Saturday, October 3, 2009

KILL BULL – Vol 1.0 - Why Indian Markets to correct 15% over the next 1/ 2 months

Summary - As per below mentioned reasons,  expect a 15% fall in Sensex /  Nifty over the next one or two months
As on this date of posting, Sensex closed at 17,100 and NIFTY at 5080.

1. Dollar to strengthen – EURO (vs dollar) already has tested significant resistance at 1.48 and has closed below 20 DMA of 1.46. Next targets being 1.44  -50 DMA , 1.41 -100 DMA. 200 DMA is 1.37.   ( further details on USD at the end). .
EURO – 5 day chart , shown below, also shows 1.48 to be significant resistance. Trend reversal signaled.

20 DMA is 1.465 and if its goes above that level then it could mean dollar fall has resumed. So can be used as a stop loss for bearish positions on equities.
great site for tracking technicals of  EURO USD

2. TECHNICAL INDICATORS indicating overbought
Agreed they have been showing overbought since the last few months.  But most emerging markets are overbought and are at huge 40% above 200 DMA.  Only Exception being China that has already corrected by 23% from being +55% above its 200 DMA to now just +7% above 200 DMA..(mentioned in detail in below 5th point). Even SnP 500 is 20% above 200 DMA -1st time since 1983, in 26 years

  • Backtesting a key trend reversal indicator shows 15% fall ahead in next 1 /2 months– as mentioned in my previous post. 40% above 200 DMA can be great “topped out” market timing indicator. Lets see the backtesting results.
  • NSE INDIA NIFTY INDEX was taken for study.
  • Total of ~4500 tradng days were considered or 18 years since 1993 to till date
  • Periods where NIFTY was consecutively +30% above its 200 DMA was searched.
  • Results – just barely 12 instances were found.( in below table)

In the above table , the last columns of the first three rows are shaded as the time period of 2 or 3 months is yet to elapse.
Below is the same table sorted on the period of consecutive days NIFTY has closed +30% above its 200 DMA.

As we can see from the above table , this current rally ( consecutive days of 30% above 200 DMA ) is third highest ever. This further increases the probability that the rally can reverse soon.
  • Thus one can see that at least a 15% correction can be expected over next 1 /2 months any time soon.
  • That correction would imply targets of 4300 on  NIFTY and 14,500 on Sensex. Also markets at those levels ( 4300 N / 14.5 S)  , would still result in spread above 200 DMA being at 15%. Which is the close to the median spread of 13% above 200 DMA in bull markets (bull run from 2003 to 2008 )
3. Valuation ratios – have jumped by 2-3x times. MSCI Index PE Ratio is at 20x vs 5 yr average of 14x.
4. China bull run close to petering out –  weakening secondary market
  • Shanghai Composite Index is Now just +7% above 200 DMA vs peak of +55% above 200 DMA - China ( SSE Composite) has corrected from being 55% above its 200 DMA to just 11% above its 200 DMA ( cmp 2840 vs 200 DMA of 2566) and seems to be clinging to the current level of 2800 as the correction from peak has already reached 20%. And further fall of even 5% would be a bad omen.
  • China is already below its 50, 100 DMA and very close to its 150 DMA at 2750.( already there as on 25th Sep) . Also I kinda agree with one school of thought that says Chinese markets led the upside and might be early indicator of the downside. Chart below

5. Early signs of weakness in Primary market
  • 24th Sep`09 -2nd Ooct`09– in the last week , 5 Chinese firms that did IPOs ( China Metallurgical  and Lilang , China South City, Glory Properties) day1 listing on Hang Seng -8-20% below offer price. ( the 1st two were over -subscribed 200x to 600x, rest were oversubs 30x).
  • 24th Sep`09 -2 US REIT IPOs – raises half of what they were expecting. Closed below issue price.
  • Indian primary markets – Adani Power and NHPC below IPO price. 
6. Baltic dry index down 10 days in a row. Down 50% from peak in Jun`09 indicating weak demand for commodities and maybe underlying real GDP growth in future.
  • Chinese steel prices are down 10-20% from peak.
  • Chinese commodities stock piling cause inventory levels to rise sharply. For eg. Total Copper imported by China till date is about 40% of annual imports.  July month imports of copper also have shown a decline. At G 20 Meet china rebuffs pressure to boost imports . 
7. Contrarian Indicators
  • Low IVs – INDIA VIX at 26. Same as US SnP VIX. If you compare with IVs being 40 plus over the past few months , buying puts is damn cheap today.

8. Huge fund raising to increase supply tremendously during falls –  apart from demand destruction  due to given the sharp 100% rally from Sensex 8000 to 17000, demand fatigue could set in for these QIP / IPO issues
Huge fund raising by Indian large caps thru QIPs / treasury stock  - raising equity dilution  and raises risk of sharp falls as these issues have no lock in and yet market has rewarded them with 3x/4x gains.Below is recent QIP issues by Indian Real Estate companies and MTM gains. Since Mar`09 to Sep`09 , 7 NSE India listed Real Estate companies have raised ~ USD 2.8 Bn and MTM gains are at USD 1.8 Bn.( ~ 70%)

  •  Reckless Equity dilution – yet to be punished by markets .Equity dilution means valuations will remain high. For eg a 15% equity dilution of a 20 PE stock would mean that even with a 15% CAGR EPS Growth over three years , 3 yr forward PE still remains at 20! For the 3 yr forward PE to drop to 15. PAT would have to at least double in 3 years ( or a 30% CAGR growth)
  • World over IPOs backlog means huge pending supply of shares. Be it in china - $15 Bn IPO pipeline or any other country. 
9. Other Factors
  • Worst monsoon in 10 years to increase agri NPAs and affect rural demand.
  • Interest Rates bottomed out – rising inflation and rates hikes not good for bulls to sustain momentum.
Contra View - for bulls

  • US Fed to keep rates low for years and continue stimulus measures due to persistent high unemployment that could in turn result in weaker dollar over time
  • US dollar still in secular bearish trend. From technical charts if EURO (vs USD) breaks above 1.48, dollar could then target its lowest of 1.60. that cud again support emerging markets/commodities.
  • Credit markets in strong bull run - Credit spreads are still at low levels and in some cases spreads/yields are making new lows. Eg. Junk bond yields are below pre-lehman levels. CDS also falling.
  • IPO volumes still yet to reach crescendo – heck even AIG is planning with a $ 8 Bn IPO.
  • Even if markets drop, a correction beyond 20% not likely and huge support will come in to sustain 200 DMA.
  • Indian Banks – like HDFC , UTI have raised capital so now can focus on Loans growth instead of capital conservation. And Indian macro consumption story should continue. ( if SBI and;ICICI raise more capital, it  will be more bullish)
  • Huge money sitting on the sidelines. ( But Nobody knows how much of that money is keen to put into equities.)
Currency - The X factor - on EURO and USD
EURO vs USD -2 year chart

1.48 levels is critical. Since last week Euro has been Unable to break above that level .
Above 1.48 , next resistance is at a huge up gap, straight to 1.55 levels.

EURO vs USD 3 months chart

Upward trend since 1 months would only break if EURO goes below 1.47 level
Since yesterday ( 25th Sep `09) EURO is below 1.47 and should target 1.43 where it should find good support.
Next few weeks should see EURO drop to this level of 1.43. that should result in decent correction (10-15%) in equity markets

Disclosure - Short on NIFTY and select Large caps
P.S -" KIll Bull Vol 2.0" will be written after targets of 14500 Sensex and 4300 NIfty are achieved.

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