What lies ahead in December

The equity market trend has a strong correlation with Foreign Institutional Investor (FII) attitude. When FIIs are net sellers, the indices move down. And, they rise when FIIs are buyers. Since January 2011, this pattern has held, though net institutional attitude was positive, with net domestic institutional buying exceeding net FII sales since then.

If this correlation continues, what would be the likely trend in December? For most FIIs, December is year-end. Historically, this has meant low FII activity through December and some cosmetic trading as fund managers straighten their year-end portfolios.

This could mean the Indian market rises slightly on short-covering. It could also mean indices will drop lower if FIIs further reduce exposure to the worst performing emerging market of 2011.

Chances of a big upside appear limited. The global situation is precarious. Domestically, the political logjam has strangled reforms and even affected normal administrative decisions.

The long investor should continue to err on the side of caution. Valuations may drop; they are unlikely to rise. A systematic investor can nibble away, lowering the average price of the portfolio.

A more aggressive trader should look for opportunities on the short side. The Q2, 2011-12 results have led to earnings downgrades. At the same time, the rating agencies and advisory services have also downgraded GDP growth projections, as well as Indian debt ratings.

A small population, of FMCG and pharma stocks, is insulated to some extent from the slowdown. The information technology industry, which is shored up by the weak rupee, could also hold on. But the vast majority of stocks could be due for corrections.

A short-seller should restrict his operations to the liquid stock futures. One technical way to find potential shorts is to seek out stocks that have hit recent (within the last eight weeks) 52-week-lows.

Another is to target stocks within 10 per cent of their 52-week lows, in cases where the low occurred over two months ago. In both cases, filter for downtrends by using moving average systems. The stock price should be below the 10-day moving average before you short. Always use stop-losses.

A third technical method is to buy deep Nifty puts. There are several ways to do this. The cheap method is to take, say, a long December 4,000c (6).

This is very, very, very unlikely to be hit. But a downswing of say, five per cent, in the next three weeks, will trigger a 150 per cent gain on premium.

Another method is to take a long January 4,500p (85) paid off by a short January 4,000p (22). That bearspread costs 63 and could pay a maximum 436. More practically, it will double in value if the market falls five per cent before January 25.

The author is a technical and equity analyst