Street never good at Budget cues

A trend will be established by any move of 3 per cent or more post-Budget.

An efficient market is built across three main pillars. Good trading systems, good back-offices and smooth, even, information distribution. The first two India possesses, the third is an unattainable ideal.

Under any conceivable system of governance, there will always be "insiders". At best, it's pragmatic to try and discourage insider trading and, failing even that, to force disclosure of insider trades.

In theory, India has such systems in place; in practice no Western legal system can decode the labyrinthine relationships that Asians internalise with their mothers' milk. It is all too easy to stay within the law and still "insider-trade" through the usual sticky web of cousins and old chums.

When it comes to the Budget, the information dissemination is asymmetric. People outside the "FinMin" loop can only guess at what's going to happen.

There may be a policy direction but we've lived with coalition governments through the entire reform era and indeed through the crisis that preceded it. There are always pushes and pulls that can scramble policy directions.

Given the information asymmetry, an efficient trading mechanism starts doing an imitation of a headless chicken. You know what the market hopes the finance minister will do.

You don't know what the finance minister will actually do. You have an inkling how the market might react to a given policy measure but that reaction may seem very silly from a fundamental standpoint.

There is a very high probability that volumes will swell in the run up to the Budget and so will daily volatility. There is a fairly high probability that the market will fall going into the new financial year "" that is, over the next month to two months.

Are these betting odds for a trader? I think so. The statistical factor may also be explicable from a behavioural angle.

Here's the deal. The market has fallen through the month (and two months) following the Budget on five of the past seven occasions. It has actually fallen after the announcement of eight of the past ten Budgets. However, in 1999 and 1997 that was induced by political trouble rather than financial causes.

Two riders. First, the market has usually risen in the two months preceding the Budget, but it's flat this year and prices have dipped sharply in the past two weeks. Second, it is always dangerous to trade on a statistical chance without understanding the causality of the events.

At the time of writing, the institutional attitude is undecided. Indian mutual funds have been clearly negative in attitude through calendar 2007 (Minus approx Rs 2,400 crore since January 1-February 21). FIIs were lukewarm in January and they've stepped up buying in February (net plus Rs 4667.50 crore till February 22).

This year, the market has really been carried up by the Indian trader. The market itself has displayed decent volume and fair breadth. In terms of valuations compared with debt yields, the Nifty has been pushing the envelope for about 15 months. On February 14, there was a yield inversion in the T-Bill yields for the 364-day (7.84 per cent) and the 91-day T-Bill (8.10 per cent).

This means that liquidity shortage in the short-term is anticipated. Money has already been pulled out to chase the Budget. But equally, more money will be found to chase the Budget if it appears favourable.

The sane reaction would be to try and take positions either way. Only, use instruments across different markets and different time-scales.

This is the perfect situation for investments into index funds and ETFs with a long term horizon of a couple of years. It is also a reasonable situation for a hedge constructed with short Nifty futures. Keep stops in both directions.

In practice, this brace of positions would require minimal liquid resources of Rs 3 lakh. You would plan to rotate out the short future if the Nifty climbs by about plus 3 per cent and deploy the margin into the long-term instrument.

If the market dips, your futures' profits would offset losses on the long side. It would be your call if you ploughed back the futures profits to average down.

The implication is that a trend will be established by any move of 3 per cent or more post-Budget. It usually is. Also, in practice, given normal Budget volatility, you may not be able to get out for less damage. This is hardly a perfect plan but it is how the traders might think.