Is the Nifty stuck in the Buttered Cat paradox?

Today’s (Dec 13 ‘11) intraday movements of the Nifty index was a classic example of volatility caused by uncertainty, with alternate bouts of buying and selling making the index gyrate about its previous day’s closing level.

Neither bulls nor bears were able to make up their minds about what to do, after yesterday’s big sell-off following the announcement of the negative IIP numbers for Oct ‘11.  It reminded me of the ‘Buttered Cat paradox’ – which is a thought experiment based on two adages:

• If you drop a cat from a height, it always falls on its feet
• If you drop a slice of buttered toast, it always lands with the buttered side down

What will happen if some one straps a piece of buttered toast (with the buttered side on top) on the back of a cat and then drops the cat from a height? The toast will try to make the cat land on its back. But the cat will try to land on its feet. The end result will be a gravity-defying equilibrium where the cat will hover just above the ground level and keep whirling round and round!

Rest assured that I didn’t make this up after imbibing a few too many. It is all over the Internet. I’m even providing the wiki link from which the cartoon below was copied:

Those of you who are enamoured by the unrealised potential of alternative energy stocks like Praj (ethanol) and Suzlon (wind) can imagine the potential of harnessing emission-free green energy from hundreds and thousands of whirling buttered cats.

If you enjoy thought experiments, here is one more. Imagine a fisherman living on a small island in the middle of the Pacific Ocean very near the international date line. Every morning, he sets out on his boat and crosses the international date line (thereby gaining 24 hours). After fishing the whole day, he returns to his island by crossing the international date line once more (this time losing 24 hours). Will he ever get old?

Stock Index Chart Patterns – S&P 500 and FTSE 100 – Dec 9, ‘11

S&P 500 Index Chart

In last week’s technical analysis of the S&P 500 chart pattern, I had commented: “Expect a bit of consolidation before the index makes up its mind about the next move.” That was exactly what the index did during the past week - closing above the 1250 level on four out of the five trading sessions – but making very little upward progress.

The good news for the bulls is that index is trading above all three EMAs, with the 20 day EMA about to cross above the 200 day EMA. The bad news is that the index has made a small rounding-top pattern, which may be signalling an end to the brief rally. Also, the slow stochastic and the RSI are showing negative divergences by touching lower bottoms in Nov ‘11 while the S&P 500 touched a higher bottom.

The technical indicators are looking bullish. The slow stochastic has re-entered its overbought zone. The MACD is positive, and above its rising signal line. The RSI is above its 50% level, but appears reluctant to move higher. No such hesitation with the ROC, which is rising in positive territory. Some more consolidation or even a minor correction can be expected this week.

The US economic indicators are improving ever so slowly. Initial jobless claims at 381,000 were at the lowest level since Feb ‘11. The Reuters/Univ of Michigan Consumer sentiment index at 67.7 was at a 6 month high, but remains below its long-term average. Even the ECRI’s Weekly Leading index rose, though the institute is standing by its earlier prediction of a recession.

FTSE 100 Index Chart

The technical indicators of the FTSE 100 chart were looking bullish last week, which pointed to a continuation of the rally. But after a brief foray above the 200 day EMA, the index formed a small rounding-top pattern and slipped below long-term moving average by the end of the week.

The slow stochastic is at the edge of its overbought zone. The MACD is above its signal line in positive territory. The RSI is above its 50% level. The ROC is rising in the positive zone. These are all bullish signs. But the negative divergences in the slow stochastic and the RSI may put an end to bullish hopes. Note that both touched lower bottoms in Nov ‘11 while the index touched a higher bottom.

UK’s opting out of the European Union agreement to protect its financial interests may have far-reaching negative consequences. There is a good possibility that its manufacturing exports to the Eurozone will suffer. Already, there is a slow down with manufacturing output declining by 0.7%. The good news is that the Eurozone isn’t going to break-up and the euro may not disintegrate.

Bottomline? Chart patterns of the S&P 500 and FTSE 100 indices are showing some signs of weakness, but as long as the Nov ‘11 lows hold there should be no cause of worry. The Oct ‘11 highs are barriers on the upside that need to be crossed for bulls to regain control. Expect some more consolidation or correction. Wait for a clear trend to emerge.

BSE Sensex and NSE Nifty 50 index chart patterns – Dec 9 ‘11

The BSE Sensex and NSE Nifty 50 indices continue their slide inside downward sloping channels. Probabilities of dropping below support levels (marked by blue dotted lines) are high. Any drops below the trading channels can induce panic selling.

BSE Sensex index chart

The sharp rally from the lower edge of the downward channel took the BSE Sensex chart above the 50 day EMA, but stalled well short of the falling 200 day EMA. Bear selling has pushed the index below all its three EMAs. The support level of 15700 is likely to be breached again. The bigger threat for die-hard bulls is a possible break below the channel.

The technical indicators are looking bearish. The MACD is above the signal line, but is changing direction in negative territory. The ROC has started falling, and may cross below its 10 day MA into the negative zone. The RSI failed to climb above its 50% level, and has started to move down. The slow stochastic has dropped from its overbought zone.

FDI inflows during the first half of this financial year has been more than double the amount received during the same period last year. But there was huge FII inflows last year. This year’s net FII outflows have neutralised any positive impact. Time to be cautious.

NSE Nifty 50 index chart

The weekly bar of the Nifty 50 index faced resistance from the falling 20 week EMA and is getting ready to drop below the support level of 4700. If the index fails to find support from the lower edge of the downward channel, there can be a sharp drop.

The weekly volume bar appears lower because of the holiday on Dec 6 ‘11. Otherwise, volumes may have been equal to or even more than the previous week’s volumes. Higher volumes on down weeks is usually a sign that smart money is exiting. The policy flip-flop on allowing 51% FDI in retail has shaken the confidence of FIIs – at least in the near term.

All four technical indicators are bearish. The MACD is entangled with its signal line in the negative zone. The ROC has dropped below its 10 week MA into negative territory. The RSI has slipped below its 50% level. The slow stochastic is barely above its oversold zone.

Food inflation has started to moderate. The core inflation and IIP numbers will be announced in the coming week. They are not expected to provide any positive triggers to the market. The depreciated Rupee is making an already widening trade deficit even worse. Exports are slowing – thanks to the debt problems of the Eurozone. Decisions on domestic infrastructure projects have practically stalled because government mandarins are sitting on their hands. As William Shakespeare wrote in Richard III: “Now is the winter of our discontent.”

Bottomline? The BSE Sensex and the Nifty 50 index chart patterns are slowly grinding down within their channels. Neither index has fallen dramatically – but that doesn’t mean that they won’t. A pause in RBI’s interest rate hikes could be the first signal that the tide is turning. Cash preservation should be the guiding principle. If you wish to accumulate beaten down stocks, choose only the best ones.