Brace for high volatility in the near-term

When a rally is driven by liquidity and the promise of more liquidity, the key stocks will usually be either in the financial sector, or rate sensitives. The Euro zone has just seen a massive injection of capital into Spanish banks. While that liquidity will not directly flow into Indian equities, it could lead to a favourable change in foreign institutional investors’ attitudes.

However, at the same time, there are warnings from S&P that India could lose investment-grade rating. This could have a serious negative impact. More than just leading to equity sell-offs, it would mean that overseas inflows into government debt would dry up.

This is an unusual period. The market is news-driven and there are specific events to watch out for. The Greek elections are due on June 17 and the Reserve Bank of India (RBI) has its next credit policy announcement on the June 18 — before the Greek situation is likely to be clear.

What happens in Greece will, one way or another, define trends in the Euro zone, in the short-term at least. What happens in the Euro zone will probably have a greater impact than the RBI’s credit policy.

Therefore, clear trends could develop in the third week of June. Until then, the market will be driven by rumours, hints and expectations. This means a period when volatility could be quite high and directional movements might not last more than a couple of sessions.

The Bank Nifty is likely to be at the forefront of this volatility. It has already seen a sharp uptick from 9,000 in mid-May to a recent high of 10,157, followed by a sudden correction on Monday. It is high beta in relation to the Nifty and highly correlated to the overall market due to its high weight. Some specific financial stocks, including banks like Axis, YES, IDBI and various specialised institutions like IDFC, PFC, and large NBFCs have high beta with respect to the Bank Nifty.

A trader, therefore, can assume high volatility in a cluster of high-beta stock futures and in the financial index over the next week or six to seven sessions. But he cannot discern a clear directional trend until say, June 19-20. The high correlation with the Nifty makes it possible for him to hedge any position taken in the high-volatility sectors. Prudence would suggest staying out of the market completely until some trends are clearly established.

However, there will be short-term opportunities during the confusion of time period. And, there are ways to hedge the potential downside. It may be worth dabbling in long positions across high-beta financial sector instruments while holding, for example, deep Nifty puts.

The author is a technical and equity analyst