Why long-term investors should look at the big picture

With the Sensex and Nifty indices stuck within trading ranges for more than a month, small investors are in a quandary. What to do next? Two days of sharp bounce from a bottom, and the urge to jump in and buy is almost uncontrollable. Three days of correction from a resistance level, and every one is worried about a 2008-like crash.

Getting worried and disturbed about short-term index gyrations only increases your blood pressure and clouds your decision making. Times like these are true tests of your investment mettle. In life, unplanned action is some times better than planned inaction. But, for building wealth through successful investing in the stock market, you should practice the discipline of planned inaction.

The inaction refers only to buying and selling of stocks. Reading annual reports, books and preparing buy/sell lists are part of the daily ritual of  long-term investors. What then is the big picture referred to in the headline? I’m not an economist, but here is my take on what is happening around us.

Thanks to the Internet and FIIs, our stock market is fully integrated with global markets. All the nonsense about decoupling because of our strong domestic market is just that – nonsense. So, keep an eye on what is happening in global markets. To keep readers updated, I regularly post about stock indices in the US, Europe and Asia. If you are not reading those posts, ask yourself: Why not?

Europe is in quite a mess due to a unified currency that is not helping profligate nations - like Greece, Italy, Spain, Portugal - that are deep in debt and have very little capabilities (or even intentions) of repaying that debt. They neither can print their own currencies, nor can they devalue their currencies. The only options are that a financially stronger economy like Germany, and perhaps the IMF, will bail them out to stop them from defaulting. But that is postponing the problem – not solving it.

Many Indian companies – particularly IT services companies – switched their export focus from the USA to Europe post the dot.com crash in 2001. Some have built up significant businesses in Europe, including acquisition of European companies. The economic mess in the Eurozone is going to affect their bottom lines for the next few years.

China is a wild card. For years, they have been far ahead of India in building world-class infrastructure and an export-led high-growth economy. But with global economies slowing down, China is desperately trying to re-focus on their domestic market. There is strong suspicion about their reported growth figures, and that is reflected in their sliding stock market. If they start cutting back on their commodity purchases, which has been sustaining the global commodities market and shipping businesses, a big crash in global stock markets may follow.

The USA is not on the verge of collapse – like they were three years back. The situation is grim, but not hopeless. There will be a lot of pain before their economy eventually turns around. But thanks to two rounds of quantitative easing, and significant belt-tightening, US corporations are sitting on a lot of cash. They haven’t curtailed spending on existing IT services, and there are signs that they may be spending more on new services. The strengthening dollar will add to the bottom lines of IT services and export companies.

Our over-dependence on oil imports will further add to our balance of payments problem. The government had introduced several populist measures to help the rural poor. Subsidies on diesel, kerosene, fertilisers have added to the fiscal deficit. Rampant corruption and scams, as well as high inflation are keeping FIIs away. Their inflows partly help in reducing the deficit.

However, our GDP continues to grow. Not at 8-9% but more like 6-7%, which is much better than almost every one else except China. That pretty much rules out a 2008-like crash in the Indian stock market. But it could take a while before we see new highs on the Sensex and Nifty.

The sensible approach will be to cut out the daily noise emanating from the business TV channels, and concentrate on companies that have capable and trustworthy managements, and have records of several years of good performances through bull and bear cycles. If they produce goods or services that find buyers regardless of the state of the economy, so much the better. Companies that sell toothpaste, cigarettes, soaps and detergents, biscuits, life-saving drugs, drugs for chronic diseases, tractors, power tillers, tea and coffee will continue to do well.

Just remember that the stocks that don’t fall much during a down trend, don’t rise much during the subsequent up trend. The ones that fall more, tend to rise more. Of course, this ‘rule’ works only for well-managed companies.

Stock Index Chart Patterns – S&P 500 and FTSE 100 – Oct 07, ‘11

S&P 500 Index Chart

The S&P 500 index chart dropped to a new intra-day low of 1075 on Oct 4 ‘11, but instead of falling lower the index bounced up sharply and caught the bears by surprise. The index has crossed above the 20 day EMA again and is likely to test the resistance from the falling 50 day EMA. The rising volumes should provide an added impetus to the bulls.

The technical indicators haven’t quite turned bullish yet. The slow stochastic and the RSI are below their 50% levels. The MACD and the ROC are both negative. However, all four indicators touched higher bottoms while the index dropped lower. The positive divergences could lead to a breach of the 50 day EMA.

The economic news remains mixed – neither favouring a double-dip recession, nor showing any strength. Sept ‘11 small truck sales were higher by 9.5% over Aug ‘11, and 20% higher on a YoY basis – a sign that small businessmen are seeing growth on the horizon. ISM’s non-manufacturing business activity index rose by 2.7% over Aug ‘11 and about 5% on a YoY basis. But announced corporate layoffs rose sharply above the 100,000 mark. ECRI’s Weekly Leading Index (WLI) of growth declined further to – 8.1 from the previous week’s – 7.2.

FTSE 100 Index Chart

 

The FTSE 100 index chart refused to play second fiddle to the S&P 500 index chart. It tested, but did not fall below, the Aug ‘11 low of 4791. The upward bounce has carried the index above its falling 50 day EMA.

The technical indicators are showing some signs of bullishness. The MACD is negative, but rising above its signal line. The slow stochastic has moved above the 50% level. The RSI and the ROC are at their ‘0’ levels, and rising. But volumes have not been great, and the FTSE 100 may fall short of reaching its 200 day EMA.

Bottomline? The chart patterns of the S&P 500 and FTSE 100 indices have bounced up sharply from last week’s lows. But remember that both indices are technically in bear markets. The rallies will probably be used as selling opportunities by the bears. Better to stay on the sidelines till the dust settles.

BSE Sensex and NSE Nifty 50 Index Chart Patterns – Oct 07, ‘11

The BSE Sensex and NSE Nifty 50 index chart patterns have completed 11 months in down trends, and the past 9 weeks within rectangular trading ranges below large descending triangle patterns. The longer both indices consolidate within their rectangular ranges, the greater will be the significances of the eventual break outs.

Unfortunately, there is no way of knowing in advance the direction of the eventual break outs. If both indices climb above the upper resistance levels, the up moves should be accompanied by strong volumes. A break down below the lower support levels need not have much volume support.

Consolidation patterns tend to be continuation patterns. That means the previous down trends, before the indices entered rectangular consolidation zones, will continue. Probabilities of downward break outs are greater. 

Rectangular trading ranges have measuring implications. On a break down below the rectangles, the indices are expected to fall an equivalent of the height of the rectangles. Therefore, the downward targets for the Sensex and the Nifty will be 14100 and 4200 respectively; i.e. another 10-15% or so from the current levels. These downward targets are very similar to the downward targets mentioned in an earlier post.

BSE Sensex Index Chart

Note that the BSE Sensex chart has formed several small gaps during the past 9 weeks, including the upward gap on Fri. Oct 7 ‘11. Such gaps, formed within a rectangular consolidation zone, are called ‘common gaps’ that have little technical significance. The much larger downward gap that occurred when the Sensex broke down below the descending triangle (marked by light-blue oval), is a ‘breakaway gap’ that is more crucial technically. Till that gap is filled, bulls will remain at the receiving end.

The technical indicators are bearish, but showing some signs of recovery. The MACD is negative and below the signal line, but attempting a turnaround. The ROC has climbed above its 10 day MA, but is negative. The RSI has bounced up a bit near its oversold zone, but remains below the 50% level. The slow stochastic is trying to emerge from its oversold zone.

Q2 results should start hitting the market in the coming week. They are unlikely to be great, but the markets tend to discount such expectations in advance. Still, there will be stock-specific moves based on positive or negative surprises. Investors should remain nimble to take advantage of any opportunities.

NSE Nifty 50 Index Chart

Despite the rally on Fri. Oct 7 ‘11, the weekly bar on a holiday-shortened week clearly shows a lower top, a lower bottom and a lower weekly close. So, the bears ‘won’ last week’s exchanges. Market sentiment remains weak, and the technical indicators are reflecting the market mood.

The distance between the 20 week and 50 week EMAs is widening, and the Nifty is trading below both EMAs. The bear market is gaining in strength. The MACD is moving sideways below its signal line in negative territory. The ROC is also negative and below its 10 week MA, but attempting to rise. Both the RSI and the slow stochastic have slipped into their oversold zones. Is the Nifty getting ready to fall below its 9 weeks long trading range?

Inflation remains a thorn in the side of the UPA government. Instead of fighting the problem together, senior government ministers are engaged in backstabbing each other. The opposition is caught on the horns of a dilemma – whether to expose the government’s corrupt deals, or to set their own house in order. The RBI will have no alternative but to increase interest rates once more.

Bottomline? The chart patterns of the BSE Sensex and NSE Nifty 50 indices are within trading ranges for the 9th straight week. The longer the consolidation, the stronger will be the move out of the range. The politicial and economic environment is not conducive to an up move. But strong FII buying (or selling) can change all equations quickly. This is a great time to learn the art of being patient till the right opportunity presents itself.