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Penny vice! - Views on News from Equitymaster
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  • Sep 24, 2005

    Penny vice!

    The Indian stock market rally came to a screeching halt this week. However, the brakes this time, unlike the usual expectations, were applied by the Securities and Exchange Board of India (SEBI) and not Foreign Institutional Investors (FIIs) (as discussed later). While the SEBI's diktat was primarily aimed at 'certain' mid-cap and small-cap stocks, the large-cap stocks could not remain unscathed. Thus, at the close of week, while the <BSE-Sensex and the NSE-Nifty were down 2% and 3% respectively, the real damage was done in the BSE Mid-cap Index and the BSE Small-cap Index, which tumbled by 7% and 11% respectively.

    Until the week earlier, while everything was merry on the Indian bourses, suddenly the Indian investors' minds seem to be wrapped in panic, fear and distress. However, prior to this, the markets this week began on the usual chirpy note. While immense volatility continued to prevail on the bourses, the Sensex breached the 8,450 levels on Monday. This continued well into Tuesday's trades as despite the continued selling pressure at higher levels, the bulls managed to scale new peaks and breached the 8,500 levels. However, on both these days, notably, the market breadth was in favour of the declines as select index stocks took the onus on them to the benchmark indices to higher territories.

    However, Wednesday was a different ball-game altogether. The until now calm SEBI, which had been watching the action from the sidelines (along with the Finance Ministry), warning investors along the way to invest in fundamentally sound stocks only, decided to finally put its foot down. The regulator not only brought certain mid-cap and small-cap stocks, especially the penny stocks, under its scanner, but also levied rules pertaining to additional margins on scrips in the 'T', 'TS' and the 'Z' groups. Further, in order to reduce the volatility in these and curtail their inexplicable rise, it reduced the circuit filters in these to 5%. Adding fuel to the fire was the news in the media of Income Tax raids on few brokers in Ahmedabad.

    All of the above led to intense panic amongst investors who opted to just dump their shares believing that another stockmarket scam could be in the unfolding. This led to intense selling pressure across sectors (see table below), which was reflected in the steep fall in the indices. Just to put things in perspective, the Sensex fell from over 8,500 levels on Wednesday to 8,100 levels on Friday. However, even this fall was too was not consistent and was filled with volatility (see adjoining chart). While the fall was steep this week, which is not reflected in the losses by the benchmark indices, owing to strong gains in the first two trading sessions of the week, the Sensex corrected almost 5% from its lifetime highs this week before sanity returned on the bourses, thanks to certain reassuring statements by SEBI and the Finance Minister. However, the damage had already been done.

    Surprisingly, the FIIs and the domestic mutual funds (MFs) were mopping up stocks at lower levels as Indian investors, largely retail, opted to dump their shares. Both these institutional players were net buyers on Wednesday and Thursday, the days when the maximum erosion of investor wealth was witnessed on the bourses. In the first four days of the trading week, while FIIs bought equities worth Rs 12.5 bn, domestic MFs were net buyers to the tune of Rs 3 bn. It must be noted that most of these investors have little exposure to mid-cap and small-cap segments.

    Key indices over the week
    Index Price on Sept 16 (Rs) Price on Sept 23 (Rs) % Change
    BSE Small-cap 6,311 5,605 -11.2%
    BSE Mid-cap 4,311 4,029 -6.5%
    BSE 500 3,493 3,369 -3.6%
    BSE METAL 6,912 6,579 -4.8%
    BSE HEALTHCARE 3,120 2,985 -4.3%
    BSE PSU 5,005 4,844 -3.2%
    BSE IT 3,077 2,979 -3.2%
    BSE AUTO 3,550 3,444 -3.0%
    BSE OIL&GAS 3,862 3,775 -2.3%
    BSE BANKEX 4,918 4,911 -0.1%
    BSE FMCG 1,471 1,515 3.0%

    FMCG stocks too were not spared this week as bears took these too in their stride. However, the same is not reflected by the BSE FMCG Index, which ended the week in the positive, up 3%! However, one would need to go a bit deeper to find out the truth behind this anomaly, if one may call it. Thus, if we look at the constituents of the BSE FMCG Index, ITC has the highest weightage of over 50% in this. And considering that the ITC stock was the star performer this week, having bucked the overall bearish trend in the market, it is no surprise that the BSE FMCG Index ended the week in the positive.

    Top gainers over the week (NSE-50)
    Company Price on
    Sept 16 (Rs)
    Price on
    Sept 23 (Rs)
    H/L (Rs)
    BSE-SENSEX 8,381 8,223 -1.9% 8,522 / 5,428
    S&P CNX NIFTY 2,552 2,478 -2.9% 2,586 / 1,696
    ITC 125 138 10.0% 149 / 71
    ICICI BANK 546 575 5.2% 588 / 277
    BPCL 388 399 2.8% 475 / 335
    HERO HONDA 685 700 2.1% 724 / 412
    L&T 1,360 1,373 0.9% 1,425 / 790

    Now, let us consider some sector/stock specific development this week.

    • As mentioned above, the ITC stock was the top gainer this week amongst the index stocks, up 10%. While there was no significant announcement that could have helped the stock resist the bear onslaught, the fact that the stock went stock-split and ex-bonus during the week and the prospects of all its businesses i.e. tobacco, foods, paperboards and hotels, remaining promising, seemingly made investors both big and small hold onto the stock. Apart from this, the news this week that ITC is looking for opportunities in China in order to improve it's geographical reach and increase focus on its non-tobacco businesses, could have aided sentiments. These diversification moves by the company are not only in line with its strategy to reduce the dependence on the tobacco business but also to effectively utilise the cash flows from this business. Other food stocks

    • Another stock that remained in the limelight during the week was that of Sesa Goa. The stock ended the week 12% higher. Sesa Goa Ltd., the flagship company of the Sesa Group, is India's largest private sector exporter of iron ore. Considering the huge steel capacity expansions, both domestic and globally, the scenario for iron ore demand remains attractive. Though China has huge iron ore reserves, it is primarily of lower grade and hence the country imports huge amounts of higher-grade iron ore from India, which augurs well for Sesa Goa. Further, including Sesa Goa, the world's leading iron ore player, BHP Biliton, has expressed optimism over iron ore prices going into 2006. Other steel stocks

      Top losers over the week (NSE-50)
      Company Price on
      Sept 16 (Rs)
      Price on
      Sept 23 (Rs)
      H/L (Rs)
      VSNL 396 345 -12.8% 445 / 161
      HDFC 1,065 956 -10.2% 1,081 / 570
      REL. ENERGY 602 544 -9.6% 707 / 436
      DABUR 166 151 -9.3% 170 / 71
      TATA CHEM. 206 187 -9.1% 211 / 124

    • Bharat Forge (BFL), the second largest forging company in the world, has acquired a Swedish company Imtra Kilsta (IK) along with its wholly owned subsidiary, Scottish Stampings (SS). These acquired companies are major suppliers to passenger car and commercial vehicle manufacturers like Volvo, Scania, MAN and Iveco. The acquisition is a positive, as it will result in execution of the company's global dual shore strategy for all of its major products like crankshafts, beams, knuckles and pistons. This, in turn, will enable the company to maintain its operating margins, if not improve the same. The stock was down 4% this week. Other auto ancillary stocks

    Going forward, with the SEBI having cleared its stance towards the mid-cap and small-cap segments, investors would seemingly now start considering fundamentals more seriously. As far as our stance is concerned, we continue to believe that this extended rally is largely a factor of the immense liquidity prevailing in the markets. Thus, investors should remain all the more cautious and try hard to search for stocks that still hold value. We would advise investors not to lose patience and do not panic. Markets would provide an opportunity to invest, as they have always in the past.

    Before we conclude, our last week's weekly round-up had brought up a quote by the legendary billionaire investor, Warren Buffet, "only buy something that you'd be perfectly happy to hold if the market shut down for 10 years". It is time now for investors to take this quote much more seriously. Happy investing!



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