Breakdown - or breakout? - The Honest Truth By Ajit Dayal
Investing in India - Honest Truth by Ajit Dayal
Breakdown - or breakout? A  A  A

Are the Indian stock markets about to breakdown?

Or are the markets pausing and letting out some steam before they breakout and head northwards towards some higher level?

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The BSE-30 Index has gained +65% from the start of the year (see Graph 1). Technical analysts - who study the past patterns and volumes of these squiggly lines - would be nervous that (at 15,896) the BSE-30 Index is below its 30-day moving average of 16,805 and dangerously close (just +2% more) to its 100-day moving average of 15,594.

Like the chief in the Asterix comic books, they will worry that the sky could fall on our heads. If the Index "breaks" the 15,594 level and stays weak, they will start to worry that it could slip to lower levels. Like the 12,585 level of the 300-day moving average.

Graph 1: Is the market tired - and about to roll over?
Source: Bloomberg

But stepping back into a different time line - say from January 1, 2008 till October 30, 2009 - one can see (Graph 2) that the Index may be tired after a great run up of +91% from its low on March 9, 2009 - but could head higher over the next 9 months.

Graph 2: Can the Index surge +31% to reach the previous peak of 20,873 set on January 8, 2008?
Source: Bloomberg

The BSE-30 Index is a sample of 30 stocks that sort of tells us where the "markets" are headed.
On a day when we hear that the markets are "down", we have this picture in our head that all the stocks we own in our portfolio may be "down".
On a day when we hear that the markets are "up", we have this picture in our head that all the stocks we own in our portfolio are "up".

What drives the Index?
While it is true that the Index is "representative" of what may happen to a portfolio of stocks the BSE-30 Index (or any Index) has a limitation: one of size.
By definition, the BSE-30 Index has 30 stocks - it cannot have more.

And there are a few stocks that are powerful and "drive" the Index.

For example, the Index lost -12,713 points from its peak to its low point (see Table 1) and 5 stocks accounted for 44% of this decline.

Table 1: The stocks that hurt the Index the most
Index high on Jan 8, 2008 20,873  
Index low on March 9, 2009 8,160  
Loss of points -12,713  
% loss of Index -61%  
Company Responsible for what chunk of the loss?
  in points in %
Reliance Industries -1,959 15%
ICICI Bank -1,101 9%
L&T -1,195 9%
Reliance Communications -685 5%
HDFC -643 5%
These 5 stocks (5,583) 44%

On the rebound, the Index has gained +7,570 points from its low (see Table 2) and 5 stocks accounted for 28% of the gain.

Table 2: The stocks that helped the Index the most.
Index low on March 9, 2009 8,326  
Index as of October 30, 2009 15,896  
Gain of points 7,570  
% Gain of Index 91%  
Company Responsible for what chunk of the gain?
  in points in %
Reliance Industries 835 7%
ICICI Bank 808 6%
L&T 725 6%
Infosys 664 5%
HDFC 502 4%
These 5 stocks 3,534 28%

One can infer a few things from these tables:
  1. The stocks that brought the Index down have not really made good all their "losses". For example, Reliance’s share price movements from the peak of 2008 to the low of 2009 accounted for 15% of the decline in the Index. But Reliance has accounted for just 7% of the gain in the Index from the lows. Reliance, in that sense, has "underperformed".
  2. In fact, that "underperformance" is true for ICICI Bank, L&T, and Reliance Communications. HDFC has pretty much made up its loss of -4% with a gain of +4%. And Infosys has been an "out performer": its gain of +5% on the recovery side was more than its loss (it did not feature in the Table 1 as its loss contribution was -2%).
  3. The Big 5 had more of a role in bringing the market down (they accounted for 44% of the loss in the Index) and less of a role in bringing the market up (28%). So, maybe this market rise is with more depth and breadth - more stocks within the BSE-30 with smaller weights in the Index have done well. For example DLF has gained +153% in the same time period that Infosys was up +81%. But, because Infosys has a larger market cap (and hence a larger influence in the Index), its +81% gain had a larger contribution to the rise of the Index.
  4. The movement of a few stocks can have quite a large impact on the Index and the broader market - and this gives the illusion that times are good. Or that times are bad. For example, the portfolio of Quantum Long Term Equity Fund has not owned Reliance, ICICI Bank, L&T, or Reliance Communications - but the sharp movements in the share prices of these bellwether stocks did have a dramatic impact on the NAV of the Fund because many other stocks in the market also declined in the "bear market". The NAV of the Fund fell -54% against the -61% decline of the Index. One can insulate one’s portfolio from specific companies but one will still move with the direction of the market.
A reflection of everything
The movement in the markets (and in your stock portfolios) is, in the final analysis, a reflection of everything that is "known".

The pace with which foreign money enters - or leaves - Indian stock markets has an impact on the Index.

The earnings of the Indian companies - themselves a complex interaction of India’s GDP, global GDP, competition, and efficiency of management - to name a few.

How we all interpret the news and the events - our "sentiments" - come to full force in the fight between the bulls and the bears.

And, boy, are they fighting!
There is a massive tug of war going on between the bulls and the bears who wish to make money on short term movements. Sometimes they switch roles within a day: a bear turns to a bull and a bull turns into a bear.

But let them play their games.

The stock exchanges will now be open for another 1 hour of trading.
Look out for more breathless TV anchors as they comment on the big battles and movements in the Index.

As investors for the long haul know, these wonderful graphs and tables are interesting things to study once in a while.

They give us some interesting data for the past - but tell us little about the future.

Whatever their battles, continue ploughing your money - bit by bit - into the stock markets for sensible long-term returns.

Suggested allocation in Quantum Mutual Funds (after keeping safe money aside)
Quantum Long Term Equity Fund Quantum Gold Fund
Quantum Liquid Fund
Why you
should own
An investment for the future and an opportunity to profit from the long term economic growth in India A hedge against a global financial crisis and an "insurance" for your portfolio Cash in hand for any emergency uses but should get better returns than a savings account in a bank
Suggested allocation 80% 20% Keep aside money to meet your expenses for 6 months to 2 years

Disclaimer: Past performance may or may not be sustained in the future. Mutual Fund investments are subject to market risks, fluctuation in NAV's and uncertainty of dividend distributions. Please read offer documents of the relevant schemes carefully before making any investments. Click here for the detailed risk factors and statutory information"

Disclaimer: The Honest Truth is authored by Ajit Dayal. Ajit is a Director at Quantum Advisors Pvt. Ltd and Quantum Asset Management Company Pvt. Ltd. The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and has not been authenticated by any statutory authority. The author, Equitymaster, Quantum AMC and Quantum Advisors do not claim it to be accurate nor accept any responsibility for the same. Please read the detailed Terms of Use of the web site. To write to Ajit, please click here.

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6 Responses to "Breakdown - or breakout?"

Sri Birupaksha

Nov 7, 2009

Hello Mr. Dayal,
So Come up with the honest truth only.....
May God give you good thinking mind...
Sri Birupaksha


marcom mar

Nov 7, 2009

insight not available


Rakesh Punia

Nov 3, 2009

Hello Equitymaster,
I realy liked this post as it reflects the 'true' governing factors moving the market. The explanantion is quite a handy to new/old investors. The relative adjustments, % Alloction of main stocks, portfolio distribution etc is commendable. Look forward to see more of it. Thanks :)


virender kumar sharma

Nov 2, 2009

the article explains the impact on our portfolio on account of rise and fall of BSE 30 in simple language. I am a banker and have not yet started in investing in stock but recently started reading the articles to keep my self updated.Thanks and regards.




Nov 2, 2009

The index is all baloney. Each of us must construct their own index, comprising of shares of companies whose business we understand and which have good sustainable cash flow streams protected by strong "moats" (made of cost advantage or brand name or barrier to entry).

My own such index has just 15 shares. All that changes for me is the proportion of shares I have of these 15 companies. If I had 100 rupees worth of shares in Jan 08, I have Rs 155 worth today. These 15 odd companies are all that I need to follow closely. This list changes very slowly, perhaps 1-2 changes a year.

There is no substitute for solid work and constructing your own index. A basket of stocks prepared either by some index preparers or some fund or a recommendation website is just that - a basket case.


s k kundra

Nov 2, 2009

A highly educative insight not available elsewhere explained in simple lucid language.keep up good work.

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