by Santosh Nair
Deep in their hearts, many knew the current round of madness was likely to end in grief for a lot of investors, as had every other bull market in the past. There was nothing like an orderly unwinding of a bull market, much as traders and investors would have loved it.
After everybody had downed a few pegs, our host cracked some witty but risqué remarks for which he was known.
One broker said he was waiting for a particular stock to make a double bottom on the price chart before he bought it. Double bottom is when a stock price falls very low, rises briefly, again falls to that earlier low, and again rises. This is an indication that the stock is unlikely to slip below that low price in the future.
‘Double bottom?,’ the operator asked the broker: ‘My suggestion to you is that you install mirrors in front of and behind your commode. Whenever you sit there you can see as many bottoms as you want.’ He had all of us in splits.
He then tried to take the discussion to an intellectual level. He launched into a monologue on sub-prime loans and the trouble brewing in the banking sphere of the developed world. He was well read (too well read for a market operator, I sometimes thought) and clued into the trends in global markets, but he was not on firm ground when it came to the complexities of sub-prime mortgages and its derivative products. Of course, barring the analysts who created those funny products, nobody had a clue as to what exactly they were about, or what risks they posed to financial markets. Like most of us present, he too knew what the basic problem was – too many people in the US having borrowed money beyond their means to buy homes. The banks that had recklessly lent to them had repackaged these loans as derivatives and sold them off to investors chasing higher returns. If house prices fell more steadily than anticipated, there would be widespread defaults on the loans, which would affect the entire chain.
‘Something is not right about this sub-prime . . . you see, there could be trouble . . . in fact, this could be the trigger for a big market correction,’ he kept repeating, trying to sound as convincing as he could, yet unable to articulate his thoughts well. Most of the party was a bit too high by then to be paying enough attention to his words.
Not I, though. I had taken just a few sips of my first drink of the evening. I wanted to keep my wits about me to hear what some of the best in the industry had to say about the market.
‘I believe Japanese investors are waiting on the sidelines armed with a few billion dollars, looking for a suitable opportunity to invest,’ somebody said.
‘I heard that some of them have already started deploying the money,’ another said.
‘Ah, one should be careful then, I guess. Next to retail investors, the entry of Japanese investors is the surest sign of a market top,’ somebody else said, prompting laughter from the crowd.
The conversation then veered to how India was the best bet among emerging markets, and how India’s GDP growth would surpass China’s before long.
‘People say India is expensive. Still, foreigners will have no choice but to buy at these prices or even higher. After all, how many countries other than China can boast of a GDP growth like ours?’ one gentleman said.
Somebody mentioned the Reliance Power IPO and the risk of a liquidity squeeze in the short term. This concern was immediately brushed aside.
‘Arre baba, you have no clue about the money waiting on the sidelines. Even if two issues like Reliance Power were to be launched simultaneously, they would be absorbed without much trouble,’ one mid-level market operator remarked.
The others nodded in agreement and raised another toast to the market.
It seemed to me that nobody wanted to talk about the possibility of a correction or a fall for fear of being laughed at. I saw this as another sign of irrational exuberance, strengthening my theory that a steep fall would not be long in coming.
The market began 2008 on a sedate note, with the Sensex climbing just 15 points. By the tenth of the month, the Sensex had made a fresh record high of 21,206, but ended the day nearly 300 points below the previous close. The index was struggling to close above 21,000 despite having topped that mark during three consecutive sessions. A few days before this, Reliance Power had announced a price band of Rs 405-450 for its 26 crore-share issue, which would be open for subscription from 15 to 18 January. For all the talk of ample liquidity in the system, an issue of this size was indeed bound to soak up a sizeable chunk of the money sloshing around.
Within hours of the announcement of the price band, the premium for Reliance Power shares in the grey market shot up to over Rs 200. The rule of thumb when it comes to grey market prices is that the premium is reflective of the minimum gains an investor in an IPO can expect on listing day.
I was amazed at the frenzy over Reliance Power shares. Premiums in the grey market climbed to Rs 450 a share over the next couple of days, baffling even the most diehard of bulls. If the grey market premium was a true indicator, then an investor who got shares in the IPO would almost double his money on listing day.
The company had no earnings worth talking about, and yet people were willing to buy its shares at absurd prices. The IPO was not being seen as an equity investment any longer; rather, people appeared to think of it as some kind of scheme where you were assured of doubling your money in less than a month. This drew even more people to the IPO, feeding the mania further. Wherever you went, the conversation would soon steer to Reliance Power. You could not miss it in even on autorickshaw and taxi rides, as the drivers had learnt from their friends that the IPO was a sure-fire way to double their money. I doubt that another IPO such as this one will be seen, one that will generate the kind of mass hysteria that the Reliance Power issue was creating. Friends and relatives whom I had lost touch with suddenly began calling me, asking if they should be investing in the IPO.
Depository participants (DPs) had a windfall, as first-time investors rushed to open demat accounts so that they could buy the shares. I heard stories about kirana store owners hawking IPO forms and even offering to help their customers open demat accounts.
Bina was taking driving lessons at the time. One evening there was an unexpected visitor as we were sitting down to dinner. It was Bina’s driving instructor; he had come with Rs 25,000 in cash, wrapped in a polythene bag.
‘Sir, hum ko Reliance Power ka shares khareedna hai; madam keh rahi thi ki aap stock market mein hain, aap meri madad karenge please,’ he said, in all earnestness. He wanted to know where I could get him the form to apply for the shares and what documents would be required to be shown.
The man was in his early thirties, and had never invested in the stock market before. I was a bit annoyed with him, but soon more amused than annoyed. The people who had sought my advice on the IPO had some basic knowledge about shares and the stock market, and were occasional investors in the market, getting lucky once in a while. But here was a person who had not the foggiest idea about the stock market, eager to invest a decent chunk of his savings in what appeared to be a risky bet.
‘But why do you want to invest in Reliance Power?’ I asked him.
‘Because my friends tell me that I will be able to double my money in less than a month,’ he replied.
I was tempted to tell him to get lost and instead try the racecourse, the matka bazaar, or, for that matter, any of the Ponzi deposit schemes, which promised fantastic returns in a short time. Bina could almost read my thoughts, and looked at me pleadingly not to be rude to the man. I relented. After all, he was her teacher, even if only till the end of the driving course next month.
I saw little point in talking this man out of his dream. There was a possibility that he would make decent returns on listing day, but I thought it highly unlikely that his investment would double. I promised to put him in touch with a sub-broker friend of mine who would guide him through the process. That was enough to make him happy.
Until that point, I had been thinking of putting some money in the IPO myself. But looking at the madness around me, I wondered if it would
be a good idea. I had little doubt that the issue would be priced at the upper end (Rs 450) because of the phenomenal demand for the shares from all classes of investors. I decided to invest in the IPO, but not with borrowed funds, as that would raise my break even point so high that the probability of losses would be greater.
The IPO signs were ominous. A day before the issue opened for subscription, the Sensex tumbled 100 points. The Nifty, however, inched up 6 points, masking the nervousness in the market. Some pressure was expected, given the sheer size of the issue. Many investors would be liquidating positions in other stocks and using that money to apply for Reliance Power shares.
The issue was sold out within the first minute of its opening on 15 January, a record for an offering of that size. By the end of the day, the issue was subscribed nearly ten times. Even as money was pouring into it, the main market took a beating, with the Sensex plunging 477 points and the Nifty, 124 points.
Mid-cap stocks suffered even more, especially the stocks in which there was a huge build-up of futures and options positions. Too many weak players had taken up positions in the derivatives segment, lured by easy returns when stock prices were rising almost every other day. Unlike in the cash market, traders betting on futures and options had to pay just 25-30 per cent of the total value of their positions. When the market was racing north, the returns on investment in F&O were much higher compared with those in the cash market.
But when prices fell sharply, these players had to square off their positions in a hurry. They could pay additional margins and hold on to their positions, but few traders had the resources to cough up margin money during a crisis. Brokers started liquidating positions of clients who were unable to deposit additional margins. This added to the pressure on stock prices and set off a vicious cycle wherein falling prices forced many more weaker players to sell out their positions.
I had by now got out of nearly 90 per cent of my long positions, even taking losses on some of them towards the end. Somewhat cautiously, I had begun short-selling Nifty futures. Still, I was not confident enough to go short on the market in a big way.
That evening (the first day of the Reliance Power IPO) as I was chatting up one of my friends at a prominent retail broking house, he said something that made me prick u my ears.
‘The craze for R-Power is unbelievable; most of my clients have withdrawn every rupee in their trading account to subscribe to the issue,’ he said.
Clients usually keep some extra funds with their brokers. This could be a safeguard against sudden margin calls, if they were regular traders, or it could help them buy a stock at short notice if it was available for a bargain.
The market was beginning to overheat, and a correction looked imminent. Prices of many stocks had more than doubled or, in some cases, even trebled in less than six months. My gut feeling was that the market had changed course. But I needed more indications to confirm this. I called a few more of my contacts at other retail broking houses to check if their clients too were acting the same way. Sure enough, they too had the same story to tell. Retail and HNIs were pulling out the spare money in their trading accounts to invest in the Reliance Power IPO.
This would turn out to be the clinching factor that would ravage the market in less than two weeks, when the market suddenly reversed course. I thought over this piece of information hard. Were the market to fall sharply for some reason, most retail investors and HNIs would not have money to meet their margin requirements, leave alone take advantage of the correction by buying at lower levels.
I decided to take a very bold gamble: I would short Nifty futures as heavily as I could first thing the following morning. Like a giant vacuum cleaner, the R-Power issue was sucking out more liquidity from the system than was good for the market. I did not have to count on a major trend reversal to be able to make a killing by going short. A precipitous fall over a few sessions would be good enough, and right now the market did look vulnerable to a bruising fall.
The following morning I started hammering away at Nifty futures as soon as the market opened for trading. I knew that at least two other respected names in the market had taken a similar view and were short on the market. One of them was a value investor who also had sizeable trading positions; the other was a trader who managed the proprietary book of a top US investment bank.
The sense of uneasiness among brokers and investors was now giving way to panic. In three trading sessions, the Sensex had fallen nearly 1,000 points and the Nifty around 260 points. There was mayhem in the futures of many mid-cap stocks as brokers squared off client positions when margin calls could not be met. Amid the carnage, the Reliance Power issue got subscribed over 65 times, making history in terms of bids received. The institutional portion of the book (50 per cent) was subscribed 82 times, the non-institutional portion 160 times and the retail portion around 10 times. In all, the company received over 50 lakh bids collectively worth Rs 7.5 lakh crore. To put this figure in perspective, it was equivalent to the Plan and Non-Plan expenditure estimated by the government in that year’s Budget. Given such strong demand, the issue price was fixed at the top end of the price band, at Rs 450 a share. Retail investors would be allotted the shares at Rs 420 apiece, 5 per cent lower than the issue price for institutional investors, HNIs and corporations.
Two weeks later, the company would say that around 4.5 lakh retail applicants who had applied for less than 225 shares had not been allotted any shares. The massive subscription in the non-institutional portion spelt bad news for HNIs who had applied for the shares using borrowed funds. They would be getting only one share for every 160 they had applied for, while the interest they paid on borrowed money would be applicable for 160 shares.
Big traders and operators were not too bothered about the Reliance IPO as they were staring at a far worse problem. The stunning fall in share prices during the week had caused heavy losses on their positions in multiple stocks, and the situation would get worse if they were unable to deposit additional margin money with their brokers.
Most of the market players I knew spent their weekend scrambling around for cash. With the mood turning on its head, the proverbial tide of liquidity that had lifted every boat suddenly seemed to have drained away.
I did not get too many calls for help, because most of my fellow traders assumed that I too had suffered heavy losses and was scouting around for cash. Unknown to my friends, I was sitting on a handsome pile of profit.
From what I could see around, the bloodbath was expected to become even more gory on Monday. There was just not enough money in the system for investors to be able to take advantage of the steep fall in prices. I foresaw more margin calls being triggered on Monday, setting off another round of panic selling. But I now had to think about winding down my short positions. Not even the most experienced trader can rightly call a market top or bottom. Of course, once in a blue moon, your trade might be the last one just before the market reverses course either way. But that trade would be merely of academic significance. The Nifty had closed at 5,705 on Friday. My instinct and my reading of the trading screen over the last week told me that the index could break below 5,000 at least once even if it did not stay there for long. As was expected, the turmoil on Monday was by far the worst in the market since it had started falling a week ago. Stocks went into a free fall from the moment trading began. Players unable to put up additional margins were selling out at whatever price they could, sending prices hurtling into a death spiral. Adding to the downward pressure was massive short-selling by hedge funds, which were adept at exaggerating market trends, whether up or down, through their heavy purchases or short sales. Also, these funds could now legitimately borrow shares from whomever was willing to lend to them, and dump those shares in the market.
As the carnage was playing out, the stock exchanges added fat to the fire by hiking margins on various stocks and then insisting on brokers paying up the margins ahead of the usually permitted time. Brokerages did not have a choice; if the
y did not fork out the margin money, their trading terminals would be shut down. Brokers were now caught between the devil and the deep sea. Trading terminals being shut down in a falling market amplified the risk for the broker if he had long positions and prices were continuing to slide. Brokers responded by liquidating their clients’ positions. In some cases, clients promptly wrote out cheques towards margin payment. The RTGS facility for speedy transfer of funds had still not caught on in a big way, and their cheques would take at least two days to clear. Two days was a long time in a panic-stricken market such as this one. Besides, there was no saying if the clients actually had sufficient balances in their accounts, given that many of them had suffered heavy losses. A climate of fear and mistrust had settled in the market.
On their part, the exchanges were right in demanding additional margins to ensure there were no defaults by brokers. But the situation would not have come to such a pass had they been gradually increasing margins instead of hiking them at one go when things began to go out of control. Keeping margins unchanged in a rising market encourages players to build up positions recklessly. As long as prices were rising, the credit in the trading accounts was good enough to take care of the margins. It did not occur to anybody that the margins would be woefully inadequate if the prices fell sharper than they had in the past.
After the 208-point fall of the Sensex on Friday, most players did not expect an even sharper decline in the next trading session. Many felt the market would rebound, even if briefly, considering it had been falling consecutively for the last five sessions. But the market was not through with its brutal punishment of the bulls.
The Nifty fell to a low of 4,977 on Monday before trimming some of its losses to close at 5,208. It had fallen around 500 points for the day and the Sensex by 979 points. I had squared off nearly 60 per cent of my positions by the end of the day after realizing a profit that would have caused heartburn to anybody who got to hear of it.
