What does the instability mean?

With the markets facing pressure, the Nifty may fall to sub-4,800 levels, offering a negative outlook for the short and the long term.

Hemen Kapadia | Print Edition: July, 2010

It was nothing short of a rollercoaster ride. The NSE Nifty fell by over 11 per cent in eight weeks and recovered swiftly by 8 per cent within nine trading sessions. Choppy and volatile trading seems to be the order of the day, even as overseas cues continue to cast a shadow on the equity market. With the dollar strengthening, the euro weakening, gold on the rampage and crude oil weak, the situation is unlikely to change soon. It doesn't help that the European financial crisis has weighed down the markets across the world.

A further tumble for the Nifty seems imminent. The short-term picture is negative as the fledgling recovery may have run out of steam, but with the Nifty closing above the resistance level of 5,210 on 17 June, there may be a case for reviewing the situation. Everything seemed to be in order as long as the correction was normal, but the disdain with which the Nifty is treating important support levels indicates that it has acquired an ominous undertone. For the first time in nearly a year, the long-term outlook also seems to be negative.

The daily MACD (Moving Average Convergence Divergence) gave a crossover buy signal on 27 May after a crossover sell signal on 7 April, but this could be shortlived as the Nifty is in no mood to sustain at higher levels. A change in trend seems improbable. Even as the weekly lower top, lower bottom scenario continues, the daily picture too seems set to mimic it.

The anticipated unsustainable corrective bounce fizzled out at 5,148, slightly below its expected level of 5,188. The Nifty remains above its support levels of 4,950, 4,920, 4,875, 4,835, 4,750 and 4,659, while resistance comes in at 5,005, 5,050, 5,080, 5,155, 5,224, 5,274, 5,303, 5,330, 5,410 and 5,455.

If one considers a retracement of 50 per cent of the fall from the intra-day high of 5,399.65 on 7 April to a low of 4,786.45 on 25 May, then the index will come to the 5,094 level. On the other hand, a 62 per cent retracement will mean a level of 5,166, even as the Nifty peaked at 5,148. A breach of the 4,920 level could also test its recent bottom level of 4,786, implying a 4,659 level on the downside.

An analysis of the various sectors indicates that the BSE Bankex's outperformance has probably ended. Following the weakness in the market, Bank of Baroda and Canara Bank could just about hold on, while ICICI Bank and IndusInd Bank seem prime candidates to go short on or book profits.

Though the BSE Consumer Durables Index has outperformed significantly, it is expected to end as the index has breached a demand line on the downside. The breach indicates the possibility of a sharper and deeper downside. The outstanding exit/short-selling opportunities are offered by Rajesh Exports, Whirlpool, Bajaj Electricals and Videocon Industries, while Gitanjali Gems could be an outperformer.

The BSE FMCG Index has shown tremendous outperformance to post an all-time high in an extremely uncertain market. This indicates a strong defensive theme in times of turmoil. The outstanding investment opportunities include ITC, Dabur and Colgate-Palmolive, while McLeod Russell is a clear weak spot. In the event of normal monsoons, companies with agriculture-based inputs will prove to be a good bets. The moderation in prices of milk, sugar, wheat and rice will benefit firms such as Britannia, Nestle, Dabur and GSK Consumer. The earnings of the firms in the FMCG space can accelerate significantly from the second half of financial year 2010-11 as the benefits of lower input costs and inflation, and higher income, kick in.

The bottom line? If the current situation continues, the NSE Nifty is likely to fall to the sub-4,800 levels.

How will the market fare?
A look at four factors affecting the Indian market, as per the recent Morgan Stanley research report, India Summit 2010.

1.Low inflationary pressure will be good for equities
The equity market is clearly saying that, right now, growth matters. A sudden spike in crude oil prices could be damaging, though a steady rise, accompanied by capital inflow, is not bad for equities. We expect the rupee to appreciate. This would offset some inflationary pressure and ease the burden on the monetary policy.

2.Valuations are rich
Equity valuations look middling at 18x trailing earnings. At a 30 per cent premium to emerging markets, this is lower than the average at which Indian equities have traded in the past six years. The broad market fares better with the mid-cap index at the low end of its valuation multiple range relative to the large-cap index.

3.Earning expectations are high
The acceleration in industrial growth will help revenue growth exceed the midteens in the coming quarters, while the gap in food consumer and producer price inflation will push corporate margins to new highs in 2011. Bottom-up companies are benefiting from greater pricing power and higher operating leverage. Corporates have considerable cash on the balance sheets. The key downside risk to earnings is that a weak global risk appetite may dampen the capital flow in India, adversely affecting the growth.

4.External deficit makes India vulnerable to global events
The external deficit—trade deficit is at over 10 per cent of GDP—seems high as the investment cycle is yet to start in earnest. The problem is how to fund this trade deficit. A large part of India's external deficit is funded by flows from financial markets, though the dependence has fallen at the margin. If global markets continue to wobble, India's growth will be affected. Indian equities correlate strongly with the global ones, though the absolute correlation has fallen from the highs of 2007-9.

The writer is CEO of Chart Pundit, a Mumbai-based technical analysis firm.

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