Stock markets in for a rough ride

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Stock markets in for a rough ride

Wednesday, 06 January 2021 | Hima Bindu Kota

The new year is full of hope. Investors expect this sentiment to be mirrored on the bourses but they might end up being disappointed

The year 2020 was one of lost lives, livelihoods, businesses and shattered economies. However, the new year has brought the hope that the march of the virus would be contained through mass inoculation and result in the global economy recovering from the onslaught of the contagion. Usually, fiscal recovery is led by a revival in the stock markets and the bourses show improvement much before the actual economic upturn. This is because stock prices are forward-looking and investors buy scrip based on their expectations of the future and not on past data or present information. So what do the bourses have in store for us this year?

Both the benchmark indices, Nifty 50 and the BSE Sensex, started the year with a bang, ending on record highs with Nifty 50 ending above the 14,000 mark and the BSE Sensex above the 48,800 levels. The sentiment was boosted by the expectation of economic revival. So, will the markets continue to rise further? Since the pandemic broke out in India at the end of March 2020, the Nifty 50 rose to double its level from 7,500 to above 14,000 as on January 1. In the US, the NASDAQ Composite index, too, rose from the 7,000 range in March 2020 to almost touch the 13,000 mark on the last day of the year. Nikkei 225, the benchmark index of Japan too, showed the same trend and gained 66 per cent to reach the 27,444 mark at the end of the year. This worldwide phenomenon of continuous stock market rise during the most difficult times in living memory shows that the bourses have already incorporated and priced in the news of positive results of the Covid-19 vaccination and earnings revival.

A trendline typically confirms the direction of the market by connecting the troughs and the peaks. An upward trend connects all the troughs and creates a support line. The strength of this upward trend and the support line is tested by the numerous times it is able to stop a price breach. Historically, looking at the last 10 years, there has been an overall primary uptrend in the Nifty 50 from the level of 2,700 in 2009 to 12,000 in January 2020, with minor secondary downturns in 2010-2011 and 2015-2016. After a steep drop in March 2020, Nifty 50 started another uptrend which lasted the entire year. At the current levels of above 14,000, the sentiment still remains bullish and there is a strong possibility of the markets moving past 14,500 in the near future. However, the upward trend during the last year shows that all the positive news about economic revival have already been reflected in the prices. On the downturn, Nifty may find support levels in the range of 11,000-13,000.

Options are considered information channels for the markets, which eventually result in stock price changes. As options markets are the preferred trading markets for informed investors, volume and open interest play an important role as predictive tools to forecast the movement of the underlying stocks as they can develop an early earning mechanism for any market crisis. They also represent the strength and potential of price change of the underlying asset. Therefore, an important indicator to consider is the put-call options volume ratio.

This contrarian-sentiment investment measure is one of the most important tools to predict the market’s direction by tracking the daily and weekly volume of puts and calls in the stock market and gauging the sentiments of the investors. Puts are generally bought as an insurance against a market decline, whereas calls are bought as a directional bet for bullish markets. So when put volume increases, expectation of the market decline increases and when call volume increases, expectation of market uptrend increases. The put-call ratio for the options in Nifty with various expiry dates from January to February this year is increasing steadily, from 1.17 for Nifty options expiring on January 7 to two for Nifty options expiring on February 4. This shows that the put options volume is steadily increasing, showing a possibility of a short-term downtrend.

The new year is full of expectation of positivity and hope. Investors expect this sentiment to be reflected in the stock markets but they have to understand that bourses are leading indicators and last year’s rally has already incorporated the economic revival. The uptrend may continue till the 14,000-15,000 levels. However, these levels have a psychological barrier and we may see a market correction soon. Support levels can come in the range of 11,000-13,000. The new year may not see just an uptrend but would also witness some profit booking. Any downtrend due to profit booking could be an opportunity for people to invest for the long-term. This year could also see increased earnings as most of the companies were able to reduce their operating costs last year during the pandemic. This may help them to increase their earnings this year. A revival of earnings would go a long way in improving stock market returns. Overall, there is hope for economic revival this year. However, since the information has already been reflected in the stocks last year, this year the markets may see a bumpy ride.

(The writer is Associate Professor, Amity University, Noida. The views expressed are personal.)

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