Tuesday, January 6, 2009

Fog around the Santa Claus Rally

Why is it hard to predict the Nifty level over a period of say one month or so?

On Nov 20 2008, Nifty was at a trough of around 2500. By Jan 05, it closed at 3100 plus. This post tries to explain the reasons for what’s commonly been called the December 2008 Santa Claus Nifty Rally. (During this time visibility was very low in Delhi and several flights were cancelled due to dense fog). FII and DII turnover was at very low levels. Overall market turnover dropped precipitously during the holiday season, though the market continued to rally. Several commentators have mentioned that the December 2008 rally was led by high net individuals (HNI s) and retail investors.
Let’s examine this in its wider context and try to understand what’s really happening. You will observe the following typical sequence in the stock market. The economy is booming. Unemployment is at historical lows. Consumption is strong. Credit is flowing freely. Productivity is increasing. There are no major wars or conflicts. The stock market suddenly undergoes a precipitous fall. Various sectors decline. You get bears coming on TV and giving meaningless reasons why the market is considered to be “overvalued” and predicting a dire correction. After some time the market goes up again, and reaches ever higher levels. This behavior is called as an “intermediate downtrend in a bull market”.
Similarly you’ve observed several rallies since January 2008. The economy is down. People are dependent on government stimulus spending to make profits. Credit is frozen. Unemployment is at historic highs. The market suddenly goes up 20% or more in a month. This completely funny behavior of the stock market is called as “an intermediate uptrend in a bear market” or simply as a “bear market rally”.
Technical analysis textbooks will tell you that these “intermediate trends” last anywhere from 3 weeks to 3 months. The corrections are usually shorter and sharper than the rallies. So far I’ve never actually come across a believable and consistent explanation as to what causes these intermediate trends.
Of course there are many theories about it, from the Elliott Wave theory to the Random Walk Hypothesis, to the Business Cycle theory, stretching across the various areas of technical analysis, capital market theory and macroeconomics. None of the theories have genuine predictive value and none of them suggest ways and means to remedy this problem.
The reason for these trends might very well be what is known as “operator play”. A stock market operator is a participant who has access to a large amount of capital, usually in the form of short term credit. This participant is able to manipulate and influence prices in a particular counter and segment. Typically the influence on prices is aided by misinformation campaigns which create increased speculative interest in the counter.
Observation of the December 2008 rally appears to indicate significantly high levels of operator play in various counters.
This is why trying to predict the Nifty levels in a particular series using the traditional methods of technical analysis, fundamental equity analysis and macroeconomic analysis can be ineffective.

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