likely to surpass their previous highs of 6300 and 21000 respectively by the year end. How much beyond these levels can the markets rise will largely depend on the liquidity flows. It seems that Christmas festivities have begun with the positive flow of economic data, India reporting 8.9% GDP growth in 2nd quarter. But this does not mean that the bad news is fully discounted by the markets. Behavioral finance tells us that human beings are in a state of denial to bad news when it first strikes, but gradually tend to accept it over a period of time. The bad news like the follow up on 2G scam and the Bank bribery scam will again come to haunt the markets around Budget time in February 2011. Coupled with bad news on economic recovery, or the lack of it, from European markets may spell doom for the markets again. The downward movement at that time could take the markets back to the sub 5500 levels on the Nifty again. This does not mean that the bull market is over, it only is a pointer to the fact that investors should keep booking partial profits whenever markets provide that opportunity.

Behavioural Finance: Investors do react to newsflow

The recent correction in the stock market has send shock waves down the spine of retail investors. Many of them who have entered the markets at higher levels are frantically calling their brokers/ advisers on the future course of action. This behaviour can be explained by understanding the concept of 'Behavioral Finance'. Behavioral Finance, is a study of investor market behavior that derives from psychological principles of decision making to explain why people buy or sell the stocks they do. Behavioral finance places an emphasis upon investor behaviour leading to various market anomalies.

Contrary to popular belief, studies reveal that  investors perceive bad news as less credible (i.e., are more optimistically biased) than good-news management forecasts and discount bad news accordingly. For this particular reason, investors remain in a denial mode in discounting the bad news in respect of the stocks that they hold. Behavioral finance tells us that most investors are most vulnerable to losing their principal investment, and thus continue to hold onto a particular stock, more so when adverse conditions have pushed the stock price below their purchase price. They are always hopeful that the market would reverse sooner than later, and they will recover their original cost. This behavior is also the stepping stone of 'Technical analysis', taking into account the support zones of stock prices.

But the bad news is discounted by the investors/ markets, albeit with a time lag. What we are witnessing now is the reaction of the investors to all the accumulated bad news. In the recent bull run that continued till Diwali, investors continued to ignore both international and national bad news when it unfolded initially. The Greek debt crisis and the slowdown of industrial production in India, were initially shrugged aside and the markets continued their upward march unabated. It took the unfolding of the political scams in India to put brakes on the markets. It is fortunate for the investors that the much awaited correction has started, which gives an opportunity for investors to re-enter the markets at lower levels. Await some more bad news to get discounted, before committing large funds into the equity markets. A 10-12% correction from the recent highs will be good for the long term health of equity markets.

Samvat 2067: The charge of the 'Bull'

We are in Samvat 2067 of the Indian calender which commenced on 16th March 2010. However, stock market traders view Diwali as the start of the new Samvat. Diwali is the time to review the performance of the stock market for the past one year. The year gone by has been an eventful year for the stock markets, and the new Samvat 2067 has commenced on a positive note with the BSE Sensex scaling a new closing high of 21004 at the close of the 'Muhurat' trading on 5th November. Before we proceed to analyse the year ahead, I would like to recall my observations on Samvat 2066, put up on my blog on October 18 2009, under the caption: 'Samvat 2066: Return of the Bull Run!'. I had written: 

• Markets are poised to retest the earlier top of 21000 on the Sensex by Diwali next year. We have to keep our fingers crossed to see whether it happens or not.
• The growth in profits during 2010-11 will ensure that valuations become attractive in the second half of FY 2010-11
• Specific sectors that are likely to outshine are those which focus on the domestic growth story: Retail, Pharma & Healthcare, FMCG, Media, PSU Banks, Hotels & Tourism.
• There is no doubt in my mind that the 'Mother of all Bull Runs' has arrived. Stay invested, add on declines to profit from the India growth story for the next 3-5 years.

However, I must admit that I was hopeful of a 5-10% correction during the middle of the year which never occurred, leading to a sustained bull run to the previous highs of 21000 on the Sensex (6300 on Nifty), achieved on Diwali day. Now for the crystal gazing for 'Samvat 2067':

• I would like to re-iterate that the 'Mother of Bull Runs' is on. 
• Technically, supported by the massive liquidity overhang, the markets are still in an uptrend. A strong base seems to have been created around the 5600 levels on the Nifty, which should hold as the base in the next correction, whenever it occurs.
• Fundamentally, the performance of companies has been reasonably good. The stretched valuations at this juncture would seem justified if inflation is tamed by the end of FY 10-11.
• Astrologically, according to eminent astrologer Bejan Daruwalla, Samvat 2067 will be excellent for the Indian economy and our markets. Barring a downturn from January 2011- May 2011, markets will be in the grip of bulls.

Considering the above facts, most market analysts are hopeful of Nifty scaling 7000 levels by next Diwali, which is a reasonable expectation. I am sanguine that this target is likely to be achieved by next Diwali. But given the risk-reward ratio for equity investment, a 10-11% yearly return is not the risk worth taking. Therefore, new investments should be undertaken only after a 5-10% correction from the current levels. The second important factor for taking advantage of the next up move in the markets would be the identification of right sectors. My sector bets for Samvat 2067 would be: Tourism & Hotels, Aviation, Auto motives, Paper products, Media & Entertainment, Health care.

Wishing you all a Happy Diwali and Happy Samvat 2067.

The return of the 'Bond'

The retail bond/ debenture market was flourishing in the 90's with several top companies coming out with debentures in the form of Non convertible debentures (NCDs), Fully convertible debentures (FCDs) or Partly convertible debentures (PCDs). The non convertible portion was separately listed on the stock exchanges and there was a fair amount of trading in these debentures. But with the opening up of the economy, the companies had more options to raise debt in overseas market, leading to a virtual stagnation in the retail bond market.

 In Budget 2010, the government introduced a new section 80CCF under the income tax act to provide for income tax deductions for subscription in long-term Infrastructure Bonds. These bonds offer an additional window of tax deduction of investments up to Rs. 20,000 for the financial year 2010-11. This deduction is over and above the Rs 1 lakh deduction available under sections 80C, 80CCC and 80CCD read with section 80CCE. Infrastructure bonds help in inter mediating the retail investor's savings into infrastructure sector directly.

Two issues of infrastructure bonds were recently launched to tap the retail segment: IDFC and L&T infrastructure bonds. These bonds offer an attractive option to fixed income investors looking for safety and tax saving. These bonds are expected to generate higher returns as compared to bank deposits and post office schemes. These bonds offer 7.5-8% annual returns, alogwith tax saving. These bonds may not appeal to investors in the lower tax bracket as they would be saving only 10.3% in taxes. However, investors in the highest tax bracket will be saving 30.9% on taxes which amounts to a decent Rs.6,180 savings on an investment of Rs.20,000. those with a long term perspective can choose to invest in these 10 year bonds, which have a lock in period of 5 years.The IDFC issue has closed while the L&T bond issue is open till 2nd November 2010. Even if you miss out on the issue this time there is no need to bother, there will be a spate of such issues towards the close of the financial year.

The salient features of the infrastructure bonds are listed below:

1.The bonds don't attract any TDS, however the interest receivable is subject to tax.

2.The interest accrued on the bonds will be credited to the respective bank registered with the demat account through ECS on the due date for interest payment.

3.The bonds will be listed on NSE and BSE and can be traded after the 5 year lock-in period.

4.Investors can mortgage or pledge these bonds to avail loans after the lock-in period.

5.An investor would need a demat account and pan card to invest in these bonds.(physical form is also allowed).

6.The bonds will be issued only to Resident Indian individuals (major) and HUF.

The Micro Finance Muddle

A spate of suicides in Andhra Pradesh, which accounts for over a third of the micro finance business in India, has seen the state government pass stringent regulations to control these institutions. The micro finance institutions (MFIs) have played an important role in fulfilling the credit requirements of the rural folk, who have limited access to organised bank finance even today. Most MFIs started as service oriented NGOs but have assumed a commercial role over a period of time.

While the Reserve Bank of India is eager to get credit to the poor and encourages banks to lend to microfinance institutions, it has not permitted them to raise deposits. Indian microfinance lenders generally charge between 24 percent and 36 percent annual interest. It is more or less on the lines of the interest rates charged by unorganised money lenders or the more sophisticated credit card companies. Banks have their own interest in extending credit to MFIs, to fulfill their agricultural lending targets.

Questions are now being raised about the functioning of MFIs. Some analysts also compare the MFI story to the sub prime crises in the US. RBI has also started an enquiry into the affairs of MFIs on a selective basis. There is definitely a need to regulate the MFIs, without killing the model that they adopt. The problem area could be multiple financing in certain pockets which could escalate into a bubble. But we must not forget that these institutions by and large enjoy an excellent recovery rate of 95-100%. The regulators will have to segregate the hay from the chef, rather than cast a shadow on the functioning of the entire MFI sector.