In the second half of February, Budget-related speculation is usually the major influence on price trends. In technical terms, the Budget is an unusual event. It's expected. But there is information asymmetry since few people are privy to concrete details. Long before B-day, every stray statement by the FM, the Prime Minister, or by senior bureaucrats is parsed for possible information. The Economic Survey and the Railway Budget help in building the sense of anticipation.
The information is disseminated incrementally with every spoken sentence and traders take positions as they listen to the speech. The actual Finance Bill isn't released until after the FM has stopped speaking. Hence, the market reaction is guesswork based on incomplete information. Some key details are often not available for weeks. Changes in direct and indirect tax must be clarified by notifications from IT and Customs and Central Excise; changes in forex regulations and so on, are notified by the RBI. These notifications may have explosive implications.
A savvy, experienced FM can use that behaviour pattern to talk the market up, or down in the pre-Budget period. Chidambaram is undoubtedly both savvy and experienced. So far he's hinted at possible tax hikes on the “very rich” but not much else.
The fetish for secrecy causes volatility through the last 10 sessions of February and on B-day itself. The market usually develops some trend post-Budget in March. On the whole, the pre-Budget trading tends to be bullish, while post-Budget trading is often bearish.
Since its inception in 1994, the Nifty has an average return of +2.3 per cent in February and a average return of -0.7 per cent in March. In these 19 years (1994-2012), the market has seen net losses in February six times. It has seen net losses in March ten times. February has a standard deviation (SD) of about 6 per cent and March, a SD of 8 percent. However, it must be noted that Budgets have often been announced in months other than February, in election years.
Still, much of the positive February returns and the negative March returns can be attributed to Budget-related responses. Volatility, as indicated by the SD, also tends to rise post-Budget. This is perhaps due to traders re-adjusting expectations as details emerge.
Is the behaviour pattern of traders rational in being generally bullish pre-Budget? It seems to be. One reason is that a stock can multiply in value while in theory, it can lose only a maximum of 100 per cent. The potential rewards for a bull are therefore, larger than the potential rewards for a bear.
It is also practically impossible to short-sell outside the F&O segment. Short (and long) futures positions are leveraged at 6.6x. There is the added hassle of rollover with the Budget on the last day of February. A long position can be taken in either equity or derivatives. The former is low-leverage and can be held indefinitely. A short can be taken only in futures. Leverage adds to risks and rollover adds to cost.
To assess potential risk, assume the trader is wrong. The risk for a bull pre-Budget is less than the risk for a bear. Cutting a short future in a bull market usually means a bigger loss than closing a long equity position in a bear market. To assess rewards, assume the trader is right. A bull can make larger profits than a bear because a bull can hold a multi-bagger equity share “forever” at no extra cost. So being bullish scores higher on potential return and lower on risk.
Should you bet on a strong February, weak March trend? February has started weak so if there are to be net gains in the month, we'd need to see a surge at month-end. Betting on a reversal is a difficult trading decision. You don't need to make it just yet. But bear the historical results in mind when you plan your Budget-strategy.
