Nifty In Technical Charts: Caution Advised. Trim.

Now that should quieten down the fears of those that suddenly felt queasy on Friday. There were some technology problems too on Friday (owing to the Microsoft issue) and this was said to be global. Many brokers in India too faced problems with the trading terminals. It is debatable as to how much of the decline can be ascribed to this technical glitch because an open-to-close decline is never a pleasant day at the markets. So, some uncertainty would definitely have been created.

This will resurface on Monday because buyers are not really going to step forward so readily, given that the Budget is scheduled for Tuesday. Therefore, we may have to spend a quiet day at the start of the week, perhaps with some continued downside bias too, as the market awaits the first Budget of Modi 3.0. Now, there are many views on how this market views the Budget and I feel most of the expectations are biased to the upside. So, there may be room for some disappointments.

But I also feel that this market is still caught in the buy-the-dip syndrome. Curiously, Goldman Sachs last week released a report asking investors to desist from such behaviour. Of course, this was a US-centric report, but everyone promptly started using that analogy here as well, citing valuation concerns. Would that apply to our markets too?

I have already expressed my views a couple of times in these letters about how I consider that valuation considerations stand swamped in the current markets by Liquidity and Sentiment. There is no sign of any easing up of liquidity flowing towards our markets yet. In fact, FIIs turned active and a bit more aggressive with their longs in our local markets. SIP flows are undeterred with Rs 21,000 crore for June. The only way to upset this domino is if the Budget carries some proviso or announcement that can directly impact liquidity flows to the markets.

On valuations, there seems to be some consensus that stocks are expensive. A widely used metric is the Buffet indicator (market cap-to-GDP ratio) and India is rated ‘mildly overvalued’ based on this indicator. While that may be so, I would go by the fact that this ratio stands around 197% for the US markets. That is way out of whack with the mean and implies a much more expensive market compared to India. On a relative front, it signals that equity returns in the US may be 0% for the near future while India is expected to produce around 6% returns. Competing for FII funds would be better yielding markets such as China (10% expected) but a casual look at the Chinese index would tell us that there is no danger of any major flow out of India into China. Incidentally, foreign funds have been burning their hands, waiting for China to perform for the past several years. Chart 2 shows a China index.

The Nikkei on the other hand has seen a terrific rally but has hit resistance zones and may be in for some consolidation or pullback. Based on the Buffet indicator, Japan is expected to have a negative return of about 3% for the year ahead. So, maybe money is not going to head to Japan either. Other developed markets are certainly not attractive enough. The Latin America index is quite a ranged affair too. So, that leaves only India holding out promises of good returns for FII money, it seems. This may act as a buffer during dips as FII money may come in if there are declines.

While this is one metric that has many spooked, the other one is relative performance of midcaps to large caps. Chart 3 shows a relative performance between Midcap 100 and Nifty (chart courtesy Bloomberg). This one show that the Midcap area has reached untenable areas in a comparative chart. The levels are at a nicely channelled resistance.

It is quite possible that many of the top midcap stocks may have had a very strong run in the recent years. But question really is, have midcaps run too far, or have large caps not performed as well? Midcap 100 delivered around 56% in a year compared to 24% in Nifty. Almost every stock from Midcap 100 performed well during the last year or two. Hence this chart is along expected lines.

Ratio charts are tricky. On the face of it, this chart suggests that we may see a pullback in midcap stocks. But the chart can also show damage with large caps performing now even as the midcaps move sideways or suffer a mild pullback. For this chart to get damaged, it is not necessary for midcaps to decline substantially — which is the fear a chart like this invokes. But with the way midcaps have run, it may be prudent to book some profits.

But the Budget is an important event and specially this year, it holds more focus. Expectations are high and therefore there is only a small room for disappointments. People who play on valuations are waiting for some weakness to book some profits. Those who play on leverage are always nervous anyway. Turn date for July is on the 24th. Flow of June quarter results continues but so far only a couple of IT names have impressed. So, the jury is out on the earnings. In this context, it would be prudent to keep track of simple channels as shown in chart 4. This chart shows three channels, in increasing steepness. Note the circled area where the channels are more or less coinciding, and the Nifty has currently traded into that zone. This is signalling caution.

If you throw into this mix some recent pullbacks in US indices, the midcap versus Nifty index reaching resistance zones, etc., and finally, the fact that the post-election political dust has still not settled down, then they could all add up to a cautionary mix that can produce a reaction if there are some misgivings with the budget proposals.

Given these evidence, I would recommend that one should take a cautionary position in the markets for the next week. Trim leveraged longs, take some money off on stocks showing you outsized profits and exit some of the more recent stocks entered. Let a day or two go for Budget proposals to be absorbed and the market’s mind to be revealed. The worst case is you may miss out on some upside action. Rather that, than be caught in a bind with some unexpected declines in the market. Stay alert.