Are the Sensex and Nifty back in bull markets?

Relentless buying by the FIIs have changed stock market sentiments from extremely negative to almost celebratorily positive. Have the Sensex and Nifty returned to bull markets? Is it time to change strategy from ‘selling the rallies’ to ‘buying the dips’?

Technically, there are four criteria that define a bull market. They are:

1. A 20% rise from the bottom.

For the Sensex, the recent bottom was 15136 (touched on Dec 20 ‘11). A 20% rise means a level of 18163. Still a little more than 500 points to get there. For the Nifty, the recent bottom was 4531 (also touched on Dec 20 ‘11). A 20% rise means a level of 5437. A bit more than 100 points away.

2. Index (or stock) trading above its 200 day EMA.

Both Sensex and Nifty are trading above their 200 day EMAs – so this definition has been met.

3. The ‘golden cross’ of the 50 day EMA above the 200 day EMA.

The 50 day EMA of the Sensex is rising, but is still 500 points below its 200 day EMA. The 50 day EMA of the Nifty is also rising but is more than 150 points below the 200 day EMA.

4. Index (or stock) retracing more than 50% of its fall.

The Sensex peaked at 21109 on Nov 5 ‘10, and dropped 5973 points to its low of 15136. A 50% retracement of the entire fall would mean a level of 18122 – almost 500 points away from today’s intra-day high. The Nifty hit a high of 6338 on Nov 5 ‘10, and dropped 1807 points to its low of 4531. A 50% retracement of the entire fall would take the index to 5434 – still about 100 points further than today’s intra-day high. (Now you know why technical experts are talking about the 5400 level.)

Only one (2 above) out of the four criteria that define a bull market has been met so far. Does that mean that both indices haven’t entered a bull market yet? Technically, the answer is in the affirmative. Ideally, meeting three out of the four criteria should leave no doubt that the bulls are on top. For that to happen, another 500 points on the Sensex and 100 points on the Nifty are left to cover. The way the FIIs are buying, that could happen in the very near future.

Related post

Are we in a Bear Market or a Bull Market?

5 reasons why this is a sucker’s rally and not a change of trend

P. T. Barnum, a 19th century American circus owner, had apparently said: “There is a sucker born every minute.” Translated into English, that means that the world is full of gullible people. Any idea, however ridiculous and unbelievable it may be, is sure to find a few takers.

Crazy ideas - from ‘the world is flat’ and ‘the sun moves around the earth’ to ‘Suzlon is the next GE’ and ‘RJ is the Warren Buffett of India – follow his portfolio if you want to become rich’ – always find believers (a.k.a. ‘suckers’).

So, what is a “sucker’s rally”? It is a sharp price rise in an index or a stock without the support of fundamentals – usually during a bear market. Here are 5 reasons why the current rally in the Sensex and Nifty indices is a sucker’s rally:

1. There is a ‘gut feeling’ among small investors that the worst is over. Gut feelings are seldom right, unless the guts belong to some one called Warren Buffett. Even Buffett is known to make mistakes. Keep your guts where they belong. Use your brains instead. The problems in Europe haven’t been solved yet. China’s economy is struggling with slower growth. The worst may not be over yet.

2. A general consensus among market players is that RBI may start reducing rates soon; even if the interest rate remains where it is, there is likely to be a cut in the CRR to increase liquidity. The RBI has not indicated any such thing. They have only paused in hiking interest rates further. That means, interest rate remains just as high as it was a month ago when the Sensex and Nifty hit their lows. Stock markets can’t sustain in a high interest rate environment.

3. Though food inflation has started coming down, it may be more due to a high ‘base effect’ and seasonal availability of vegetables. Core inflation has moderated a bit, but still remains high. RBI has made it quite clear that controlling inflation is their top priority. Unless core inflation drops below 5%, interest rate cuts may not be effected. Inflation won’t come down as long as the government spends recklessly on various schemes to buy votes.

4. The government’s policy inaction will continue till the annual budget is announced in mid-March – thanks to the impending elections in five states. The only bit of good news for foreign investors in recent times has been the Supreme Court’s judgement in the Vodafone case, stating that the Income Tax department has no jurisdiction over a transaction between two overseas entities. But that judgement is more in the nature of removing an unnecessary irritant than paving the way for any fresh investments. The government has to be far more proactive on the policy front to change the commonly held perception that it is bureaucratic and inept.

5. Technically, both the Sensex and Nifty are in 14 months long bear markets. Bear markets (and bull markets) don’t turn around suddenly. They usually form some sort of a reversal pattern, which takes a few weeks to a few months to form. No such reversal pattern is visible as yet.

The recent spate of FII buying has begun to attract inexperienced small investors who don’t want to miss the bus. Technical indicators are looking overbought. The stage seems set for the big boys to get out. The suckers may get stuck with shares bought at higher prices.

Use a Stock Screener to make a ‘buy’ list

The down trends in the Sensex and Nifty index charts have completed nine months, and are showing no signs of reversals. In fact, relentless selling by the FIIs in August ‘11 has turned a bad situation (from the bullish point of view) even worse.

Any sensible investor would stay far away from buying in a stock market that is showing all the signs of a full-fledged bear market. So, why a post about making a ‘buy’ list? If you have participated in the Boy Scout movement, then you wouldn’t need an explanation. The motto of the Boy Scouts is: ‘Be Prepared’.

Just as all good things must come to an end – like the heady bull run from the Mar ‘09 low did when it peaked out in Nov ‘10, bad times don’t last forever. In the not too distant future, inflation rates will start to moderate and interest rates will be lowered. The stock market will ‘discount’ the good news in advance and start to rise much earlier. That would be a good time to buy – provided you are ready with a ‘buy’ list.

Small investors face a big problem. With thousands of company stocks traded in the stock market, how does one begin to make a short-list of stocks for more detailed research? This is where a Stock Screener can come in handy. What is a Stock Screener? It is a software that allows you to use certain fundamental criteria to make a short-list of stocks that meet those criteria.

Which Stock Screener should you use? Every financial site probably has one, so there is a lot of choice. You have to do a bit of trial and error to find out one that works well for your style of investing. You can start with the Stock Scanner available at the BSE web site:

http://www.bseindia.com/stockscanner/stockscanner.aspx

It is quite rudimentary, and has only four fundamental criteria that you can use: Last traded price (LTP), Market Capitalisation, EPS and P/E. Each of the four criteria has a range of values to further fine tune your search. Try out with different permutations and combinations to arrive at a short-list from all the stocks traded on the BSE.

Edelweiss has a Stock Screener (as do many other such sites):

http://www.edelweiss.in/Tools/screener.aspx#

This also has four fundamental criteria, with Dividend Yield in place of LTP. An additional feature is you can short-list by specific sectors. If you don’t mind registering at the site (it is free, but you will get periodic mailers), then you can add more criteria for your short-listing.

Let me add here that I’m not a great fan of Stock Screeners – mainly because the criteria I use for short-listing are not available in most of the free software. In any case, you have to do a detailed study of each short-listed stock to find out if it merits a place on your ‘buy’ list.

A Stock Screener can be a good first step for short-listing stocks for making a ‘buy’ list. Be sceptical of unknown stocks that get short-listed. Don’t think that you have ‘discovered’ a hidden gem that the whole world has missed. If you keep trying different combinations, you may get lucky and stumble upon an undervalued stock.

Happy hunting!

Was it a panic bottom or a capitulation?

Within a matter of a few minutes after opening of trade, the Sensex fell sharply by more than 500 points on Mon. Jun 20 ‘11. The Nifty dropped nearly 200 points. What happened?

Apparently, the selling was triggered off by the news that the Indian government was planning to review the double tax avoidance treaty with Mauritius. The treaty stipulates that taxes on capital gains incurred in India on sale of stocks by Mauritius entities will be payable only in Mauritius (which does not levy any capital gains tax).

It is unlikely that Mauritius will agree, since the tourism paradise has little industry of its own. They attract investors with the lure of their liberal tax regime. Many companies have set up shop in the island nation primarily to invest in the Indian stock markets.

40% of the so-called FII inflows into the Indian markets come from Mauritius. It is an open secret that much of this money is ‘round-tripping’. In other words, black money is sent to Mauritius through ‘hawala’ channels from India. That money comes back into India under the garb of FII inflow, and black money turns into tax-free white money.

It is laudable that the Indian government is trying to plug a loophole through which crores of capital gains tax are slipping through. But it is unlikely to happen any time soon – if at all. Then why the panic?

It was just a ‘negative’ news that seemed to get discounted in haste. Such sharp falls are typical in bear markets. The market has been in a down trend for seven months, without falling even 20% from its Nov ‘10 top (which is one of the definitions of a bear market). Bears tried to force the issue in their favour by using the treaty review news as an excuse to start selling.

Stop-losses got triggered as the indices dropped through known support levels, and added to the panic. Two thing happen in such situations. Weak holders tend to capitulate. Bottom-fishers start buying and lend some stability to the market.

So, was it a capitulation or a panic bottom? We won’t really know till Mr Market tells us in which direction it wants to go. A capitulation usually happens near the end of a bear phase, when investors get weary of waiting for things to improve, and start selling off at any price. It tends to be a slow, grinding down process followed by the start of a new bull phase.

A panic bottom, on the other hand, sets up a temporary bottom before the next down move, because panic bottoms seldom hold. This is another one of those ‘technical rules’ which don’t always work. The interesting point to note is that the Feb ‘11 lows of the Sensex and Nifty were tested but not broken. That keeps the door open for a double-bottom reversal. Possible, but seems unlikely at this stage.

What should small investors do? Maintain a strict stop-loss at the level of the Feb ‘11 lows. If those lows are taken out, another 10-15% correction from current levels will not be surprising.

BSE Sensex and NSE Nifty 50 Index Chart Patterns – Jun 17, ‘11

The bears were determined to drive home their advantage from the previous week. Even though the repo rate hike of 25 bps by RBI was widely expected, I had mentioned the possibility of more selling in last week's post. Why? Because both the BSE Sensex and NSE Nifty 50 indices are technically in bear markets. Repeated interest rate hikes do not help the bullish cause.

BSE Sensex Index Chart

The only good news for the bulls was that the index tested but didn't break the support level of 17780. It may only be a temporary reprieve. All the technical indications are bearish.


The blue down trend line is under no threat of being breached. All three EMAs have turned downwards, and the Sensex is trading below them. Note how the falling 20 day EMA resisted all efforts at an up move during the week.

The MACD is negative and has slipped below its signal line. The ROC is also negative and below its falling 10 day MA. The RSI has dropped below the 50% level. The slow stochastic has entered the oversold zone. A fall below the Feb '11 low of 17300 can lead to a deeper correction.
 
Nifty 50 Index Chart

The level to watch in the Nifty chart is the Feb '11 low of 5180. There is a good chance that the Nifty will fall lower because there are no positive triggers for the market, and the FIIs have been net sellers.

Retail investors are almost out of the market, so the FII selling is being absorbed mainly by the DIIs. The question is: when will the FIIs resume buying? The US and European markets are sliding. So are the Asian markets. Commodity prices have already been bid up to high levels. The time-wise correction in the index is almost over. Valuations are no longer expensive.

There seems to be maximum pessimism around. Retail investors are fearful of a big fall. Good time to play contrarian, but one has to pick stocks carefully. 

Bottomline? The BSE Sensex and NSE Nifty 50 chart patterns are poised near important support levels. Things aren't looking good for the bulls. Both indices can lose another 2-3% from current levels easily. Stay out if you are a conservative investor. Any buying should be done with a 2-3 years time frame. 

BSE Sensex and NSE Nifty 50 Index Chart Patterns – Jun 03, ‘11

The bears continue to dominate the chart patterns of the BSE Sensex and NSE Nifty 50 indices. In last week’s analysis, I had pointed out positive divergences and bullish rounding-bottom formations in the technical indicators. Net FII buying helped the cause of the bulls in the earlier part of the week.

By the end of the week, the bullish fervour got exhausted as both Sensex and Nifty found strong resistances form their 200 day EMAs. Friday’s trading turned out to be a ‘reversal day’ (higher high, lower close) - a signal that the mini-rally from the support levels of 17780 for the Sensex and 5345 for the Nifty has probably ended.

BSE Sensex Index Chart

The Sensex will remain in a down trend as long as it trades below the blue down trend line. It is technically in a bear market, since the 50 day EMA is below the 200 day EMA and the index is trading below both EMAs. That is bad news, as far as the bulls are concerned.

The good news is that in spite of the scams, raging inflation, rising interest rates, slowing GDP growth, the Feb ‘11 low has held so far. The periodic rallies have also ensured that the 200 day EMA has remained sideways for the past 5 months, and hasn’t yet decisively turned downwards. The Sensex closed 110 points higher on a weekly basis.

The technical indicators are showing signs of weakness, but the rounding-bottoms and positive divergences are still visible. The MACD has crossed above the signal line, but both are in negative territory. The ROC is above its rising 10 day MA, but has turned down sharply to the ‘0’ line. The RSI is at its 50% level after a brief foray above it. The slow stochastic is at the edge of its overbought zone, but turning down.

Nifty 50 Index Chart

The volume bars present an interesting picture. Tuesday’s (May 31 ‘11) up day volume was the highest during the previous month, as the Nifty jumped above the 20 day EMA. Volumes are only a secondary (or supporting) indicator, but do show buying interest (or lack of it) – particularly from the FIIs. By the way, FIIs were net buyers on Friday’s ‘reversal day’. A contrarian sign?

Looks like the bull rallies in the US and European markets are stalling. On a forward P/E basis, the Sensex and Nifty are not looking that expensive. Some outflows from the developed markets may re-enter emerging markets. A number of mid-cap and small-cap stocks with strong fundamentals are trading at attractive valuations.

GDP growth has been gradually coming down over the past few quarters, though it is at a still-respectable 7.8%. India Inc. seems to have put capital expenditures on hold on growth worries and high-interest rates. In a recent interview on a TV channel, Morgan Stanley’s Ridham Desai mentioned that the top 100 Indian companies are sitting on more than Rs 30000 Crores of cash! That should set the stage for some judicious mergers and acquisitions.

Bottomline? The BSE Sensex and NSE Nifty 50 index chart patterns are mired in down trends for almost seven months. Several revival efforts have been thwarted by the bears. Despite all the negative sentiments, apathy among retail investors rules out a crash. Good time to concentrate on picking good stocks for your ‘buy list’.

BSE Sensex and NSE Nifty 50 Index Chart Patterns – May 27, ‘11

Last week, the BSE Sensex and NSE Nifty 50 index chart patterns had thrown up bearish and bullish possibilities. The scales remain tipped in favour of the bears, in spite of the FII buying on the last two days of the week that ensured that both indices closed about 1.5% higher on a weekly basis.

Why? For three easy-to-observe technical reasons:

1. The down trend lines (in blue) from the Nov ‘10 tops are intact

2. Both the Sensex and Nifty are trading below their 200 day EMAs

3. Both indices have spent 4 straight weeks below their falling 20 day EMAs; the 20 day EMAs are below the 50 day EMAs; the 50 day EMAs have slipped below the 200 day EMAs – the dreaded ‘death cross’.

Are the indices getting ready for a bigger fall?

BSE Sensex Index Chart

All the signs are pointing towards a deeper correction. What should investors do? The answer will depend on what kind of a fish they are! The Anagatavidhatas should sell and preserve capital; the Pratyutpanyamatitwas may set a stop-loss 3% below the Feb ‘11 low of 17300; the Jadvabishyas will await their destiny.

The technical indicators are showing signs of life, but are still bearish. The MACD is deep in negative territory, but has moved up to touch the signal line. The ROC is above its rising 10 day MA, but both are still negative. Both the RSI and slow stochastic have emerged from their oversold zones, but are below their 50% levels.

Observant readers may notice the positive divergences. The Sensex reached a lower bottom of 17786 on Wed. May 25 ‘11. The ROC, RSI and slow stochastic made higher bottoms. Was the net buying by the FIIs on the last two days of the week a mere coincidence?

Nifty 50 Index Chart

There is every chance that the Feb ‘11 low of 5200 (or 5178, if you want to be precise) will be tested, if not broken. I’m not a gambling man, but if I was, I would put some money on 5200 level holding. Why?

Three reasons. First, despite all the negative news and lack of buying support from investors, the Nifty has not crashed. Second, the time-wise correction of the 20 months long bull rally (from Mar ‘09 to Nov ‘10) is almost over. Third, the MACD, the RSI and the 10 day MA of the ROC are forming bullish saucer-like rounding-bottom patterns. My guess is that the FII buying was triggered by these technical reasons.

Food inflation went up again. The proposal to allow FDI in multi-product retail – should it become a law – will not only help tame inflation, but provide huge job opportunities for semi-educated youth. The impending hikes in the prices of diesel and cooking gas, and the likely moderation in the GDP growth rate have already been discounted by the market.

Bottomline? The BSE Sensex and Nifty 50 index chart patterns have entered bear markets, and may face steeper corrections. There are signs of reversal of the down trends in the near term. Unless the down trend lines in both indices are convincingly breached, one should not go on a buying spree. This may be a good time to nibble into fundamentally strong stocks that have corrected a lot.

Why Japan’s calamity can hurt the global economy and stock markets

There is an English proverb: Misfortune never comes alone. In Japan’s case, misfortune seems to be coming in droves. Before the stoic and resilient people from the island country could recover from the horrendous calamity of the massive earthquake and devastating tsunami, the explosions and radiation leaks from the ageing Fukushima nuclear power plant has sent shock waves through the entire global economy.

Oil prices dipped on the assumption that demand from Japan will diminish as the economic growth may stall while the nation reconstructs the severe damage to life and property. Japan is the third largest oil consumer in the world, and there may be a drop in demand in the near term.

But global demand for oil may increase. Many countries, including the USA, depend on oil for their energy requirements – unlike India where coal-fired power generation is the norm. The US-India civilian nuclear treaty was supposed to be a win-win agreement for both. New nuclear power plants built with US technology was supposed to alleviate India’s perennial power shortage, and boost the demand for US-made equipment and consultancy services. The crisis in Japan’s nuclear power plant, built with equipment and technology from the US giant General Electric, will now put nuclear power as an alternative energy source on the back burner.

Japan also happens to be a large market for luxury goods, with more than 10% of world sales. Any further slowdown of an already slowing Japanese economy will seriously affect the businesses of luxury goods makers the world over. Many of these luxury goods – whether Gucci bags or parts for BMW cars – are actually manufactured in Asian countries.

With the Japanese Nikkei index taking a beating, investors are likely to pull out of Japanese funds that invest in global stock markets to cover their losses. As per a CNBC report, more than US $7 Billion has been invested by Japanese funds in Indian markets – and that is less than 20% of their total investments in emerging markets as a whole. The Sensex dropped 18% when FIIs recently pulled out US $2 Billion. Any Japanese withdrawal can cause a much bigger correction. Already, European indices have felt the heat.

Many Indian companies have built up their Japanese bases over a long period of time. Infosys and TCS are among them. There is talk of repatriation of Indian employees. It remains to be seen what effect that may have on the bottom lines of Indian companies.

Unlike the rise in oil prices, which every one expects to moderate in the near term as the unrest in North Africa and the Middle East gets quelled with firm hands, the crisis in Japan isn’t going to end soon. A melt-down in a nuclear reactor in a populated area can have serious long-term repercussions. Operations of many global companies will be disrupted because of damaged roads and ports, and shutdown of manufacturing facilities.

Indian investors need not sell in a panic. Corrections due to ‘black swan’ events, like the one in Japan, provide buying opportunities. Be patient and stay prepared for a deeper correction.

The state of the stock market – a broker’s views

I cornered my erudite stock broker friend just after he had finished his morning round of golf, and asked him about the current state of the stock market. Here, in no particular order, is the gist of his uncensored views during a freewheeling discussion:-

1. The Sensex is very likely to test its recent low of 17300. It may even go down to 16000, but the probability is low.

2. The market is likely to trade in a range for another 3 months, or even longer. With high oil prices further messing up India’s fiscal deficit, markets won’t be able to move much higher.

3. The second half of the year should be ‘technically’ better. That is when the ‘big players’ have decided to sit down together with the Udayan Mukherjees of the business channels to decide (and announce) where they are going to push up the stock market.

4. Oil prices won’t come down any time soon. The turmoil in the Middle East and North Africa will be fomented by the USA for two main reasons. The first is their insatiable desire to corner oil resources, which was the main reason for their invasion of Iraq. Every one knew that there were no ‘weapons of mass destruction’ in Saddam Hussein’s armoury.

The second reason is the dismal state of the US economy. All the dollar printing hasn’t improved anything. The US economy thrives after wars. A Republican president would have used the Tunisia and Egypt uprisings as excuses to send troops. The Democrat president is pussy-footing around. But he will soon have no choice but to start a war by sending in the US marines. There is already talk of enforcing a no-fly zone in Libya.

5. The talk of ‘valuation difference’ between developed and emerging markets being the reason for the recent correction is all hogwash. Valuation differences were there a year back, when FIIs were pouring money into emerging markets.

6. The export lobby has been moaning and groaning about the rupee appreciation against the dollar hurting the country’s exports. There is not a peep from the import lobby because none exists. The government is the biggest importer. They should ignore the exporters and let the rupee appreciate against the dollar. That is the only way to cushion the rising cost of oil imports. Imports far exceed exports anyway.

7. There is no greed and fear in the Indian stock market. There is only more greed and less greed. Nothing else explains the paltry cash volumes compared to the huge F&O volumes of trade every day.

8. Small individual investors in the more evolved and sophisticated US market invest mainly through mutual funds. In India, any one who has Rs 5000 to spare wants to invest in equity shares. Since he doesn’t have enough money to buy even 10 TISCO shares, he goes out and buys 15000 shares of Cals Refineries. How smart is that?!

Part of the blame lies with us brokers, who want investors to regularly buy and sell stocks, because our livelihoods depend on that. But, small investors will be far better off investing regularly in an index fund or a balanced fund.

Is the Nifty overvalued or undervalued?

Since hitting a peak in Nov ‘10, the Nifty has been in a corrective mode for 4 months. The correction began when the Nifty came near its earlier all-time high touched in Jan ‘08. What initially seemed like a routine bull market correction, turned into a more serious correction due to the unrest in North Africa and the Middle East that sent oil prices above the three figure mark.

The index dropped 18% from its peak before recovering somewhat, and has been trading within a range of 5200 - 5600 for the past 5 weeks. The FIIs have been net sellers during 2011, pulling out $2 Billion to redeploy in their home markets. Relative valuations of developed market indices like the S&P 500 and the FTSE 100 were more attractive. Of late, they seem to be buying again, as the overseas markets are correcting.

What should investors do? Is the Nifty undervalued after the correction, making it a good opportunity to buy? Or is it still overvalued despite the correction? The best way to find out is to look at Nifty’s monthly P/E ratio chart, drawn for the period Jan ‘99 to Mar ‘11:

Nifty’s P/E ratio has varied between 11 and 27 during the past 12 years - with peaks of 27.35 on Mar 1, 2000 and 27.64 on Jan 1 2008, and troughs of 11.62 on Jan 1, 1999; 10.86 on May 2, 2003 and 11.76 on Dec 1, 2008. The average P/E ratio over the past 12 years is 18.24.

Leaving the peaks and troughs aside, as it is next to impossible to catch the exact tops and bottoms, we can reasonably assume that P/E ratios between 15 and 21 is the ‘hold’ range. In other words, only stock specific buying should be done when the Nifty P/E ratio is between 15 and 21. Any drop below 15 is the across-the-board ‘buy’ zone and any move above 21 is a ‘sell’ signal. Patient, long-term investors can use these levels to decide entry and exit points for almost assured returns.

The Nifty traded at or below 15 P/E continuously between Aug ‘02 – Aug ‘03, providing the ‘mother of all buying opportunities’  in the past 12 years. It also traded continuously below 15 P/E between Jun ‘04 – Nov ‘04, Feb ‘05 – Sep ‘05, and Nov ‘08 – Apr ‘09. The market does provide great buying opportunities, if only investors would learn to wait for them.

On the other hand, between Dec 1 ‘09 – Jan 3 ‘11, the Nifty continuously traded at or above 21 P/E – giving excellent selling opportunities to those who may have bought earlier. Nifty’s P/E ratio on Mar 1 ‘11 was 21.04. So, it has only dropped to the outer edge of the ‘hold’ range – in spite of the four months long correction.

Since the Nifty is trading above its average P/E ratio of 18, it is still ‘overvalued’. That is one of the reasons why FII money is flowing out.

How much longer will the Sensex trade within a range?

That may be the question on the mind of many investors, as the Sensex has been trading between 17300 and 18700 for the past 5 weeks. The short answer is: I have no idea. It could be six weeks or six months. Buyers and sellers seem evenly matched. The post-budget rally appears to have come to an end.

What could be the triggers for the Sensex to move up?

1. The RBI may not increase interest rates on Mar 17. Since inflation remains a concern, another 25 basis points rate hike is being expected by market players. Ms K Morparia of JP Morgan said in a recent TV interview that she won’t be surprised by three more rate hikes of 25 basis points each. Not increasing the interest rate will be taken as a positive by the market.

2. Q4 results will hit the market in another 5 weeks or so. With higher commodity prices and higher interest rates, profitability of India Inc. is widely expected to take a hit. If results are flat, even if not better on a QoQ basis, markets may interpret that as a positive.

3. India is still dependent on good monsoons. Agricultural production gets a boost. That helps the rural economy to grow, and has a cascading effect on the economy as a whole. Signs of a good monsoon may shake the market out of its current gloomy sentiment.

What could be the triggers for the Sensex to go down?

1. Despite several rounds of interest rate hikes by the RBI, inflation continues be in double digits. Government spokespersons have run out of excuses. More rate hikes could bring the growth momentum to a screeching halt.

2. The unrest in North Africa and the Middle East has sent oil prices shooting up into three figures. Economic growth and high oil prices are a disastrous combination for stock markets. If oil prices remain high, India’s fiscal deficit and inflation may spin beyond control. As it is, artificially depressed kerosene and diesel prices is causing havoc to the finances of the oil companies. The real inflation rate is much higher than the published figure.

3. The FIIs have pulled out about $2 Billion from the Indian markets in 2011. This amount is less than 10% of what they invested in 2010. Still the Sensex lost 18% from its Nov ‘10 peak. The relative valuations of the US and Europe markets are cheaper. If the FIIs continue with their selling and pull out another $2 Billion, the Sensex could test its May ‘10 low of 16000.

Looks like the sideways consolidation in the Sensex may continue for a while longer. As I have mentioned several times before, investors should not get too bogged down by Sensex movements. When the market is unexciting and boring, it may be a good time to take a vacation and catch up on your reading. If you have already read books by Graham, Lynch, Fisher, Pring – read them again. You will understand many things that you missed when you read those authors for the first time.

Why Indian investors should look at Emerging Market ETF charts

Indian investors have been worried about why the FIIs are pulling out of emerging markets and redeploying in developed markets. Some say that the relative valuation difference between emerging markets and developed markets is the real cause. Others are of the opinion that this is not a flight of capital but routine profit booking. There is another school of thought: the turmoil in North Africa and the Middle East has pushed up oil prices and made emerging markets riskier.

There is no doubt that FII selling in emerging markets has affected the Indian stock market indices. The series of scams – be it the inflated costs for the Commonwealth Games, or the telecom 2G spectrum allocation, or the various scams involving real estate development – seems to have shaken the confidence of the FIIs. The rising inflation rate, leading to a steady rise in interest rates, has increased the cost of doing business.

When and how will this situation get turned around? Politicians, government officials and the real estate mafia are not going to turn into honest and law abiding citizens overnight. Nor can inflation be curtailed by pressing a button. Who knows where the Middle East turmoil will be heading? In other words, the uncertainty overhang can not be wished away. And stock markets hate uncertainty.

Is the current fall in the Sensex and Nifty 50 a good buying opportunity? Will prices become even more attractive if one waits? How can an ordinary small investor decide what to do in uncertain circumstances? When fundamental analysis can’t provide clear answers, one has to look elsewhere.

Given below are the one year closing charts (in blue) of two Emerging Market ETFs traded in the US market – the iShares MSCI Emerging Index ETF (EEM) and the Vanguard MSCI Emerging Markets ETF (VWO). Superimposed on the two charts are the BSE Sensex chart (in green) and the S&P 500 chart (in red):

Since both the EEM and VWO ETFs track the MSCI index, their chart patterns are similar. The BSE Sensex was the clear outperformer during the period Jun – Nov ‘10. EEM and VWO ETFs caught up and outperformed the Sensex during Jan – Feb ‘11, even as they corrected down. Percentage profit booking in the Indian indices exceeded the selling in the MSCI emerging markets index.

During Feb ‘11, the S&P 500 has been the outperformer, but the gaps between the S&P 500 and the two emerging market ETFs are reducing. It is interesting to observe that the recent rallies in EEM, VWO and the Sensex have coincided with profit booking in the S&P 500.

Indian investors would do well to track the EEM and VWO ETFs for signs of FII investments returning back to emerging markets. Without FII buying support, the Indian markets are not going to move up any time soon.

Why is the stock market so excited about an unexciting budget?

These are the irreverent views of a non-economist. Take them with a pinch of salt.

It isn’t bad, so it must be good

There was a lot of uncertainty surrounding the budget this year. Rising inflation was not contained even after several interest rate hikes by the RBI. Higher interest rates were beginning to slow down Indian Inc’s growth momentum. Some tough tax measures were expected from the Finance Minister (FM). None came. The markets heaved a collective sigh of relief.

Shorts got trapped

The four months long correction in the stock markets had turned sentiments negative. All attempts at pullback rallies were getting sold into. The FIIs were selling heavily and redeploying in their home markets. Several experienced players were shorting the market. The unexpected surge in the indices on Budget Day was mainly due to short covering.

Auto sector gets an indirect boost 

A 2% excise duty cut was offered to auto makers a couple of years back as part of the economic stimulus. A roll back was discounted by the market. The FM left the excise duty unchanged. Feb ‘11 auto sales numbers have shown decent growth. Auto stocks soared on this twin good news.

Smart move from ITC

An increase in excise duty for cigarettes and other tobacco-related products was widely expected. In anticipation, ITC had increased the prices of some of its most popular brands prior to the budget. No such increase was announced by the FM. Don’t expect your pack of smokes to get cheaper. ITC’s bottom line will be a direct beneficiary.

Not so great for Mukesh Ambani

By transferring his shareholding in Reliance to a clutch of Limited Liability Partnership (LLP) companies, Mukesh Ambani ‘legally’ avoided paying income and other taxes (such as dividend distribution tax). LLPs have been brought under the purview of 18.5% MAT. Bad luck for big brother – he has to now pay taxes like a mere mortal! If only he had known earlier, he may not have built the ostentatious eyesore he calls home.

Reduced surcharge on corporate taxes

This would reduce cash outflows, and is a definite positive. Hopefully, the extra cash will get channeled into expansion activities and help to increase GDP growth. Investors may get rewarded with higher dividends.

Tax benefits for senior citizens

By reducing the qualifying age for a senior citizen from 65 to 60, several lakh tax payers will be able to avail higher tax exemptions. Some of the extra tax savings are likely to find their way into MFs and equity.

Does all this justify a 600 point rise in the Sensex today? Is the correction over? Should investors start buying again? Answers to these questions will become clearer over the next few days – now that the uncertainty about budget proposals are behind us.

Don’t let relief cloud reality. There has been little change in the global or local situations. Uprisings continue in the Middle East. Higher oil prices will further stoke the fire of inflation. Get set for another interest rate hike. FIIs were net sellers on Budget Day. The Sensex and Nifty are near strong resistance zones.

Stick to your asset allocation, and don’t get swayed by short-term index moves.

5 Reasons to start buying now and 5 Reasons to wait

With the BSE Sensex and Nifty 50 indices dropping like bricks and shattering likely support levels, small investors are naturally anxious and bewildered by the quick turn of events. Both indices were near their all–time peaks just three months back. But a deadly cocktail of corruption and scams, generously mixed with untamed inflation and rising interest rates have left investors punch-drunk and chased FIIs to the exit doors.

In an earlier post, I had given 4 definitions of a bear market. So far, only definition number 2 has been satisfied, and definition 4 – the ‘death cross’ – may be satisfied soon. That will confirm a bear market. So what should investors do now? Use the correction to start buying, or wait for the correction to end?

Those are tough questions to answer – mainly because there are no simple answers that will satisfy all investors. Given below are 5 reasons why investors should start buying now, and 5 reasons why investors should wait. The idea is not to confuse, but to provide alternative arguments that investors can evaluate and then decide their own courses of action.

5 Reasons to buy now

1. The BSE Sensex and Nifty 50 indices touched their Oct ‘09 peaks. Since previous tops tend to provide support, a bounce up from current levels is a possibility. The technical indicators are looking oversold – also hinting at an upward bounce.

2. If you missed the rally from Mar ‘09 and had waited for a correction to enter, well you’ve got it. The indices are down 18% from their Nov ‘10 peak, and the downside seems limited. It is very difficult to time the market perfectly, so this is a good time to start accumulating.

3. You should invest when you have the money. It doesn’t matter if you have the cash to invest because you missed the rally, or because you were one of the smart ones who have been regularly booking profits. Many stocks are at or near their 52 week lows – even some good companies can be found in that group.

4. Inflation rate has shown the first signs of reducing. Whether it is the base effect or the effect of monetary tightening is some thing the economists can debate about. But a positive fall out for the stock markets could be that RBI may hold off on raising interest rates further.

5. The FIIs are selling, but not at the rate they did in 2008. It is more of profit booking in emerging markets and redeploying in developed markets because of valuation differences. With each passing day, Indian indices are falling and US and European indices are rising – progressively reducing the valuation gap. The Indian growth story is in tact. At some point, the FIIs will be back.

5 Reasons to wait

1. Volumes have been higher on down days than on up days. That means selling pressure hasn’t abated, and the up days have mostly been due to short covering rather than investment buying. That points to further selling.

2. If you missed the rally since Mar ‘09 because you waited for a correction, why not wait a little longer? No point trying to catch a falling knife. Let the selling subside. Once the indices start to turn around, that would be a better time to enter.

3. One of the four bear market definitions (mentioned above) have already been satisfied. If  the ‘death cross’ happens, a bear market will get confirmed. Any subsequent upward bounces will be sold into, and the indices may drop much lower. How much lower? Check this post. Remember the old saying: The early bird catches the worm? Guess what happens to the early worm – it gets caught! Many small investors bought during May ‘08 during a bear market rally. They were badly ‘caught’ in the crash that followed.

4. The government is trying to show that it can also act against scams and corruption. But so far it has been too little – too late. Investor sentiments have gone for a toss, and no one wants to step up and buy. FIIs continue to sell. This isn’t the time to be brave.

5. FIIs have lots of choices about where to invest. China has been growing faster than India. But the Shanghai Composite index has been in a bear market for more than 3 years. There is no reason to believe that FIIs will pour in money like they did in 2009-10. India’s GDP growth rate is beginning to slow down. Investors may be better off by taking advantage of the higher interest rates and safer option of bank fixed deposits till the correction plays out and the bull rally resumes.

What would you like to do, dear reader? Are you in the ‘buy now’ camp or ‘let us wait out the correction’ camp and why? Your opinion may help other readers to decide.