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Posted on 24-Dec-2018 Comments  0

Mid Cap Stocks

Despite a sharp correction, it may still be too early to buy mid caps

The year 2018 has been one of the worst years for mid cap and small cap stocks in the last 7 years. The BSE mid cap index was down by 14.4% for the year while the small cap index was down by nearly 24%. This is the overall index. The actual damage in specific stocks was as bad as 70-80%. What exactly drove this carnage in these mid cap and small cap stocks? 


In the Union Budget 2018, the FM imposed capital tax on long term equity gains at the rate of 10% above Rs.1 lakh. This led to a virtual sell off in most of the mid cap and small cap names as individual and institutional investors tried to exit these stocks before the cutoff date of 31st March. Most of the mid cap and small cap stocks hardly recovered from that point. There were two more reasons for this sharp fall. Firstly, the additional special margins (ASM) imposed by SEBI on small and mid cap stocks was a major blow to the speculative demand that most of these stocks attracted. With speculation and intraday trading diminished, there was rampant delivery selling in these stocks. Secondly, the SEBI directive to mutual funds to reclassify their schemes, also forced most of the mid cap and small cap stocks to be sold as it did not fit into their larger definition. All these factors actually combined to result in a sharp correction in these mid cap and small cap stocks which saw a bad year.

Macros did not support

At a macro level, two important factors worked against these mid cap and small cap stocks. The sharp rise in the oil prices worked against these stocks. Over the last four years, the sharp fall in crude oil prices had resulted in a sharp fall in input costs and these mid cap and small cap stocks had benefited the most from weak oil prices. With oil touching a high of $86/bbl, the pressure was too much and that accentuated the sell-off. By the time the price of crude reversed, most of the damage to these stocks was done. The sharp weakness in the rupee also worked against them. Above all, the key corporate governance issues and concerns over transparency also spooked most of the mid cap and small stocks. This added to the sell-off.

Not yet time to buy

The damage in the last one year to mid cap and small stocks has been quite sharp. While specific stocks in the mid and small cap space may see some traction, at an index level there may not be much respite. Corporate governance issues are still quite a challenge and that will keep these stocks on tenterhooks. Also the institutional appetite is likely to be much weaker with most of the domestic funds going slow on mid cap fund inflows. Year 2019 may continue to be a challenging year for the mid cap and small cap stocks. It may be too early to get your shopping carts!

Nifty 50 Options

Nifty will be the real test of the concept of weekly options

During the month of December, SEBI granted the NSE permission to launch weekly options on the Nifty 50. It may be recollected that the weekly options on the Bank Nifty was launched in 2016 and this product has seen very good traction since then. The question is what happens when the weekly options on the Nifty 50 are also launched. While the move should be positive on paper, the real test of the power of weekly options will only be visible when the Nifty 50 options are launched.

Merits of weekly options

Weekly options are not without merits. In the case of Bank Nifty, the weekly options have led to a sharp growth in the volumes on Bank Nifty derivatives. There are some distinct advantages that these weekly options have. Firstly, it opens up the doors for arbitrage between weekly and monthly options. That is quite popular in these Bank Nifty options and that is likely to have a positive impact on the Nifty 50 option volumes too. Secondly, traditionally retail investors have been wary of selling options because of the high costs involved and the higher implicit risk due to the longer tenure. The introduction of weekly options should entice retail investors also to buy and sell Nifty options more confidently as the risk is much lower due to the shorter tenure. That could again position the Nifty 50 options as the most popular options in the derivatives market.

A better hedge

Unlike the Bank Nifty which is still a sector specific index, the Nifty 50 is a broad based index and covers a much broader portfolio. This gives two distinct advantages to the trader in weekly options. Firstly, it is more predictable since technical levels could work much better in case of the Nifty 50. This will make it easier for traders to determine the strike price on which to write these options. Secondly, the weekly options are also a cheaper way to hedge a set of stocks or beta hedge a more diversified portfolio. Bank Nifty options may not be the best way to hedge the overall market risk. Also, weekly options make the task more granular. You can only hedge the Nifty 50 for the particular when you foresee greater volatility due to news and event flows. This helps reduce your risk and cost of hedging with weekly options.

A good starting point

The regulator has experimented with the idea of weekly options with Bank Nifty and now that template can be replicated for Nifty 50. For traders and even for hedgers, this is a more granular approach to hedging your portfolio risk with very specific time contours. Also it will encourage more liquidity on the sell side of options rather than just institutions and prop desks. To that extent, this can make the markets a lot deeper and broader!

Fed rate hike

If the Fed holds in 2019, it will be good for the world economy

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Source: Trading Economics
In the last 3 years since the Fed started hiking rates, it has managed to hike rates by a full 225 basis points. The CME Fed Watch is still ambiguous and is assigning just a 2% probability to another rate hike in the January Fed meet. Of course, these are live numbers and can change. Broadly, the markets appear to believe that the Fed may turn slightly dovish from 2019 onwards. Why would that be so?

Powell has growth worries

In his last public statement, Jerome Powell has hinted at likely brakes on growth due to the impact of the trade war between the US and China. The third quarter growth in GDP in the US and the weak consumer spending are already manifesting that trend. Also, the Fed may not be too keen to throw a wet blanket on the green shoots of recovery by raising the rates. FAANG stocks are already complaining about the effects of a strong dollar, which has led to these stocks losing nearly 25%.

World prefers dovishness

For the global markets in general and India in particular, a more dovish stance with lower target rates will be a good change. Firstly, with the Fed going slow on rate hikes, the RBI will be able to convert its stance into neutral from calibrated tightening. This will not only remove the overhang of rate hikes but also open the doors for rate cuts if called for. Secondly, most emerging market currencies across Asia have lost nearly 40% since the beginning of the year. This has been largely driven by the strength in the US dollar. With the rate hikes ceasing, the EM currencies including the INR will become less vulnerable. Above all, a weaker dollar gives the US the opportunity to give a boost to its exports and that will automatically take care of its massive $650 billion trade deficit. Once that is achieved, the trade war with China should die a natural death. For 2019 a more dovish Fed will be a great boon for global markets, especially the EMs! 

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