Markets are Trapped in a 10% Range

Last week, I wrote that I would be more bearish than bullish. I was expecting the markets to break down and retest the levels of 5175. I also mentioned that the upside looks capped at 5500-5550 on Nifty, from where it may start a downfall if it doesnt sustain at the higher levels.

Exactly on Monday it made a high of 5562 and on Wednesday again made a high of 5553. But it did not succeed to close above 5550 and started to go down.

However, what is surprising is, it did not break below 5300-5350. The Nifty closed at the lowest point of the week at 5375 which pushes me to think that the bulls and bears are equally divided. This also means that the bigger bull run post May-June 2011 is in making and this time it will be stronger than all the past rallies. The way bulls are protecting the downside despite FII selling and very low global sentiments, it is now getting more and more clear that downside is going to be limited. But does it mean we are going up and away? I guess not.

The support during March is largely attributable to the long term insurance flows and some really strong hands buying after a 20% correction in the market.

I believe, that the current strength in the market might continue till the insurance flows exhaust completely. That would be around mid of April. And hence, in absence of any good news, we expect the markets to fail at the higher levels. It is quite difficult to assess what that higher levels could be. But looks like we are heading towards 5700-5800 region from where we would again show some signs of exhaustion.

Those who have invested rightly during the recent bottom can liquidate some part of their portfolio for the better entry levels in May - June. And those who want to hedge their portfolio can wait for Nifty to cross 5700 and then short.

Why Japanese Quake is Enough to Shake Our Markets?

Last week, we wrote that the week could be a turning point. We expected that the markets is likely to fall to 5300-5350 level and then bounce. Similarly the Bank Nifty level which we mentioned were 10,500-10,570. We were at 5535 and 10,967 levels when it was written last week.

The markets fell on Monday itself and after dropping to 5400 levels / 10,650 levels bounced sharply. It gave an impression that the dip was short lived and we were back on the rising territory. However, the development over last 3 days have not been very encouraging.

Markets were showing strength till Wednesday, when the Govt. announced that the fuel price mechanism (to change the retail prices of fuel whenever there is a rise in international crude prices) will not be followed. I think, that was the starting point of the new fall. That day, Bank Nifty gave out all gains and Nifty also closed weaker.

From that day onwards, every incremental news has added to the concerns to the market rather than doing any good. First, it was a news of Moody’s downgrading Spain which strengthened Dollar against Euro. Next, it was yen getting weaker against Dollar due to the Earthquake.

What can happen next week:

Quick Macro:

1. ECB continues its stance to increase the interest rates by 25 bps. As I mentioned in my last blog, this can distort the recovery path of the PIGGS countries and hence, the European Debt Crisis can re-emerge.
2. In Indian Markets the IIP numbers came at 3.70% is better than what market expected. And that makes it almost certain that in March, RBI will increase another 0.25%.
3. Japan was hit by the massive earthquake, which has damaged a significant portion of their North Eastern Port areas including blast in Nuclear Plant and host of bad news of massive destruction. This would mean that Japanese Economy will have to do a lot of fiscal expenditure to bring back the economy on track. It means lot more which we will discuss next.
4. Libyan situation is showing no signs of improvement. However, the international crude prices have shown some cooling off simply because of dollar getting stronger against host of currencies.

How does this impact:

·         Increase in Bank Rate would again mean additional burden on Indian corporate and also for banks, it would squeeze the margins, while increasing the risks of NPAs.

·         Dollar getting stronger against many currencies is not a good news for Emerging Markets for three reasons.

·         One, the market returns in dollar terms depreciate due to appreciation in Dollar. If there is a view that in a short term dollar will continue to rise, expect a big sell off in Emerging markets.

·         Two, dollar rising against rupee would mean higher current account deficit, which is already running under stress. This would mean further stress on rupee.

·         And three, all the commodity plays are driven by their international prices. With dollar increasing and international prices dropping, it puts pressure on the Indian Companies, whose profitability is directly linked to the prices of the commodities.

How the Micro looks like:

1. As we anticipated last week, a reversal seems to have started. That means, we need to be very cautious at higher levels and protect the long only profits. Nifty seems to have got trapped and if it opens low on Monday with showing no signs of recovering, we may see a sharp fall during the week.
2. Nifty can go up to 5530-5550. But if it doesn’t sustain at higher levels, the fall is almost certain and we may go back to the previous lows.
3. Before breaking the previous lows of 5175, it may try sustaining above 5320-5375, where the near term support is being put.
4. Similarly, Bank Nifty can head up to 10030 on a higher side and if it doesn’t sustain, it can go back to previous lows.
5. Immediate support is at 10,650, which was last week’s low. But there are high chances of this getting broken due to poor sentiments and macro uncertainties.
6. Next support is only in the region of 10,380-10,450 levels.

My current view is more BEARISH than BULLISH. This is because after a 5 week relief rally, the markets have started showing signs of uncertainties and weakness. Although the levels anticipated were not broken during last week, it also gave an impression that there are macro headwinds and global uncertainties which makes it almost clear that there is “No Good News in Making”.

So, if you have not liquidated your longs during last week, be agile this week and also think of taking a hedge by shorting Nifty / Bank Nifty at higher levels.

Be Careful this week - It could be a turning point again...

A lot of things which we mentioned during last week came true:

1. We said that the Budget would be largely a Non-Event. And the fiscal discipline and fiscal deficit targets at 4.80% or lower will be stressed upon. Our finance minister actually has put the next fiscal deficit target of 4.60%...

2. In fact, the rally in the markets from the budget day was largely attributed to Banking Sector which started a sharp rally after the FM mentioned the fiscal deficit target of 4.60%.

3. We said, we are more bullish than bearish with the caution that if the Nifty levels of 5160-5260 breaks, we might see an immediate downside of another 400 points. We were anticipating the Nifty Targets of 5440-5490 and Bank Nifty Targets of 10,900 (When the Nifty was 5313 and Bank Nifty was 10,450).
To our surprise, the Nifty went up all the way to 5611 and Bank Nifty to 11,155 ! This, inspite of Crude Oil Shock and Libyan Crisis.

However, the week closed very close to our targets. Nifty closed at 5535 and Bank Nifty at 10,960.


Now what next...
Quick Macro:

• Libyan Crisis have been worsening. When we wrote this last week, Crude was at 97-99. We were anticipating the crude to cool down to 95 levels. But it swiftly moved up and currently at around 105 levels. US has announced an attack on Libya to oust the dictator.
• ECB (European Central Bank) president Jaun Claude Trichet has expressed his willingness to increase interest rates in April, to fight inflation.
• And the latest one is - DMK has pulled the support and theoratically, UPA government has lost the majority.

Analysis:

• Directionally, now everyone has started factoring higher crude oil prices through out the Calendar year 2011. Some analysts have started building a worst case scenario with Crude at 120-130 for entire year. Crude Singly has the ability to distort India's Growth and Future Prospects. It puts pressure on Rupee through Current Account Deficit and puts pressure on Interest Rates through indirectly pushing up the Fiscal Deficit of Indian Govt (through subsidies). If the Govt. decides to pass on the cost to consumer, it would immediately spike the inflation.
• So, "Crude not showing any sign of weakness" is going to be big trouble maker for Indian Markets. And the Banks will start becoming extremely vulnerable with this.
• ECB's stance of increasing Interest Rates in April by 0.25% doesnt affect us directly. But it more or less confirms that RBI will have to increase the interest rates in this policy meeting. So, the chances of avoiding the rise due to slower growth (IIP numbers) during December, January and February has gone.
• There is one more serious implication of ECB's rate increase. It can distort the recovery path of PIGGS countries which were facing soveriegn crisis during 2010. Those stories can come back in May & June this year again. And that should be a potential trigger for the Western Markets to fall again.
• Domestic News of DMK pulling the support is not shocking. It was largely anticipated since the 2G scam came out and Congress passively participated in Raja's exit. I dont think it would become so worst that we will have to see Election Again.
• HOWEVER, THIS CAN BE THE CENTRE STORY FOR SPECULATION DURING NEXT FEW WEEKS. The school which believes that this would cause a big uncertainties in Indian markets will start pulling out the funds and that can take the markets to much lower levels.

How does Micro Set Up looks like:

• Nifty for whatever reason, if opens and trades below the Friday's closing, has a potential to lose good 200 points and straight away, go to 5300-5350 range, where the weekly support is placed.
• If this support breaks it would open the possibility to retest 5175 and go down even lower.
• ALTERNATIVELY, It may happen that when we are close to the support levels of 5300-5350, we may see important macro or domestic news which will finally decide whether the support breaks or acts as a strong support.
• However, one needs to be very cautious as this is going to be 5th week from the bottom and it can be a turning point again. With no "Good News in Sight" and only incremental bad news coming, the set up becomes weak. The odds are in favor of Bears right now, with the only possibility of rescue that if something really good comes out by Tuesday-Wednesday like Crude going back below 95 or some alternative to the Libyan deadlock or some international good news.
• In such scenario where the markets react positively to the good news and start moving up from the levels of 5350 support, the next week we can close at 5700 on Nifty.
• Similar levels in Bank Nifty are: Support at 10,570 to 10,310 levels. If breaks forcefully, we can go down all the way to 9500 levels in coming days.
• Alternatively, if we get really a good news, and there is a turning point from 10500 kind of levels, we may see Bank Nifty close near 11,200-11,400.

Whatever be the case - Up or Down, this week we will have large movements either on upside or downside with good volumes. And once we are through with this week, we will see the final medium term direction of the market.