by Santosh Nair
My big worry was that the government may direct the LIC and maybe even some of the state-owned banks to support the market by making purchases. Something like that would help stabilize the market and prompt bears like me to start covering my positions. By now, many players were short on the market, and if all of them rushed to cover at the same time, the market might just take off.
There was no public statement by the finance minister or any other senior ministry official. But if the market fell any further, there would surely be some soothing words from the government to assuage the rattled investors. Or maybe SEBI would declare a ban on further short sales just before the market opened, setting off a stampede among bears to cover up their positions. Still, my trader’s instinct told me there was one more round of sell-off coming, as many brokers and traders were still struggling to pony up cash to pay margins on their outstanding positions.
I slept fitfully that night. Despite all the money that was waiting to pour into my bank account, I still had this niggling worry that the market could once again change course abruptly and dent my profits. After all, I still had outstanding positions. Perhaps my sleeplessness reflected my guilt complex, as I had been making money while many of my friends were in dire straits.
I had strange dreams that night. In one of them, I was arguing with my friends who had accused me of being selfish and not helping them out even though I had the resources to. In another, a cop turned up at my doorstep with an arrest warrant, saying SEBI had identified a set of people who were spreading terror in the market through short-selling. Ignoring my pleas, he walked me through the streets with handcuffs on, much to the delight of the onlookers who were clapping in glee.
When I protested, the cop told me he had orders to make an example out of me so that people would stop short-selling. Perhaps this particular segment of my dream had to do with an inflated sense of self-worth that I was behind the market crash.
As I headed to work next day, the nightmare of my arrest and parade through the streets was playing on my mind. But my run of luck continued that morning, with the indices crashing 10 per cent within minutes of the start of trading, leading to market-wide circuit filters being triggered. Trading was suspended for an hour, according to rule.
Sure enough, the finance ministry swung into action to calm the agitated market players who did not know what had hit them. Banks were asked to extend additional credit lines to brokers, and finance ministry officials assured the market of enough liquidity in the system. State-owned banks were told not to offload shares that had been deposited as collateral with them in a hurry, as this would further aggravate the downtrend in share prices. Some of the bank chiefs remarked on the strong fundamentals of the economy, some others promised full support to brokers through additional credit, and a few even spoke about increasing their capital market exposure as they felt valuations were attractive. Later, many brokers would complain that banks were offering them additional short-term credit, but at interest rates as high as 24 per cent.
The finance minister himself stepped in to say that all was well with the country.
The market opened for trading an hour later, and there was some semblance of sanity. Still, every rise was met with heavy selling, and the Nifty finally ended the day at 4,900, and the Sensex at 16,729. With a near 25 per cent dive from its peak over just seven sessions, the bull market appeared to be over.
Many small-timers and part-timers in the market had been wiped out for good. It would be years before they fully got over their trauma, and could even bring themselves to think about the stock market. Some of the larger firms and players too had just about managed to avert serious setbacks. For many, that dream house, dream car, or the month-long sightseeing tour of Europe would not be possible for some years to come.
As for me, I was a rich man. I had made the boldest bet of my career so far, and it had paid off handsomely. But it was not entirely about the money. My satisfaction lay in my decision to stand up against the market right in the midst of a raging bull run and coming out on top.
I thought of celebrating my triumph in style by taking Bina and the kids out for dinner at a five-star hotel that night, and gifting them a grand vacation in April to any location of their choice. For some reason, I decided against it. Maybe it had to do with a subconscious feeling of guilt, or not wanting to tempt fate. Instead, I chose to unwind at home over music and a long chat with Bina.
I was gripped by conflicting emotions. On the one hand, I wanted the world to know of my success, and yet, I was not comfortable at the thought of the envy it would evoke at a time such as this. I would also be drawing attention to myself, something I had always avoided. It would not be long before the size of my pay-out became the talking point in the industry. That was something I could not avoid, no matter how hard I tried.
27
The Denouement
The troubles that had seized the market were not fully over yet.
The final act of the dark tragedy was pending – R-Power’s debut on the bourses two to three weeks away.
The first indications that the stock’s listing could be an anticlimax of sorts came from the grey market, of course. The premium, which had climbed to as high as Rs 450 at one point – suggesting that Reliance Power shares would list at a 100 per cent premium to the issue price irrespective of the wider market mood – was now down to Rs 200 after the indices had shed 25 per cent in a week’s time.
Even though their expectations had toned down considerably, investors in the issue still believed they could make a decent return. The massive demand for the IPO was the foundation on which this hope rested. If investors had got only a fraction of the quantity they had applied for, it stood to reason that they would be eager to buy the remaining quantity from the open market when the shares listed.
11 February was fixed as listing day for R-Power shares. The market appeared to be stabilizing in the run-up to the listing, and many players felt the worst was over. A good showing by Reliance Power could even get the market climbing again, they felt. The premium in the grey market, however, kept dipping, with not many deals taking place.
Outside of the grey market, everybody was looking forward to what was likely to go down as a historic moment in the annals of the Indian stock market.
There could not have been a bigger anticlimax.
At 9.55 a.m., R-ADAG group chairman Anil Ambani sounded the gong on the floor of BSE to signal the listing of the shares. He might as well have rung a dinner bell signalling to a sloth of starving bears to dig their claws deep into his stock.
The shares briefly topped Rs 500, but not many trades happened at those prices. On BSE, the highest price for the day was Rs 599 and on NSE Rs 530. But this was just a flash in the pan. Within minutes the share price sank, hitting a low of Rs 355 before ending the day at Rs 372, 17 per cent below the issue price. The average price during the session was Rs 416.
It was possible that the overall downtrend in the market aggravated the slide in Reliance Power shares. Later, Anil Ambani would accuse corporate rivals of having orchestrated the debacle by hammering the prices to force existing investors to sell out and scare off potential buyers. Those who had bid with such enthusiasm for Reliance Power shares during the subscription period did not turn up to buy more shares even though they would have got them much cheaper.
Only a handful of investors managed to exit their positions at a decent profit. And even those who got a good price may not have been able to offload as much of their stock as they would have liked to, as the stock price fell so fast.
The tremors of the disastrous listing were felt in the grey market too, where many players reneged on their commitments after suffering heavy losses. The grey market is illegal and functions purely on trust; there is no way you can drag somebody to court for going back on his word. Still, this market had stood the test of time, which is proof that players rarely wriggled out of their commitments. But this incident shook the faith of players in the grey market. I
t would be a very long time before their confidence in it returned.
Stung by bad press in the wake of the debacle, Reliance Power, on 24 February – a Sunday – announced a bonus share issue solely for its non-promoter shareholders. Investors were to get three bonus shares for every five shares they held.
What many failed to understand was that even if the bonus share issue reduced the average cost of purchase in absolute terms, the market price would automatically adjust lower, to the extent of the extra shares in circulation after the bonus. The bonus issue itself would not assure investors of good returns; there had to be a fundamental reason for the stock price to go up if investors were to make meaningful returns. Looking at the price charts and the trading screen, I was convinced that the stock price would crack sooner than later. I wasted no time in going short on the stock.
The market now appeared to be stabilizing in the 17,000-18,000 range after a series of bruising sell-offs since January. The easy pickings for bears appeared to be over for the time being. Just when they were running out of bullets came unexpected ammunition from none other than the finance minister himself. In the final Budget of the UPA’s tenure, P. Chidambaram announced a Rs 60,000-crore relief package for farmers, including complete waiver of Rs 50,000 crore of farm loans to small and marginal farmers.
To the stock market, this was a clear signal that the government’s main priority now was to win the Lok Sabha elections due next year. That meant more populist measures in the offing, something the market dreaded. Emboldened bears went on the offensive, knocking nearly 3,000 points off the Sensex over the next three weeks, dragging it to below the psychological 15,000 mark. Even the most diehard bull now had to admit that the near five-year bull run had finally ended.
What allowed bears to sustain their attack was the steady stream of bad news pouring in from global markets, the US and UK markets in particular. Investment banks, which were at the forefront of the sub-prime loan boom, were now haemorrhaging capital as borrowers defaulted. Faced with a severe liquidity crunch, these banks were pulling out whatever money they could from other markets they had invested in.
The dramatic change in sentiment had hurt the fund-raising plans of other companies, as fund managers appeared to have developed cold feet for IPOs. Wockhardt Hospitals was looking to raise around Rs 750 crore and Emaar MGF – a joint venture between Dubai-based Emaar Properties and India’s MGF Development – hoping to collect Rs 6,400 crore through IPOs. Both public issues had to be shelved.
I decided to take a well-earned break from trading, and went on a vacation with my family to Sri Lanka. I tried not to get distracted by market news, but kept track of events that were rapidly unfolding across the globe.
I could afford to do nothing for the rest of the year but watch from the sidelines. But the thrill of trading in a market that was changing course at whim was too much to resist.
It was evident that the market trended lower every time it attempted a climb after a bout of selling. Adding to the pressure on stock prices was the short-selling by FIIs who were borrowing stocks held in P-note accounts. Unknown to investors in P-notes, the broking firms holding the shares on their behalf would loan their shares to other FII clients for short-selling. This was a lucrative business for the broking firms as they could charge a juicy fee for this ‘loan’. The FIIs would first sell the borrowed shares, then buy them back at lower prices and return them to the broking firm.
Since the mood in the market was bearish, these ‘borrowed’ short sales, while earning handsome profits for the FIIs, further collapsed share prices. Ironically, the stocks that bore the brunt of this selling fury were among the favourites of institutional investors only a few months ago. Many panicky FIIs dumped their holdings and fled to safer havens.
Over the years, I had come to like bear markets and the art of making money through short-selling. Any novice can make money in a raging bull market but only a truly professional trader can profit from a falling market. Short-selling tests a trader’s nerves in a way that going long does not.
I still remember GB’s explanation as to why there were always more bulls than bears in the market and why most traders were loath to short-sell in a falling market as aggressively as they would go long in a rising market.
‘Human beings are by nature optimistic, and traders are no exception to the rule, even if they are only concerned with making money in whatever way possible,’ he had told me many years ago. ‘It is easy for a trader to buy a stock and hope that it will go up, rather than sell a stock and then hope that it will decline. If you buy a stock for Rs 100, you know that at worst the price can go down to zero, and that the maximum you stand to lose is Rs 100. Of course, a stock price will never go down to zero. If you short-sell a stock at Rs 100, there is no limit to which the stock price can rise.
‘So a trader long on the stock can sustain his hopes even if the stock price falls to Rs 90. But most traders short on a stock at Rs 100 will start squirming the moment the stock price climbs to Rs 110. To begin with, many of them are going against their natural tendency when they short-sell, and will be uneasy till they see the price slipping below the rate at which they have sold. That is why it takes a really courageous trader to go short, even if the market can give up in a week the gains that took months to build. Traders are more disciplined when it comes to short sales and, in general, end up losing less than what they would from long trades.’
The crisis in the global financial markets was growing steadily worse, reaching a flashpoint on 15 September. That was the day when Lehman Brothers filed for bankruptcy after being denied a federal bailout, and Merrill Lynch got taken over by Bank of America in a distress sale in the space of a few hours. Between them, the two storied investment banks had a history of nearly 252 years. On Wall Street, rumours were swirling thick and fast that it was a matter of time before Morgan Stanley, Citigroup and even the seemingly invincible Goldman Sachs went belly up.
In a matter of just six months, three of the Big Five US investment firms – Lehman, Merrill, Bear Sterns – had become history, and the surviving ones – Goldman Sachs and Morgan Stanley – had changed in character, altering the landscape of Wall Street forever.
It was hardly a surprise that financial sector stocks in the US were being hammered out of shape. Fearing that more banks could go under if the share prices continued to fall at this rate, the Securities and Exchange Commission (SEC) announced a temporary emergency ban on short-selling the stocks of all companies in the financial sector.
I was hoping that SEBI would not imitate SEC’s strategy and impose a similar ban here. On Dalal Street, the sector that had the most to fear from the marauding bears was real estate. Stocks like DLF, Unitech, HDIL, Sobha Developers, Anant Raj, Omaxe and Orbit Corp were down 60-70 per cent from their peaks in January, and it still did not look as if the stocks had bottomed out.
The ‘land bank’ fad, which I have described earlier, had pushed up the prices of these stocks to dizzying highs. Investors valued these companies on the basis of the large parcels of land owned by them, though the title deeds of many of these parcels were in dispute. Also, it was a case of counting the chickens before they hatched, as it would take a while before the land was developed and buyers emerged. Real estate prices had been on a tear, as it always happens in a bull market, and everybody felt property prices would be on the upswing for many years to come, if not in perpetuity. Investors had also overlooked the poor corporate governance standards in the sector, a good chunk of whose dealings were done in cash that would never show up in the account books. Promoters of most of the realty companies were also known to play their own stock, and many had raised funds by pledging shares held in benami accounts. But now that the cycle had reversed, the same investors who had once chased prices were now exiting.
Even a ban on short sales in real estate stocks by SEBI would have provided little more than temporary respite to the sector. The market had realized how hollow these companies’ valuation model
s were, and its disenchantment with the sector was so strong that despite the massive collapse in prices, no price for realty stocks seemed too low. Juxtaposed against the better managed and fundamentally sound companies available at good prices, the real estate stocks looked all the more ugly.
Even as bulls were licking their wounds, there followed an even more brutal sell-off in October. This one was triggered by the appreciation of the Japanese yen against the dollar, and the unwinding of what is known in market parlance as the yen ‘carry-trade’. In a typical carry-trade, investors borrow in a currency with the lowest interest cost, convert it into dollars and invest the funds in assets – usually risk assets like equities, commodities, currencies or high-yield bonds – that offer a handsome return after adjusting for the currency conversion costs.
In a yen carry-trade, the money is borrowed in Japanese currency. After borrowing in yen, an FII would convert the funds into dollars and then again into the local currency of the market in which it intended to invest. On the way back it would have to convert the local currency back into dollars, and the dollars back into yen to repay the original loan.
There was a cost to each of these conversions, and the overall returns would have to be well above the conversion costs through the entire round trip. This trade works well as long as the currency (yen in this case) in which the funds are borrowed remains stable or even depreciates relative to the dollar. At the same time, the assets in which the funds are invested have to keep appreciating.
But it is bad news when the yen appreciates to the dollar, because it means the investor will need more dollars to repay the original yen loan. It is worse if, in addition to this, the assets in which the funds are invested start depreciating in value. And that is precisely what began to happen from September onwards, when prices of emerging market equities, commodities and risky bonds like mortgage securities went into a free fall, triggering margin calls. The carry-trade had begun to gradually unravel towards the end of 2007, and accelerated after the events of September 2008. As investors unwound their carry-trades and began to convert dollars into yen to repay the loans, the demand for the yen rose, strengthening the Japanese currency against the dollar. This double whammy of a rising yen and falling asset prices set off a vicious cycle, triggering more unwinding of carry-trades, the tremors of which were felt across global financial markets.
