If you were watching the market yesterday (especially after 2pm), you can’t have missed the vertical drop in the Nifty index (and Nifty May futures, but NOT Nifty June futures) at 3pm, followed by a super quick reversal. That’s what this article seeks to explain.

• Economic Times: FIIs let short positions expire in May

Being net short in Nifty May futures and 2 crore contracts still outstanding going into the settlement day, FIIs had a simple choice to make.

With no pressure of a short squeeze, they (FIIs) could either have rolled over these short positions into June or had let them expire in May itself. Since rolling over such huge short positions into June was a bit tricky, they decided to let them expire in May. But, how about making a bit of money before these shorts expire?

The Nifty fell like a stone in the consequential last half hour making an intra day swing of over 3%. No wonder, Thursday’s provisional figure revealed that FIIs were net sellers of Indian equities to the tune of a whopping Rs 1,277 crore. On the other hand, Nifty future contracts expiring in June added a 68 lakh shares in open interest to end the day at a huge premium of 23.35 points as compared to a mild discount on Wednesday.

• Mint: Costs, subsidy delays make going tough for fertilizer cos

Subsidy payments have skyrocketed in the past four years from Rs15,779 crore in 2004-05 to an estimated Rs95,000 crore in 2008-09, or 1.9% of the gross domestic product. Last year, the subsidy stood at Rs40,338 crore, which includes Rs7,500 crore paid through the first-ever issue of fertilizer bonds.

Fertilizer production requires natural gas, naphtha or furnace oil as feedstock, which account for 70% to 80% of the production cost. All feedstock variations are derivatives of crude petroleum and their prices vary with oil prices. In the past two years, the prices of liquefied natural gas, naphtha and furnace oil have increased by 198%, 50% and 71%, respectively. Out of the 28 functional urea plants in the country, 12 use naphtha or furnace oil as feedstock.

Similarly, the prices of crucial raw materials like phosphoric acid, sulphur and rock phosphate have gone up by 331%, 867% and 297%, respectively, in the past two years.

• Mauldin @ Investors Insight: The Geopolitics of $130 Oil

George and his team are calling the beginning of a new era of global competition. The weapons now won’t be the nukes of the Cold War or the suicide bombers of the post-9/11 world but rather exportable oil and food, and the huge piles of cash that come from exporting surpluses.

The real winners are countries that can export and generate cash in excess of what they need domestically. So countries such as Venezuela, Indonesia and Nigeria might benefit from higher prices, but they absorb all the wealth that is transferred to them. Countries such as Saudi Arabia do not need to use so much of their wealth for domestic needs.

The big losers are countries that not only have to import oil but also are heavily industrialized relative to their economy. Countries in which service makes up a larger sector than manufacturing obviously use less oil for critical economic functions than do countries that are heavily manufacturing-oriented.

The United States is an oil importer, but its relative vulnerability to high energy prices is nothing like it was in 1973, during the Arab oil embargo. De-industrialization has clearly had its upside. At the same time, the United States is a food exporter, along with Canada, Australia, Argentina and others.

Yet another unqiue perspective on oil.

• Morgan Stanley: Growth Cycle – At the Crossroads

Phase II – Acceleration to Overheating Zone (2004-07)

The timing of the acceleration in India’s GDP growth from 2004 coincided with a resurgence in the overall emerging markets growth trend. The positive trigger came in the form of an increase in global risk appetite from 2003 onward and an increase in capital inflows in emerging market economies. One of the key drivers of this phase was the prolonged low real interest rates in the US over mid-2001 through 2004 . . . total capital inflows into India increased to US$98 billion in 2007 from US$12 billion in 2002. We believe that these large capital inflows played a key role in boosting India’s growth cycle to above-sustainable levels.

Phase III – Reverting to Potential (1H08)

Policymakers allowed the phase of above-trend growth to last for a little longer despite early signs of overheating . . . The lagged impact of RBI’s monetary policy actions brought GDP growth down to an estimated 7.5% in 1Q08. Indeed, industrial production growth decelerated even more sharply to 5.8% during the quarter ended March 2008, from a peak of 13.6% during the quarter ended January 2007.

• Bloomberg: Time for Goldman to Add Indonesia to the BRICs

O’Neill says that if he were to sit down tomorrow and revise the BRICs, Indonesia would fare reasonably well. “Of them, we would rate Mexico as closer to a BRIC status than Indonesia, but it would not be far behind.”

. . . Indonesia isn’t an easy place in which to invest. It requires patience, disciplined research and a strong stomach given the lack of legal protection, the multitude of regional taxes and fickle politicians.

. . . it’s Indonesia’s potential and vast natural resources that are attracting interest from the likes of Reliance Power Ltd., the energy company controlled by billionaire Anil Ambani, and ArcelorMittal, the world’s largest steelmaker.

• Business Standard: FII stake in top companies back to June 2005 levels

FIIs trimmed their holding in the BSE 500 companies by nearly two percentage points to 17.8 per cent, bringing it back to June 2005 levels, according to a Citigroup report. FIIs pulled out shares worth $2.8 billion over the past quarter . . . The scenario is in quite in contrast to bull run of the last five years when FIIs pumped in more than $52 billion.

The drop in foreign ownership has been largely picked by promoters whose share of the market continues northward march. The uptrend continues even after accounting for public offerings where free-float is quite low.

Currently, they (FIIs) seem to be betting on industrials, telecom, consumer discretionary and materials.

Rupee at 43, FIIs back to ‘05 levels, EPS growth in single-digits . . . it’s as if everything is in reverse!

• Bespoke: Bespoke’s Commodity Snapshot

• InvestorsInsight: Let’s Get Real About Bear

The $2 a share offer is simply to keep Bear from having to declare bankruptcy which would mean a long, drawn out process and would have precipitated a crisis of unimaginable proportions. Cue the lawyers.

As I understand this morning, JP Morgan will take a $6 billion write down, which is essentially what they are paying for Bear. The Fed is taking $30 billion dollars in a variety of assets. They may ultimately take a loss of a few billion dollars over time, although they may actually make a profit.

The stock market would have crashed by 20% or more, maybe a lot more. It would have made Black Monday in 1987 look like a picnic. We would have seen tens of trillions of dollars wiped out in equity holdings all over the world.

• Economic Times: Bear Stearns sells local stocks worth Rs 1k cr

Bulk deals data on NSE indicate that BSMA (the FII arm of Bear Stearns that is registered with Sebi) sold shares worth more than Rs 1,000 crore on Friday and Monday to different entities, including Deutsche Securities, Citigroup, Merrill Lynch and Goldman Sachs Investments.

Bear Stearns holds tiny stakes in close to 120 listed Indian companies, with the largest holding in JP Associates (at $150 million) and significant stakes in Jindal Steel & Power ($88 million). It also holds shares worth $28 million in Opto Circuits and Madhucon Projects.

• Business Standard: Sub-prime hit FIIs on selling spree

A clutch of foreign institutional investors (FIIs) – led by sub-prime-hit Citigroup, Morgan Stanley and Bear Stearns – sold a record Rs 1,881 crore worth of stocks through block deals during the first two weeks of March. This was the highest net sales in the last four months.

The mid-cap and small-cap companies that have been battered by the big FIIs sales include Bajaj Hindustan, Bank of India, Ceat, Clutch Auto, Dabur Pharma, EID Parry, HEG, Hindustan Oil Explorations, Ipca Lab, Jai Corp, Saregama and Rain Commodities.

No end in sight?

• Business Standard: Satyajit Das: The East-West Symbiosis

The East is now an important centre for currency trading reflecting the volume of dollar reserves held by investors. Asia is also the centre for structured products especially in interest rates, currencies and equities reflecting the amount of investment capital, wealth concentrations and also the search for higher returns.

Products originated in Asia increasingly flow back into Europe — a change in the historical pattern of product innovation. In mergers and acquisitions, the focus is on servicing eastern investors and corporations expanding into developed markets. Hedge funds and private equity funds are spreading into the East. Bankers are headed East for reasons other than spiritual enlightenment.

• Brookings Institution: Hedge Fund Wizards

Hedge funds are risky for another reason. It is extremely difficult to tell, based on past performance, whether a fund is being run by true financial wizards, by no-talent managers who happen to get lucky or by outright scam artists.

. . . take a position that yields high returns with high probability and extremely poor returns with low probability, and keep your fingers crossed. Credit default swaps are one example, so are bets on interest rate spreads. Such strategies are risky but not fraudulent; the manager can always argue that his opinion about the odds differed from the market odds (he was simply engaging in arbitrage).

• Big Picture: Fed’s Folly: Fooled by Flawed Futures?

. . . it took only 2 days to learn just how ill-considered the Fed’s emergency market rescue plan was: To wit, a fraudulent series of losses led to a major European bank unwinding a huge trade: Societe Generale Reports EU4.9 Billion Trading Loss.

SG’s $7.1Billion dollar unwinding led to panicked futures selling on Monday and Tuesday.

Hence, we quickly learn what sheer folly and utter irresponsibility it is for the Fed to use its limited ammunition to intervene in equity prices. Their panicky rate cute were not to insure the smooth functioning of the markets, but rather, to guarantee prices.

Whoa! So that 20% drop in 2 days was for nothing? Do we see 20k+ on the Sensex soon? And here we were debating valutions, FII flows, margin calls & such!

• Seeking Alpha: WisdomTree Launches Broad-Based India Earnings ETF

In early February, WisdomTree Investments plans to launch the WisdomTree India Earnings ETF.

The ETF’s benchmark includes 150 locally listed companies. That compares to around 62 companies the MSCI Index tied to the iPath uses, . . .

The WisdomTree India Earnings Index also screens for profitability as a criteria. “We only include Indian companies that’ve been profitable in the last reported 12 months,” Lavine said.

Stocks are weighted in the index by “their contribution to the earnings stream of corporate India,” he added. “We look at trailing net income and work with S&P in those calculations.” The rival ETN is market-cap size weighted.

• Business Line: FIIs betting on reverse-arbitrage?

If you go by the SEBI figures for recent FII investments, then you may conclude that they are net sellers in the Indian equities. But it’s deceptive, say brokers and overseas fund managers.

“Foreign investors, particularly participatory notes holders, have adoted a reverse arbitrage strategy for 2 to 3% additional spread available because of dip in the futures prices compared with that in the cash segment.

. . . all the big investment outfits, who have large inventories of participatory notes, have been strong net sellers in the cash market in the last five sessions. However, as their trade figures in the derivatives market do not indicate whether they are ‘buy’ or ‘sell’, this strategy of reverse arbitrage is not in the public domain. Since the settlement is round the corner, the new investment tactic is likely to pay off huge dividend . . .

This is why first-level analysis of daily FII flows is usually insufficient. Simpliy looking at the SEBI net purchasese/sales by FIIs can lead to incorrect conclusions.

• Bloomberg: Rogers Says U.S. to Have Worst Recession `in a While’

“If you’re worried about a recession, you might think about buying agricultural commodities,” Rogers said. “I suspect agriculture is going to do well no matter what happens to the world economy.”

A decline in crop yields because of droughts from Ukraine to Australia, combined with rising demand for biofuels, has spurred a rally in agricultural commodities that sent wheat to a record last month and corn and soybeans to multi-year highs.

Cotton, coffee and sugar may gain the most, he said, adding that he wouldn’t buy crude oil after prices rose above $100 a barrel last week, or industrial metals such as tin or lead because a slowing U.S. economy would curb demand.

Same old, same old.

• Economic Times: Potential FII outflow to send Sensex, rupee crashing

. . . a possible outflow of FIIs has a potential to send the benchmark Sensex crashing down to 14,000 points within a quarter, a report said today.

While strong inflow of funds from foreign institutional investors (FIIs) has been a reason to cheer, it could turn into a nightmare and if the global investors make a sudden exit with about 12 billion dollars within a quarter, it can send the bourses crashing by around 30%.

I think if we do have a crash, the cause is going to be something much different from what most people are focusing on - which definitely rules out FII flows.

• Business Standard: IPO frenzy sees slew of new demat account
  

Around 1.6 lakh new demat accounts were opened in the two depositories during the first eight days of January.

“Retail investors, who up till now had never looked at the stock markets, are making a beeline for demat accounts to invest in RPL’s issue,” said a broker.

OK - I am glad that the potential user base for Moneyoga continues to expand at a rapid pace. But there is something about this retail IPO/demat mania that feels bearish.

• Bloomberg: If Soy Is Expensive, Why Does Goldman Say Nevermind?

Goldman Sachs in New York expects soybeans to rise 29% in 2008, the best investment in commodities. Investors who followed the banks’ advice and bought raw materials last year profited as the Standard & Poor’s GSCI Index advanced 33%.

The bank forecast December 2008 corn prices will increase 12% to $5.30 a bushel from $4.735 now. Goldman recommended buying corn and selling wheat in a “spread” trade to exploit changes in the relative value of the crops.

• Safe Haven: The “Commodity Super Cycle” - Ready to Rumble in 2008

India could face a supply shortfall of about 4-million tons of rice in 2008, threatening to turn the world’s largest exporter of rice into a net importer. With tight supplies of wheat this year, Indian demand for rice could grow to 96 million tons or higher, and above the rice crop of 92 million tons last year. India is also Asia’s third-largest oil consumer, and imported 9.25 million tons of crude oil in November, or 2.8 mil barrels per day, up 6.5% from a year ago.

In Australia, the M3 money supply rose 20.7% from a year ago, Brazil’s M3 +17%, Canada’s M3 +12.9%, China’s M2 +18.5%, the Euro zone’s M3 +12.3%, Hong Kong’s M3 +31.5%, India’s M3 +21.5%, and the USA’s M3 +15.8%, a 47-year high.

• InViVo Analytics: What Quants Know and What Traders Refuse to Believe

Paul Wilmott is a quant’s quant. He wrote the book on quantitative finance. Somewhere in the 3 volume set, Paul Wilmott on Quantitative Finance, he stated that most of his personal money is invested in…index funds. Gasp, you say! The man who can derive Black-Scholes 10 ways can’t trade? Well, that is not exactly the case. He can trade well, but as a quant, he knows that that the market is nearly impossible to beat over the long run.

Renaissance has reportedly produced even higher returns. (Most of the top-performing hedge funds are closed to new investors.) Kat questioned whether such firms, which trade in huge volumes on a daily basis, ought to be categorized as hedge funds at all. “Basically, they are the largest market-making firms in the world, but they call themselves hedge funds because it sells better,” Kat said. “The average horizon on a trade for these guys is something like five seconds. They earn the spread. It’s very smart, but their skill is in technology. It’s in sucking up tick-by-tick data, processing all those data, and converting them into second-by-second positions in thousands of spreads worldwide. It’s just algorithmic market-making.”

• Ajay Shah: Understanding FII investment

When Nifty yields positive returns in a given month, FII inflows are elevated in the following four months (and vice versa). A month with 10% returns on Nifty induces additional inflows of 0.2% of Cospi market cap - roughly $3 billion - over the following four months.

When future volatility of the S&P 500 is higher, less money comes into India, and vice versa.

Firms which fail to make the grade on size, liquidity and corporate governance do not get into the FII club. Once club membership is secured, similar factors (size, liquidity, corporate governance) affect the proportion of non-promoter holding that is bought by FIIs. The most interesting result of this exploration (slideshow, paper) lies in the extent to which it explains the dramatic change in foreign ownership of Indian equities from 2001 to 2007.

• Bloomberg: Sandstone May Invest More in India to Take Advantage of Growth

“India, on a relative basis, continues to look attractive,” Patel of Sandstone, an India-focused hedge fund that manages $1 billion in South Asia, said in Mumbai today. “The markets in India are still inefficient and ripe for opportunity.”

“A mountain of money has been raised by private equity firms,” said Sama from Baer, who’s based in London. “The credit crisis in the U.S. has become ugly, so large firms like Blackstone Group LP will look for other opportunities and some of that money could find its way to India.”

Keep it coming, I say! And of course, that leads us to more aggressive calls on the rupee.

• Meri News: Rupee could hit 30 to a Dollar in five years?

GEORGE LYONS, an economist with Standard Chartered Bank, has predicted that in 5 years, INR (Indian rupee) will further strengthen vis-à-vis the USD (US dollar) – so much so, that the USD may fall to INR 30. This strengthening of the INR will only increase the sufferings of the Indian exporter.

Lyons’s comment has come at a time when Indian exporters are taking a hit on account of the INR appreciating a record 12.5% against the USD during the current year alone. This has already inflicted a loss of approximately INR 35,000 crores on Indian exporters. A further 5-10% appreciation of the INR will lead the Indian exporter to a point of no return.

Okaaay ..but what then should we make of this?

• Also from Meri News, Despite rupee appreciation export has increased by 35%
  

IT APPEARS that 12.5% appreciation in Rupee has not ruined the overall export performance of India. At least the department of commerce press release on December 3 confirms this. In the month of October 2007, Indian exporters exported $ 13.30 billion (Rs 52560.85 crores) worth of commodity and services to the other countries of the world, which shows a whooping 35% increase, over $ 9.80 billion worth of exports during October 2006. But in rupee terms the export during October 2007 was higher by only 17.88 per cent compared to October 2006 figure.

• Orpheus Capitals: Top Down Investing
  

The current market situation in India clearly exhibits where technology, energy and staples stand today versus the broad market Index. Technology and staples underperformed in 2007. Playing with or against emerging sectors can be a key profitability differentiator for a fund. And since sectoral underperformance can not last forever, knowing when the cycle is turning can really push the fund up in relative rankings.

Macro economic trends can also assist in sector selection. According to the recent IMF report the rising food costs impact headline inflation to as much as 55.9% for developing Asia. Rising food can have a direct impact on the staples sector. And Indian companies featuring in Business Week Asia’s top 50 today might change tomorrow with performers still coming from pharma, alternative energy and consumer companies like Cipla, Sun, Suzlon, and ITC rather than the banking, auto and tech majors like HDFC, Tata Motors, Hero Honda and TCS that also feature in the list.

• Bloomberg: Bond Traders Reclaim Master of Universe Title

Government bond traders were all but forgotten as derivatives geeks dominated fixed-income desks. The cozy club of primary dealers that deal directly with the Fed had less relevance as hedge funds did pretty much what the dealers could do, only better.

Don’t write bond traders off just yet. Diminished, maybe, but not forgotten. What comes as a surprise to the stock market is often old news to the bond market.

Counterintuitive as it may seem, the more hawkish the Fed rhetoric, the greater the expectation of rate cuts.

“The market is saying if you don’t ease now, you’ll have to ease more later”.

• Business Standard: Record FII registration in November

The total number of FIIs registered with the regulator has increased to 1,170 from 1,124 at the beginning of the month.

CLSA, Goldman Sachs Investments, Citigroup Global Markets, Morgan Stanley and Swiss France Corporation from Mauritius, Thomas Weisel Partners, Wintergreen Fund and ICON Advisers from USA, Credit Suisse from Singapore and Indus Capital Advisors, Bennelong Asset Management and Ferox Capital Management from United Kingdom (UK) are among the newly registered FIIs.

• Conde Nast Portfolio: The Evolution of an Investor, by Michael Lewis

In the beginning, back in the 1980s, Dimensional Fund Advisors (D.F.A.) didn’t sell to individual investors at all. The funds sold themselves by word of mouth. Finally in 1989, D.F.A., with some reluctance, agreed to allow financial advisers to steer clients’ money into D.F.A. funds, but only after those advisers had demonstrated their purity of heart. They must never, ever, sell individual stocks, try to time the market, or suggest to investors that it is possible to systematically beat the market.

Having demonstrated sufficient cynicism about Wall Street, the financial advisers must pay their own way to Santa Monica, California, and listen to speeches that explain why, if anything, they should think even less of Wall Street than they already do.

Along the lines of Jack Bogle & Vanguard.

• The Big Picture: The Panic of 1907 (Book Excerpt)

The authors point out the following Déjà vu — 100 years later: “War was fresh in mind. Immigration was fueling dramatic changes in society. New technologies were changing people’s everyday lives. Wall Street was wheeling and dealing . . .”

They also name 7 factors are required to develop a financial panic: Buoyant Growth, Systemic Architecture, Inadequate Safety Buffers, Adverse Leadership, Real Economic Shock, Fear and Greed, Failure of Collective Action.

Check out excerpts of the first 3 chapters - fascinating stuff!

• Mint: FIIs: the smarter lot in current rally

From only a 20.6% share of India’s free-float market capitalization in early 2003, FIIs now enjoy a 34.7% share. Retail investors held a higher 28.7% stake in free-float market capitalization in March 2003—it’s now fallen to 21.5%. Domestic institutional investors, including mutual funds, insurance companies and banks, have also seen their share fall, from 23.5% in 2003 to 19.7% currently.

FIIs, which are benchmarked with the Morgan Stanley Capital International (MSCI) India index rather than the Nifty, have their biggest overweight position in industrials (408 bps) and they are significantly underweight in consumer staples.