The writing is on the wall.
09 JULY 2010 www.indiacharts.com
Indian investors have luck on their side. The markets mother of all 9 month long distribution pattern gave you enough time to run out the door. The government for all the flak they are getting used every thing in their possession to keep sentiment up in the face of a global sign up for austerity. We did our own bit by announcing that we would cut our fiscal deficit too. The same news that was bad for the Euro and Euro zone was very good for the Nifty. Never do we realize that such a contradiction was possible. But it was for the simple reason that India was the only country [apart from China] that had an environment conducive for inflation. In China the first signs of heating up were attacked with higher interest rates however in India we have let it flourish for as long as god is willing. I am not saying its good or bad for me. If you know how to hedge your self against inflation its great. Asset prices like equities and real estate will usually go up in the face of inflation. Gold prices can also go up a lot. However for Gold to go nuts the value of the rupee needs to reflect what is happening. The chart below is an updated chart of the CPI.
This gives investors two things to do. 1 thank the government. 2 choose the door before its too late. The reason for this and the growing evidence is what I discuss in today's report. In the long run [meaning 20 years] mankind will always advance to higher levels of civilization. So no one can be a perpetual bear. But there are times in your life when a small step can save you a lot of pain. The coming few years will be one such period of pain and anguish around the world and its not possible that we in India are not affected by it. Financial cycles are 50-70 years long which start at the bottom reach the top and then correct all the way back to start again. This is called the Kondratief cycle discussed in my detailed report http://www.indiacharts.com/vwave/KFW.htm. India since globalization is part of the cycle with some lag effect, but that we have gone global as an economy there is no way we cant get sucked into it...ok there is but it requires political will of a degree that is almost revolutionary. Else we have to go down hill before we can come out stronger. And stronger we will be. The advise to choose the door out is to be there when the natural cycles have corrected themselves. Such long term cycles are once in a lifetime event and that is why the Kf cycle is often called a generational cycle. You only have to avoid the pitfall once in your life and it will make the difference of a lifetime for you and your children's financial future.
CPI%
That brings me to the rupee. Clearly starting a wave 3 up the rupee is now on its course to finding a new value range. Which based on Elliott wave analysis should be above 60Rs to the dollar and potentially 90Rs to the dollar over a longer time period. The only reason we are not there is that India's currency is in a unique position. Its true value is masked by portfolio flows i.e. FII investment flows. It therefore does not reflect the damage done by rising crude prices in 2008 or our trade gap. This masking also allows you to expand money supply without affecting your currency position. This is why floating currencies became so popular since the 1970s. It became possible to mask the real situation with a relative situation. So people have been calling demise of the dollar for years not realizing that the dollar had already lost value when the FED printed trillions of dollars. But the price in the market is relative. If everyone expands their monetary base by the same % [not value] of GDP the currency values don't change much. So the trade price of a currency only reflects the relative value. So to avoid a currency crises during a global financial crisis it was very important that the whole world follow the same path, everyone announces bailouts together or everyone announces austerity together. A step outside this path and you get a currency crisis as you almost did with the Euro. India has enjoyed the benefits of this but as the chart below suggests in wave 3 up we will reflect years of internal devaluation. Within wave 3 the USDINR has now subdivided into wave I and II and wave III has started. Wave III has the near term potential to go to 49.5 and maybe extend till 52.
Having understood the above its clear why expansionary monetary policies are unlikely to work. In the US it had no effect and M3/M2/M1 are all contracting. In India it cased double digit inflation. But if we are to grow we need to feed the economy with capital. This years budget hopes that private capital will fund it. This can either come in the form of private debt [recently seen in the telecom sectors debt expansion], or from FDI/FII flows, which in the face of an almost certain global slowdown next year is going to be hard to find. I am often given the argument money has to get invested somewhere? Yes somewhere provided that money supply globally is not contracting causing a reverse pressure on global liquidity...falling M3 and austerity measures are all about capital preservation.
The most direct impact of liquidity is on demand side of the equation and one recent lead indicator of that is the Baltic dry index. The two charts below from Bloomberg show different time frames to give you a perspective. This index came to my attention after a long time because it continued to fall every day in June and continues to fall to date losing 2-4% every day. This sudden trip off from a level far below where it was in April 2008 tells you that something has gone wrong somewhere and its probably more than a seasonal trend [inputs are welcome on this]. This at a time when commodity prices have started falling since the highs made in April. I got one argument on NDTV that falling commodity prices would be good for India. Yes sounds good, but it does not factor in that a falling rupee can quickly offset the short term gains made in costs from the same. So a falling rupee would make sure that we do not get any of the benefits of global deflation in slowing down inflationary measures and we would have to do that ourselves though monetary tightening.
Let the Waves Talk
In my previous report[MAY 14/10 REPORT PDF]I discussed why I am not choosing the wave count below as my preferred count. Its easy to choose this one and call for a target of 100000 and sleep over it. But for reasons discussed above and all the charts I plan to show below I prefer the next best bearish alternative till proven otherwise, which today would be above 18300.
The chart below from my previous report is updated. The volume pattern below shows that volumes always expand in the direction of the trend and contract against it. You can see how they did that for 2008. The overall expansion contracted throughout the next year into April 2010 which registered the lowest volume along with the highest price in the index for wav B. Wave 1 of C down has now seen expanding volumes and long as this trend continues the next leg down is in force. While wave C down can be deep price wise it may happen fast or over several years depending on the path we choose as an exit from financial pressures. The observation of lowest volumes near the April high make it an important top [wave B] and therefore it should not be surpassed except on still lower volumes if the bear market rally is still not over. Wave wise the 5 wave decline since 18050 in April confirms that the larger trend is down.
The Midcap index today made a new 52 week high along with the BSE 500 and what could be the beginning of an inter-market divergence that is usually seen when important long term tops or bottoms are established. The divergence is at two degrees. First that the April high is not surpassed by the Sensex but is by the BSE Midcap. Second that the recent 21 June high is also not surpassed by the Sensex but is by the BSE Midcap/500. The chart of the BSE Midcap below shows an ending diagonal in wave Z since January and wave e reached its touch point to complete the pattern. It may now be throwing over in a final burst as bulls attempt to stay in the game. Once complete this index should drop off almost one sided. It has also almost retraced 61.8% of the 2008 bear market. IF you look closely you will see how the Midcap index continued to fall to new lows in March 2009 but the Sensex did not, this was a classic bullish inter-market divergence. Today the reverse is happening where the new highs in the BSE Midcap are not yet confirmed by the Sensex, a classic bearish divergence.
These inter-market divergences are not a subject of the Sensex/Midcap alone alone. Let me attack the decoupling theory. In Feb 2001 for the first time since Indian markets started correlating with the Nasdaq I noticed that the rally into that month making a new 3 month high was on the back of a lower top in the Nasdaq and a falling trend over the same time period. It appeared as if we had decoupled. One day suddenly we had not and markets started to fall, a month later there were news of scams that drove prices lower. Here are charts of the S&P 500 v/s Indian indices. On the left S&P is in blue and Sensex in green. See how the rising and falling trends are almost similar except for a brief period in Oct07-Jan08. The Sensex formed a rising wedge while the S&P was crashing almost appearing to have decoupled from the west. What followed is history. Now look at the last years activity in the right where I have used the BSE Midcap with the S&P in blue. The US market has been crashing but we are appearing to have decoupled and the index is forming an ending diagonal pattern. Once complete the outcome is likely to be the same as before we will swiftly catch up with global trends, and that trend is down. I am not an advocate of decoupling so the only way this goes wrong is if the the S&P turns up and runs away.
The breadth of A/D ratio is seen below. Its a 40dema of the A/D from BSE data. The average has been making lower tops with each new high on the Sensex and has now spent the last 3 months below 1 meaning more stocks are declining than advancing. Note that that I have drawn two lines to this average and a breakout on the upside will mean a change of sides i.e. the breadth starts to take off as beaten down stocks make a comeback. But its too early to judge a breakout. You need to give it a few days, so by sometime next week we should get a picture of whether this indicator failed at the resistance or broke out.
The volume Put/ Call ratio as discussed in the last report is showing a multi-month bearish divergence. Its the first in the history of the data usually a few weeks is enough to cause a trend reversal. Recently readings below 0.35 are resulting in a 1-2 month top in the market and today the reading fell to 0.33 odd. This is probably the sign of a large ongoing distribution.
The IV broke out of a falling wedge in May and after moving up has fallen back to extreme low readings. These readings are lower than in 2008 meaning the market is pricing in risk less than that at the top seen in 2008. This appears to be a sign of complacency when markets dont price in risk, unless of course there isnt any and I am just getting carried away. But simply put IVs and price move in tandem so recently IV has contracted on rising prices so it can expand only on falling prices and therefore the odds favor a fall soon.
The next chart is another measure of volatility using 2 standard deviations as an oscillator. Each time this oscillator falls very low showing contraction in the bollinger bands a large directional move develops. Of the 3 periods chosen 2 were on the upside and one on the downside. On two occasions the contraction repeated after the markets moved in an 5-10 percent range and then broke out after a second contraction in volatility. This time too Feb saw the first contraction and July is seeing the second one, so by this indicator we should be very close to a serious break out of the 4800-5400 range by a good margin. All the evidence I present in this report is for the downside case but if wrong it would be a large move on the upside. A move beyond the April high should be a warning that something else is happening than what is presented here.
All of the above supporting charts above among others are all suggestive of one thing that the market is distributing for nine months and the larger trend down will start sooner than later. There is growing evidence that we are very close to the inflection point. The last time we had an over one year trading range was in 1982-84 after which the markets tripled. So a breakout on the upside if predicted should have lots of potential. But such an attempt should be made only if much larger target can be set comfortably. At this point it does not make sense trying to call for the next 5% except if you are a sharp trader and can exit without being stuck. Investors at large should stay out till a clear view emerges.
A few last charts. The quarterly and monthly candlestick patterns. The quarterly chart shows a hammer a doji star and now a doji. All thee patterns mean a loss of momentum on the upside and a potential risk of trend reversal. However on such a large time frame the low of the 3 candles is at 15300. A break below that would confirm that the bull run is over. Therefore we look for evidence at a lower time degree. On the monthly candle chart we have conflicting candles. Two previous bearish candles did not work in Jan and in April as they did not get enough follow through on the downside for a trend change. In June we now have a bullish engulfing pattern. Now this is either a warning that the bulls are back, or its what is called a last engulfing pattern meaning that the last of the bulls are being sucked in. With so much conflict the resolution is only likely from an actual break out of the range. Failure to go above 18050 would be a sign that the bulls failed. A breakout above that level along with the A/D breaking out as shown above would mean that the bears are out of ammunition and selling has been absorbed.
Conclusion
While most of my analysis points to weakness ahead in the markets as market internals continue to deteriorate, we are close to an inflection point for a breakout. Some data points like the A/D ratio and candles are conflicting with the bearish view and need to be watched for an upside breakout, but everything else tells me that the view is in tact and the upward push in prices is unlikely to last long as we enter wave 3 of C down.C
A Word on Socionomics
It was amazing to see that the biggest value was assigned to cricket players just months after the 2008 top and the high in april saw the same IPL come back but this time in controversy. It must have socionomic inclinations when record money shows up in news paper headlines that is almost obscene. Another recent observation was a new high is bidding for Indian Art in an auction.