SETUP for Budget 2020

30 January, 2020

SETUP for Budget 2020

In the short-term, like we have seen at the start of 2013 and 2016, the nifty may be nearly completing a 5 wave move up and can give us the deeper retracement before heading higher. Short term sentiment indicators however are getting slightly oversold. What do these two tell us? Remember today is expiration for the month and a lot of data will change starting tomorrow. For this week the max open interest was in the 12200 strike so we were unlikely to go above that. However the near term sentiment indicators are showing near the lower end of pessimism that was associated with previous short term bottoms so we are now getting close to one ahead of the budget.

First the FII options OI the indicator in the lower end of this graph is near the grey line, and second the total FII position at the top end is near the first grey line. Today's market decline could get us an even lower reading. FII futures positions for Dec and Jan were near the zero line +/-20k contracts meaning they were not betting either way, however in the last week they added to Nifty futures shorts nearing -50k contracts.

The client Options positions as a % of total OI shown below went back to 31% and made a slightly higher high like a positive divergence as the nifty made a lower low. Near the lower grey line this is getting very oversold.

On a larger time frame the Nifty appears like a 5 wave advance from the Sept'19 bottom where the tax cuts were announced. In 2014 the 1^st rally saw a pullback of 38.2% in terms of retracement ahead of the elections. In 2016 during the 2^nd half of the year following demonetization the nifty retraced 50% of the 1^st rally before starting a clear move higher. If the nifty does complete a 5 wave move near 12,480 in the coming weeks and does not breakout higher then something similar could be in store at this time as well. So far we have seen a 23.6% retracement but why should we not see more? The short term set up shows that we may bottom and rally higher and the medium term one remains open to a pullback first. 23.6% is normal so both options are open and the recent decline over corronavirus may determine the ultimate outcome. If it is wave c in bank nifty it already indicates that a 3rd wave can start as bank nifty has retraced 38.2% and if Nifty makes a lower low than day before it may also fit the bill. In other words a weak market ahead of the budget maybe setting itself up for a post budget rally to new all time highs.

Among the macro factors to watch out for it should be the rising dollar which if it breaks out to new highs could also push the USDINR towards 75 or higher in the weeks ahead and keep the pressure on equity prices. Simultaneously we might also see continued interest in individual stocks as the momentum in the broad market appears to have returned and might not go away that quickly. Most of the correction therefore might be in index and Index stocks.

I’m not sure to predict outright deflation at this stage because central banks remain proactive and if oil drops below $ 40 and copper goes back to $ 2.45 there is surely going to be some policy response from the US Europe or Japan.

The Federal reserve’s policy statement tonight might also throw light on their current stance given the complex situation of a high stock market and a weak economy based on incoming data and earnings growth. If the Fed is going to wait for a crisis to respond then it is more likely asking for the mighty market to offer them a crisis first.

While I write this all eyes are on the Coronavirus and its possible impact on many of the factors that I discussed today. However the rising dollar did not start 4 days ago it only broke out this week. Oil has been selling of since the IRAN attacks ended and while copper made a late rally zinc nickel and aluminium were barely participating on the upside.

Clearly a return to the reflation trade requires fresh evidence and till then it makes well to take some risk of the table. While these risk are playing on the mind the market internals are actually showing that there is little risk out there. What are market internals? The breadth and participation from the second line stocks in the market. 2018-2019 was a 18 month bear market in stocks but the rising Nifty finally got the attention of value investors who have come back in droves to buy into Mid and Small caps. That is now clearly evident in the Relative Strength chart below as it has broken out of the downtrend. This reversal signals that apart from any near term volatility that may stem from virus fears or a rising dollar the worst is priced in, and stocks may continue to get attention in the coming months. Any knee jerk reaction in Nifty might eventually get bought into. In a rare situation as I mentioned in October, the USDINR and Nifty might rise together. Such trends are now already evident in places like Brazil where the falling currency is not stopping the stock market anymore.

Conclusions

The short term setup is getting oversold ahead of the budget setting us up for a post budget rally. If we complete an A-B-C decline [meaning wave C is 5 waves], it would confirm that a larger third wave toward 12600-13000 is on the cards. If not we stay open to a deeper retracement in Nifty even as stocks in the second line continue to push up the Midcap and Smallcap indices. In a rare situation if the rising dollar poses any threat USDINR and Nifty can also rise together. Especially if the rising dollar involves a safe haven trade that drives up US stocks as well. In short till a larger US market sell off occurs equities might still find support at lower levels. The dollar risk could also end up being temporary as central banks go back to more easing and lowering rates. Many factors to watch and we will need to adjust positions accordingly.