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.

Thursday, December 22, 2011

Leading indicators for a market breakout

Economic fundamentals indicate that we are probably near bottom of cycle, however leading indictors of recovery are still not in sight.

Typically market itself are the best indicators of recovery and tend to breakout from their bottoms many months before a economic recovery can finally be confirmed.

However there do seem to be a few macro variables which tend to act as a leading indicator for a market breakout itself.

The analysis is based on how the recovery and market breakout progressed during the 2008 crisis, and on otherwise well known relationships between some of these variables.

The primary indicators are

Quarterly profit growth

An improvement in YOY percentage of net profit would point to an impending breakout in a few months. And the first time that quarterly profits show a positive growth (even if sales growth is negative) after a period of de-growth, the breakout would have just happened or about to happen.

WPI Inflation

WPI inflation less than 5% would point to an impending breakout within a month or two.

Given that the Sept’11 quarter net profit profit showed a decline of around 23% YOY and Nov WPI Inflation is at 9.1%, we seem to more than a few months away from a decisive breakout.

Secondary Indicators

There are a few other indicators which can probably be used as more of confirmatory indicators rather than primary indicator due to reasons of volatility/ data reliability /variable being a decision of a person (e.g rate hike)

These are :-

- YOY percentage change in IIP to show improvement (even if means a lower negative number). Breakout likely to happen almost immediately .

- Commodity price indexes would make new lows and start to rise just prior to breakout

- US Govt 10 year yields would form a bottom a start to rise. The rise in the 10 year yields would precede the breakout in S&P 500 in US. And I am assuming that we need to see some kind of breakout in S&P 500 for the breakout in domestic equities to sustain

- Advance tax estimates of top 100 companies likely to show an uptick a month or two before breakout

- FII monthly outflows to slow down compared to immediately preceding six months. This one is very volatile and FII’s have not been been as bearish as in 2008 period, so I would use this with a pinch of salt.

- Gold likely to correct 15-20% from its 52 week highs a few months before breakout

- RBI would have cut rates substantially

- Surprisingly, Non food credit and Exports growth do not show any clear relationship to a market breakout and in fact keep on deteriorating even as market makes higher tops.

If time permits, I will try and post detailed analysis around each of these variables separately and also some of my findings around the chronology of these events.

Thursday, December 15, 2011

Macros point to a Rate/ CRR Cut – Will the RBI be bold enough?

The consensus expectation seems to be that it is too early for RBI to cut CRR, however if we go by how the RBI reacted during the 2008 crisis, there does seem a fair chance that CRR might be cut. Or at the very least some kind of liquidity infusion measure might be announced as a change of stance from hawkish to dovish.

Compared to the macro scenario in Oct 2008, when the first rate cuts happened during that period, this time the scenario is much worse. Comparing the pre rate cut period of Sept-Oct 2008 to current macro conditions, GDP is worse now, IIP is worse, Inflation is better and non food credit is worse.

Here are are the numbers :-

1. RBI cut the Repo rate by 100 BPS in Oct 2008, just three months after the last hike during July 2008. During the same month, along with Repo rate cut, it also cut the CRR by 300 BPS,  just two months after it had hiked CRR to a high of 9% . It’s just two months now since RBI did the last repo rate hike, and not really too early to cut CRR.

2. When it cut the CRR and Repo rate in Oct 2008, GDP had already fallen from a high of around 10% to 7.9%, while this time around the GDP is now at 6.9%

3. IIP had come down to 5% level by the time the first rate cut/ CRR cut were carried out, while the IIP now is at a negative 5% levels.

4. Monthly WPI inflation had shown three successive months of decline from a high of 11.15% in July 2008 to 10.66% in October 2008 and the world food price inflation from FAO had come down from a high of 57% in Feb 2008 levels to negative 3% by Oct 2008.  RBI did not wait for the monthly WPI to fall to 7% levels the last time also. This time the WPI has shown two successive months of decline from a high of 10% in Sep 2011 to 9.11% for Nov 2011 and the Nov inflation of 9.11% is way lower than the 10.6% when RBI cut repo rates and CRR in Oct 2008. As for the FAO index, its down to 1% in Nov 2011, from a high of 37% in March 2011

5. During the first rate cuts in October 2008, the non food credit growth yoy was around 25% levels, while this time around it already in the 18% range.

RBI was bold in raising the rates during the last one year, during which time the repo rates almost doubled from 4.75% to 8.5% .

The question is will it bold enough to start infusing liquidity now.

Sunday, December 11, 2011

EU : In need of Life support

The big EU summit has happened, and like all the prior summit this one too comes with a lot of hot air.

The solution involving fiscal discipline for EU nations is good and noble and something that had become absolutely necessary. However, that is a very longer term solution and something where even the agreements are expected to signed only in the first half of 2012 !

And like all the prior EU solutions, there is very likely to be slip between the cup and the lip.

EU is like a patient in ICU – it needs life support (read liquidity injections) immediately, and lifestyle changes (fiscal discipline) in the longer term.

Just look at the demand for funds,i.e the amounts coming in for rollover (rollover just means that the governments and banks will take a new loan just to pay the old one).

  • Euro 200 Billion of EU sovereign debt due for rollover during Dec 2011
  • More than 2 Trillion dollars due for rollover in 2012, half of which is Euro government debt and the remaining is Bank debt
  • Roughly half trillion dollars of debt will become due every quarter in 2012.

Now look at the supply of funds

  • Pretty much nobody wants to loan to EU governments and EU banks. (Spanish and Italian yields nearly doubled over past one year !). Japan is reported to have sold off all its EU bondholding
  • ECB is not ready to act as a lender of last resort
  • China is indicating that It might help the EU, but nothing committed anything yet
  • The Euro 200 B of new funding mentioned in EU summit is still hot air.
  • The Euro 500 B of EFSF would fall woefully short and has just some Euro 50 B of committed funds till now.

What markets are expecting are a big ‘bazooka’ somebody to provide the kind  of backstop that Obama and Geithner did in 2008 and 2009 committing Trillions of dollars towards funding, guarantees and recovery programs.

Tuesday, December 6, 2011

Bottom Bottom Where Are You?

Was looking at the charts and also my previous post around bottom formation. Was also catching up on various views on where the bottom could be and whether the current rally is sustainable.

Dont know why, but reading up on all the hopes for a bottom and for a final breakout, I started humming “ twinkle twinkle major bottom, how I wonder where you are…..”

So here’re my latest analysis as a poem. Poetry is really not my forte, so request all poetically oriented folks to forgive transgressions of literary rules, if any.

Twinkle twinkle major bottom
How I wonder where you are
You seem so near, yet so far
You come in reach, then fall afar

Head and shoulder in October
With a breakout just before November
Bought smiles to bullish fellows
Went away, when you made lower lows

Bullish divergences in charts now
Will there be a breakout now?
Will there be a bottom now ?
Or will you do what you did ago,
Go on to make a lower low

The wise men say -Wait wait wait
Try not to catch a falling blade
You'll know a bottom -  only later in the day
When sun has broken through the ray

You seem so near ,yet so far
You come in reach, then fall afar


(Charts below show the bullish divergences between price and MACD in daily and weekly charts)