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Stock Market: Diwali effect...

Nov 21, 2001

Considering the start to Samvat 2058 -- BSE Sensex gained 5.4% in two trading sessions -- we undertook a study to identify whether the traditional new year sparked a 'feel good factor' among investors leading to a rise in the markets. Consequently, did entering the market at Diwali time lead to super-normal returns. As the study dug deeper it seems to have come upon few interesting insights. Taking Diwali day, as 'day 0' the one month, point-to-point return does not seem to show a trend to support any schemes for beating the street. In fact, going by probability, the chances are one will lose money on this long strategy, as the Sensex declined on 6 out of 10 occasions over the past decade. Also, the difference between rise and fall is too small to support a shorting strategy. Hence, there does not seem to be a 'Diwali effect'.

Taking even a three-month window period does not seem to support the theory. Although, the results have reversed, with the markets rising, point-to-point, on 6 out of ten years. The past three year data, however, seems to suggest such a trend developing. But two out of the three years were part of the 18 month bull frenzy, which led to the Sensex crossing 6,000 levels in February '00. The start to this rally was in October '98. The sell off in 2000, also peaked in October leading to a subsequent run-up to Budget '02 before breaking of the scam.

Event (Diwali) Day '0' Preceding 1 mth Subsequent 1 mth Subsequent 3 mths January effect** Budget effect** 1st Half Feb***
1991 1,918.0 8.2% -2.1% 19.3% 20.6% 31.1% 5.9%
1992 2,987.2 -8.3% -14.4% -14.4% 2.5% -1.1% -1.5%
1993 2,786.4 2.8% 24.0% 40.4% 19.4% 8.6% -2.4%
1994 4,303.7 -0.8% -5.1% -15.5% -7.9% -5.4% -3.7%
1995 3,486.2 1.2% -15.5% -16.9% -5.7% 15.7% 20.8%
1996 3,080.3 -1.5% -9.1% 11.8% 9.6% 8.0% 5.8%
1997 3,803.2 -2.5% -6.1% -15.2% -11.9% 12.3% 7.0%
1998 2,853.3 -7.7% 3.9% 12.8% 8.5% 2.5% 0.0%
1999 4,650.5 -6.3% 4.6% 17.7% 4.0% 4.6% 11.5%
2000 3,757.2 -8.1% 5.6% 12.7% 8.9% -1.8% 2.5%
2001 3,113.0 5.8% - - - - -
* All returns are point to point ** one month performance *** Performance in Feb 1st half # Last three columns pertain to following year

We delved deeper to identify whether the reversal in results for the 3 month window was also due to a 'January effect'. The study seems to indicate that there is no such thing as 'January effect'. Again the trend in the past three years is due to the reasons mentioned above.

With all this number crunching why not a little more and that seems to have yielded some return. What we term the 'Budget effect'. Sensex performance in the month of February has yielded above average returns. Only on two counts out of ten in the past decade (not including 2001) did the Sensex decline during the concerned period. The trend could be attributed to investors building positions prior to the budget, which is announced on the last day of February. Even in 2001, the Sensex rose by 2.5% in the first half of the budget month. Performance in calendar year '00 & '01 suggests that the Sensex declined in the latter half of February. This is due to investors attempting to bail out -- booking profits -- at higher levels leading to the eventual sell-off.

By the very nature of markets and assuming a large number of participants read this article, the 'Budget effect' is progressively going to get difficult to take advantage off. In the coming year, we may see the Sensex rise in January, as investors attempt to exploit the 'Budget effect'. And, consequently, fall in February, as participants hurry to lock-in superior returns. But, if markets are efficient no investor can consistently earn superior returns, as no trend can persist on a sustained basis. Therefore, soon, there will be no 'Budget effect'.


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