Why the trend in financials and rate-sensitives will be negative

The RBI produced a negative surprise by raising the repurchase rate by 0.25 per cent. It left cash reserve ratio (CRR) unchanged. This will probably not make a difference to the prevailing interest rates offered by bank and non-banking financial companies (NBFCs). But it does indicate that the central bank is focussed on inflation rather than trying to stimulate growth and it means that bank net-interest margins will be squeezed.

The market reaction is likely to be negative. The Bank Nifty tested support at 10,350 in the session itself and the trend looks negative with a breakdown in the financial index. If the breakdown is valid and the downtrend sustains, the Bank Nifty should drop below 10,000 fairly soon. It may not happen this settlement but it could happen early into February.

A negative outlook on financials has a string of other implications attached. First, banks, and associated financials such as housing finance majors, have the largest sector-weight in the Nifty and Nifty Junior. A negative trend in financials will pull down the major indices.

Apart from that, the impact on rate sensitive sectors (more or less everything except IT is rate-sensitive) will be negative. Perhaps the impact will not be very sharply negative since, as mentioned above, rates and liquidity in the commercial system will not change. But there will be no relief for corporates, which are struggling with high debt burdens and low consumption demand.

There is also the taper. The Fed's time table will be clearer by the end of the month after the FoMC meeting. If there is another $10 billion cut soon, Emerging Markets will be inclined to tank. An acceleration of the rate of tapering looks unlikely because the US is seeing a weak recovery. But one never knows. A higher rate of taper would also be likely to push the dollar up, though the Reserve Bank of India’s rate increase might counter-balance to some extent.

If the Fed doesn't increase the rate of taper, there might be a relief rally of sorts in early February, though this will be muted. At best, the Fed will hold the rate of taper unchanged at a cut of $10 billion a month. This means that liquidity could remain at the same levels in the most bullish scenarios and it could fall in case the taper accelerates.

Weighing all the factors, most financials and many rate-sensitives look to be in downtrends, or on the verge of going into downtrend. The big players are all available in the highly liquid derivatives segment and shorting isn't a problem. But shorting could be complicated due to the upcoming settlement. It is possible to start shorting now but that involves coping with carryovers and the inevitable volatility around settlement and the FoMC meet.

The prudent action for a trader would be to wait out the settlement and the FoMC decision before taking decisions on whether to go short in February. Targets for shorts could be the Bank Nifty itself, or PSU banks, housing finance majors, other NBFCs and specialised lending institutions. The auto industry, capital goods, real estate and other rate sensitives could also come under the hammer. If the FoMC does decide to increase the rate of taper, there might be a big fall. If it doesn't, the trend still looks negative.

The author is a technical and equity analyst