Sunday, December 25, 2011

Macro-Technicals point to a possible bottom

The current state of macro and technical indicators point to an increasing probability of the markets being at the bottom or near a bottom. If I have to assign a subjective probability, I would say that there’s a 60% chance that we have already touched the bottom. Of course that means that there is still a good 40% chance that  a new bottom can be be made.

Key reasons why we could have probably bottomed out are:-

  • falling monthly inflation number
  • falling commodity prices
  • possible bottoming out in US 10 year yields
  • bullish divergences in MACD histograms in weekly and daily charts of Nifty.

However, to get a better confirmation on bottom we’ll need to see:-

  • the monthly WPI inflation come down to 7% levels
  • corporate profitability not getting any worse
  • an uptrend starting in US Govt 10 Year yields
  • bullish divergence in daily charts not being broken in next minor downtrend.

This part should will become clearer in another month’s time, by end of January 2012. If these bullish factors hold on for another month then very likely that a bottom has been made, and we then need to wait for the leading indicators for market breakout to turn green. However, If they break then the next stop is very likely to be Nifty levels of 4200.

Of course there could be shock events, either positive or negative, which could very well accelerate the move in either direction. Some examples of positive shocks :-$2 Trillion funding for EU , RBI rate drop by 200 BPS, Oil drop to $ 80, Rupee drops to $45 etc etc. Examples of negative shocks :- Greece defaults and exits, US Q4 GDP less than 1%, Italian / Spanish yields go above 10%, India GDP less than 6% etc etc.

Some more explanations below

In my previous analysis we looked at quarterly profits and monthly WPI as being the primary leading indicator for a market breakout. Variables like auto sales, US Govt 10 Year yields, commodity prices, gold prices, RBI rate cuts, advance tax estimates, IIP number and FII flows act as a secondary indicators to be used for confirmation.

- The very first indicator which reverses is the monthly WPI which shows a consistent drop to sub 5% YOY levels prior to a breakout. Monthly WPI has shown just a slight fall in Nov’11. However trends in weekly WPI inflation, world food indices and global commodity indices indicate a sharp fall in monthly WPI over next few months.

- Global commodity prices are on a decline – combined with lower WPI, will lead better corporate profitability in coming quarters. However commodity prices typically start to rise after touching a bottom, just prior to a breakout

- US 10 Year yields seem be forming a bottom, pointing to possible bottom in US equities too. Market breakout is typically preceded by a breakout in the yields, pointing to flow of funds to risky assets. Though, we would still need for the yields to rise before we can say that a breakout is near

- Rupee is not a major factor. A market bottom is typically preceded by a major fall in Rupee, however Rupee can continue to remain weak even as the market breaks out as long as quarterly profitability shows an improvement..

- From a technical perspective, the Weekly and Daily charts of Nifty are showing a bullish divergence in MACD histograms with prices making lower lows but the histograms making a higher low. This points to a possible bottom. However the key is that the bullish divergences should not get broken in the next minor downtrend. And if that is combined with markets making a higher low in the next minor downtrend, that will further increase the probability that a bottom has been formed.

By end of Jan 2012, we’ll come to know whether the abovementioned  bullish indicators hold up or get broken. If the bullish indicators get negated, then the next bottom is likely to be around Nifty levels of 4200 based on long term support levels. That would mean a correction of just around 35% from the last highs. 30% kind of corrections are very normal corrections during bull markets and have happened many times over and have lasted anywhere from six months to nearly four years for the 2000-01 dotcom bust/ Ketan Parikh scam.