Sunday, October 25, 2009

KILL BULL – Vol 1.0 - More evidence for Indian Markets to correct 15% over the next 1month

This post in related to my previous post dated 3rd Oct 2009, about why Indian Markets ( Sensex / NSE India Nifty indices to be specific) is due for a at least 15% correction over the next 1 or 2 months ( not exactly in calendar months but 30 / 60 trading days to be precise). 3 weeks have passed since the post ( 14 trading days) and have lost some money on short positions but still now as I stand all the more convinced of a 15% fall in next 1 or 2 months.
Summary - NIFTY cmp -4997 as on 23rd Oct`09. I expect to test 4300-4400 by Nov`09 end./Mid-Dec`09.( 10-15% fall fm cmp)
Here is the further evidence -
  1. Technicals signaling weakness ahead. Also Backtesting indicator of 40% above 200 DMA has now confirmed that the unending buying spree is over or nearly over in the short term and a mean reversion towards 200 DMA is very likely now. The confirming indicator is that the period of consecutive trading days where Nifty / Sensex was above +30% of the 200 DMA has ended on 21st Oct`09 and that period lasted for 40 trading days.that made it the 3rd largest since last 18 years and the Largest since 2003. see the table below -

Parts of the 3rd column is shaded grey as 1 month is yet to be over.
Also  NIFTY is now showing strong signs that rally has peaked. NIFTY already closed below shorter term DMAs - below 5,10 and 20 DMA. as seen below. Looks ripe for mean reversion to test 50 /100/150 DMAs.


Bears have also tasted blood in a sector Telecom ( Bharti airtel 400 strike puts were up 10x , from 7 to 70 in just 4 days as it fell from 430 to 330. In just 2 days it closed below its 200 DMA of 370). More such targets would be sought by bears.
2) Valuation of most large caps- leaves lots of room for correction. Most large caps are trading at 25-30 PEs . For example, for a stock to justify its price that is currently trading 25 PE.ratio , the earnings have to grow at least 40% CAGR so that in the next two years the forward PE drops to a relatively cheap 13 times. 40% CAGR earning growth means PAT has to double or go up by 2x in the next two years !!. Which large cap company has that kind of earnings visibility and certainty ? Again the reported earnings are heavily distorted by accounting policies so a better way to measuring growth is measuring Cash flow from operations or CFO. . Let us take example of Institutional favorite stock and hot Infra sector - Larsen And; Toubro or L and T. Latest results not inspiring- H1 Sales was up a mere 5%. Sep`09 EPS of 9.7. Last Fin. Year FY09 PAT was up by 60% but CFO was down by 24% ? Larsen is at trading 40x PE ? has to correct by at least 15%..

 ( if one is interested one check out many large caps like NTPC BHEL ABB TATA POWER GAIL  AMBUJA CEM ACC SAIL that would also show similar results - showing CFO negative growth but good EPS growth)
Now to find the actual reasons of this anomaly of EPS growth by 60% and CFO decline by 24% in FY09 by Larsen,  further time has to be spent to dig more but just this plain fact should make investors holding or buying LnT stock ask themselves the question that is it actually worth PE of 40x P/CFO of 60x ? Well this kind of large cap and high volume traded stocks and in such hot sectors provide an ideal mix for a stock to reach such ridiculous valuations in bull markets. Some old lessons would be learnt again I guess. Warren Buffets quote "The investor of today does not benefit from growth of yesterday".
I would add a note that Investors should also look into the quality of growth. By the way in India , Quarterly balance sheet and cash flow release is not required, only P and L is. that is a big disadvantage and leads to very poor disclosure standards. Anyways I have disclose my bias also. I track and have long positions at least a dozen mid cap / small cap stocks that are trading at PE of less than 6 with CFO growing at 2x , debt free, with 3% dividend yield , so why would I even think at large caps ?.

3 ) NIFTY 50 stocks 30 /50 DMAs showing weakness -NIFTY internals or drill down of 50 stocks would show that short term early signals like stocks spreads of 30 and 50 DMAs are going negative. Also overbought can be seen by the % spead above 200 DMA as almost 95% of NIFTY stocks are above 200 DMA and some by a huge margin.


 Below -NIFTY stocks sorted % 200 DMA spread in descending order
  
so as you can see from the above most over bought NIFTY stocks (on % 200 DMA +spread basis), among the top are Jindal Steel, Hindalco, HCL tech,TCS, Tata Motors, Sterlite, Tata Steel. Nifty stocks that are already showing clear signs of weakness are in the bottom five - Grasim, Ambuja Cements, RCom, Idea and Bharti Airtel. (Must add that just because a stock is 100% above its 200 DMA doesnt mean that it doesnt have more upside. For eg. even after its 100% above 200 DMA and its at PE of 5 vs fair value PE of 10. then it still has potential to go up 2x over the longer term so it can also be a contra bullish indicator and might just signal that in shorter term stock might fall and it could be a good time to buy)
4) RBI meet in 27th Oct could hike CRR by 50 bps. Not sure if market is discounting that. But going by most economists predictions the consensus believes RBI will keep policy loose. Also according to TV18 poll , just 20% expect a CRR hike so a CRR hike can cause damage to the uptrend.
I believe there are more reasons why RBI might hike CRR.
Inspite of RBI cutting rates by 425 bps banks have cut their PLRs by only 200 bps. Implying monetary transmission efficiency of a low 50%.
Add to that banks are parking $15-20 bn in reverse repos instead of giving loans ( latest data shows credit growth at 10% an 8 yr low). Intervention by RBI to in the forex markets to would also need sterilization to keep money supply at less than 20%.
5) Chinese recent 23% market correction signal for other markets  - why is it important is that Chinese market are good case for stress testing the bull market ? It is  because of 2 reasons (1) the chinese govt stimulus is the biggest in the world $ 1.3 trillion of new loans in just past 9 months or 20-25% of GDP (2) no currency factor as Yuan is fixed peg. inspite of these two reasons if chinese markets can fall 23% then any stock market can .
 6) US markets great earnings - till date out of the the results declared of the S and P 500 companies 81% have beat their estimates. This just shows how wrong /pessimistic / low balling were the expectations and therefore you seeing a 50% to 70% rally rather than implying that the earnings of companies are now on the V shape recovery path. Heck if you are surprised by this quarter US SnP 500 results then wait for the Dec 2009 quarter results that is expected to rise 63% YoY.Can these expectations be beaten again ? Are these sustainable?see post at http://bespokeinvest.typepad.com/bespoke/2009/10/estimated-sp-500-earnings-growth.html
7) Root causes of the last years bust not yet fixed - be it rating companies, overpricing IPOs by I bankers and firms, excess leverage by the banking system and consumers. Current conditions resemble 2007 peak - sharp rises across all asset classes be it real estate ,art, commodities, stocks. It just shows rising tide lift all boats. ( low interest rates). So what will happen when the tide reverses ?

8) Negative News flow - 
  • Inflation could reach 10 percent by March
  • Dollar sharp fall is meeting `fundamental resistance`-Increasing evidence that emerging markets will intervene to stop the rapid rise in their currencies. (See news on Brazil below.). Heck ,if push comes to shove even Helicopter Ben can raise rates to protect dollar reserve status (think of it as a nuclear option that the US can unleash on the world financial markets that could cause capital flight from emerging markets back into US).
  • After sharp 35% appreciation in its currency Brazil imposes 2 % tax on foreign inflows
  • Obama declares swine flu a national emergency
Beginning winter season might see rise in H1N1 cases as flu historically peaks in Dec / Jan. See flu trends http://www.google.org/flutrends/us/
Thats all for now. Views / criticism are welcome.

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