Bullish ? - Think Again
28 Jun 2020 ● 08:01 PM
Bullish ? - Think Again
Is the Stock Market “Bearish as Hell” or “Bullish as hell”. These are the only two choices we have to make every month. It has to be backed by facts. This is not easy to say especially at 10,550 an exact 61.8% retracement of the previous fall. To sound more bullish after the market has rallied 3000 points would risk appearing completely wrong. At the same time turning bearish just to make bears happy is senseless as well.
As always, I will back my opinion with the data and analysis that are strongly in support of my expectations. As some of you have suggested I will try to discuss the alternate paths as well. We can never ignore risk management as part of a strategy with level is where we need to at if things go wrong. We also need to have the macro factors in mind that will eventually ensure whether we are broadly right or wrong irrespective of the short-term gyrations.
We must remember not to extrapolate exogenous events like the pandemic far into the future.
For me the market fundamentals lie in an analysis of the macro factors, and the market technicals are a function of charts standalone either confirming or breaking away from the fundamentals. The best setups however are when both are aligned on the same side of the trade.
Thus it is just the fate of events over the last few months that has led to an alignment of strategic factors all on one side of this trade. Let me explain.
The Macro Fundamentals
The May 2020 issue was very detailed in explaining the reflation trade that finds its roots in the idea that the dollar index has started a bear market in 2017 and made a double top near 103 in the year 2020. Unless the DXY goes back above those levels I will consider it in a bear market with all the below effects likely over the next 2-4 years. Why because the following chart shows 7 year bear markets historically for the DXY and 2017+7=2024
The direct consequences of a falling dollar are.
1. Rising precious metals and commodity prices
2. Potential for nominal inflation or stagflation
3. Rising emerging market currencies
4. Rising Emerging market stocks and equity flows
5. Reduced pressure on emerging market debt and bonds
This is not a complicated situation. We have been here before and seen this movie before our eyes between 2002 and 2008. If you go back far enough in time to where floating-rate currencies and globalization had taken hold, dollar bull markets have been associated with emerging market stress and dollar bear markets have been associated with booming global growth. With the US providing most of the dollar supply, when the dollar is rising the US attracts most of the attention and dollars flowing to US assets creating a strain on countries that borrow dollar debt or hold trade deficits that need to be filled with dollars. On the other hand and the dollar is falling it eases pressure on emerging markets and their currencies allowing them to borrow even more and expand their economies. The cycles have been repeating with a 7 to 9 year time horizon over and over again as seen on the dollar index chart above.
2017-2024 is now such a period unless I am proven wrong on the dollar. So the bets are on. Bullish these asset classes including EM stocks like India. This combined with lower interest rates and the potential of greater government spending in the face of the crisis going ahead we have a case for Global Reflation of Asset Prices.
The set up is similar to 2002 except starting at a higher base level of debt. The 2001 Euro bull market saved the Eurozone periphery from default as they could borrow at higher ratings and lower interest rates by joining the Euro. This time as EM debt has expanded over the last decade the next dollar bear market will allow EMs to consider lowering interest rates to new lows and stimulating their economies with fresh borrowing and spending.
With that the macro backdrop is set and I discussed it with many charts in the May report I am not repeating everything here. But I capsuled it in my winter update on the Regime changes as follows.
1 The falling dollar is coming back as explained above
2. Combined with lower interest rates it will eventually change the trend in inflation
3. Between high enough inflation that pops the bond market bubble eventually and today there is an opportunity in price action on the upside that we should participate in
4. This reverses the trend in deflating commodity prices that should rise along with mining and mineral stocks
5. The out-performance of DMs over EMs shifts back to EMs outperforming over DMs
6. Re-emergence of Value buying in beaten down names in the new regime over and above growth investing.
7. A higher volatility regime as expanded liquidity chases up asset prices even faster than before. A new range for the VIX.
The full report with all the charts for the above regime changes is here THE BIG BANG THEORY
With that let us spend the rest of this month’s pages on the technical and sentiment that is out of whack. Last week I wrote a note about coming regime changes and this week I wrote a note about the markets positioning that did not make it to the press. I did carry it on my CNBC interview yesterday. Reason?
The Technical Picture
At 10550 everyone is scared of publishing a bullish story given the risk that more infections lead to higher deaths or cases resulting in another lock down. There is also concern over the geopolitical risk between the west and east. Even more close by, between India and China. Last but not the least is the risk of a second wave of viral attacks. Not the current re-emergence of some cases but after this dies down there is the risk of another future wave in the second half of the year. Such waves were seen in the 1918 flu and the Spanish flu as well. While such risks are real they will always be there in markets and are very hard to discount because they are exogenous shocks. They may not happen. For this reason the market will only react to it after it stare’s them in the face. They sometimes come and go away. We may just slowly adjust to the new virus regime with more and more stimulus to avoid financial market pain. What we cannot wish away is risk. So we will use the charts to manage risk technically.
But on a 2-4 year time horizon apart from the near term risk the big picture should follow the Reflation narrative as of now.
So every time there is a shake up in global markets we will get a correction here in the Nifty as well but all we can do is manage it with levels.
So first let me highlight the near term risks that everyone wants me to talk about. I will start with the short term chart.
Nifty is trying to make a higher high but till it goes past 10553 bears can make one last argument that this was wave B and we are going back to 6000 or to retest 7511. The daily momentum in sell mode as of now we can say that if 10300-10250 breaks we can go back to 10100-9726 as a normal correction back to the lower Bollinger band. The bull run will resume afterward.
The second scenario is that this we are forming an expanded flat from the 10328 high and maybe longer term we are forming an ascending triangle from the low of 7511. An expanded flat means we can go near 9290 on the way down, and if we retrace 61.8% of the rise at 8685 it maybe wave C of the triangle. This scenario plays out if this is a slow and unfolding recovery with pain in between. Bad news good news interplay keeps us gyrating for long.
The worst case outcome is that we end wave B at 10553 and wave C down starts that goes back to the swing low long term near 6825 or lower before making a longer term bottom. Such a big move down now would require a major event to occur, chose your pick. I will only consider this after the technical picture is damaged on daily and weekly charts rather than prempt it.
After years of playing the bear on the front foot after the crash in business groups sectors and midcaps that I called over the last 4 years I feel less inclined to be bearish on a front foot and to stay on watch for Reflation. That was my strategy in Jan-Feb of this year as well. At the end of FEB I confirmed the larger crash but not at 12300. However in Sept I called for a move to either 11600 or 12300. Then too I was rising a possible reflation after the economic slowdown that had already taken hold. The pandemic ended that scenario. Now the scenario is again alive and with more support from governments that it should be ignored. So yes if we start making lower tops and bottoms and weekly momentum rolls over I will go for 6825 but not now. In the interim I will use the levels in the short term to manage risk on trades till then. That is it.
Now My Story!
All the above bearish technical picture is to satisfy people who have been messaging and calling me about the bearish alternate in the Nifty. What if 10200 breaks and what if 9800 breaks? At what level will you give your view for 6000? Yes I am still getting this question very often online. The answer is if weekly momentum rolls over and if the dollar index breaks out on the upside I will change my view to outright bearish again. If the rupee goes past 76.40-77 again v/s the dollar we have a problem but in a rare situation both Nifty and USDINR can rise together. Lastly if the pandemic starts an official second round after normalization then all bets are off on the bullish outlook.
If none of the above happen I feel that every correction small or larger to 10200 or 9800 will get bought into. We will on weekly charts continue to form higher tops and bottoms that can be marked as the early start of a new longer term rally to be marked as 1-2-1-2-3-4-3-4-5 on the way up. It is possible we form a leading diagonal as well in wave 1 if it does not go past 10820 in the small wave 5 channel and sells off again as shown in this chart. After that wave 2 comes back to 9545 and then goes up in wave 3. However my current wave counts are on line of wave 3=1 being achieved at 11200. Then wave 4 and 5 complete an impulse.
A larger correction may come after a 5 wave rise. This scenario fits in with the following. I understand that the Covid situation is very volatile and unpredictable. Spoke to someone at ICMR and the conclusion of the discussion is that everything today is an experiment. There are no known's. There is no certainty of a virus vaccine as there are none against previous strains of corronavirus. So most of the fighting is left to our immune system and antibiotics etc. It is also not clear if antibodies will develop inside us or die down risking future infections later. And it is very much possible that many people develop immunity and the virus gives up eventually. The end game is not known. This whole process is one step forward and two steps back. So markets do not really know how to respond to the situation. The only way then to read into it is by looking at the technical picture both on price action and sentiment and trade accordingly. I think if something bad is the outcome that too will be known only in the second half of the year when experiments fail. So between hope and despair there is a cycle. So I will trade this on the trend and watch sentiment indicators that I discuss later and strongly favor more upside. Later in the second half we may see a reaction downward in markets if things do not work out. But there is no known good or bad news as of now from Covid, the biggest risk factor.
But there is some hope in this data below. The reason some parts of the world have high rates of cases like Sweden is that they are taking the risk of allowing this to work out by avoiding a shutdown and keeping the country open. This chart shows how despite high cases they have a falling death rate as the hope against this fight. So while lockdowns were an experiment at ending the virus, this is the opposite case of no lockdown to ending it.
Another measure of the same looks at the per capital infections, meaning infections per million people and here you have both US and Sweden. So while the media is chasing numbers that capture headlines they miss the truth below the surface that we are learning to live with it at a lower death rate. More testing is showing more infections but not everyone is at risk right away.
The US markets may have fallen but the S&P 500 is where it was in May 2020, from where it rallied. At the lower Bollinger band. So this looks like a normal correction so far that can end in 1-2 days and resume higher from a higher bottom. Unless that trend of higher highs and lows breaks I should think bullish. In fact a large part of Fridays fall was on Facebook losing one months revenue from ad withdrawals by some MNCs but they may work things out over the next few days so keep watching.
Why Think Bullish?
Sentiment. This is what has happened in the markets over the course of the last 3 months. This is the Note that was to be published in Media and I discussed on CNBC on Friday.
We have seen one wild rally from the low seen in March 2020. The move has come from a time when FIIs were net short (-173133) at the start of the month of March. At the 8055 low Nifty in April FIIs held a short position of (-63014), then again when the market fell in May to 8806 the short position went to -45470. The most recent pullback to 9544 saw FIIs build a max short position of (-7774) contracts on the 15th of June. The higher highs in the market involved smaller and smaller short positions. Now as the market goes on we need to watch out for the opposite behaviour. Do FIIs go from short Covering to outright buying into the long side? So far as of Friday night the data shows they added back some shorts and are -17k contracts short. That is not big yet. But this alone is not the entire picture.
This negative sentiment is even more extreme in US markets where the Commitment of traders report shows that Managed money or Speculative accounts accumulated a maximum short position of (-303.3k) on 19th of June. The data is released weekly and this is the highest short position since 2015 just before the start of the Trump rally with a reading near (-290k). The highest reading was after US debt was downgraded in 2011 by one rating agency with a reading of (-383K) contracts. These are the 3 highest readings since 2009 and each was followed by multi month rallies in US stocks. It needs to be seen if the same repeats.
While all this was happening the dollar has started falling easing pressure on emerging markets. Most EM currencies have strengthened by a large margin but the USDINR is lagging behind on this front once again as seen below. In March USDINR was the last to go up. Now the INR was not getting stronger till now. The INR strengthened by almost 40p on Thursday. Major Nifty rallies are associated with periods when INR goes up [meaning USDINR goes down] a lot and that might have just started today. The table shows USD pairs to compare how low against each pair the dollar fell this year and where it closed yesterday. Most have recovered significantly compared to the INR. In fact most have recovered their losses for the year as well and we have not. I think we need to catch up and will with a lag as always.
Low for 2020
Now here is one that supports the idea of a short squeeze in India very strongly. It reflects that in India too sentiment is extremely bearish on stock markets.
The last chart here is that of the 30 day average of the Nifty Premium/Discount calculated daily. This is the difference between the Nifty Spot and Nifty futures price. A discount usually means that public is at large short on the market [unless there are large dividend payments- usually in June of the year]. A premium means everyone is long. The chart shows a multiyear record low in the reading was reached in March 2020 when the Nifty crashed almost 40%. So by now everyone should be bullish right? Wrong. There is record short in Nifty based on this data again.
The discount in Nifty futures is as low as it was at the March low, which means that the public is as bearish today as they were in March. It is surprising this short does not show up in the client and FII data. But the futures market trades everyday and the discount does not tell lies. Someone is short big time. You can argue back saying that the smart money is short, but that would usually show up in client data. History shows client data [not FII] has the max short at each major market top. Client shorts however came down at he 2019 Modi election top compared to previous occasions but it was short. Recently there were some shorts at the short term highs in Nifty at 9880 and 10336, but on Friday the report shows clients Long by 33156 contracts. Now of course market can fall till they add more longs and then we get a better short term bottom. But the data on this chart today is not at either extreme to say anything. So if smart money was short big it should show on this chart as a major short like -100,000 contracts short. But nifty futures trade at a crazy discount. The short is by dumb money is my view.
You can also argue that the Open interest in index futures is lower today than maybe in FEB. But that to me is irrelevant. If you are willing to sell something at a discount it reflects your opinion and thus the sentiment on the street. That is the relevant information. This is a market people are willing to sell even after a 3000 point rally with a vengeance. I am sorry to say that market is unlikely to oblige except for short term corrections. Many tops and bottoms have formed along with extremes in futures market. The total futures open interest was down from 144k to 70k during the crash from Jan to March, but is now at 116k crore from March to Jun.
The next chart shows a longer term chart of the data. In Jan there was a very high premium and the market peaked now there is a huge discount. What is surprising is that the discount re-emerged after a rally. In 2009 March when we had a bottom the discount went up because the Nifty did not fall to a lower low but midcap and bank indices were doing so and that drove the negative sentiment. This time after a rally the negative sentiment is off the charts and never been seen before. If the market crashes from here it will be a case of bearish positions getting paid. A rare event. If history is any guide the US and Indian market positions indicate that all dips get bought into and short covering then keeps driving the market higher for months to come.
Another signal that is often indicative of market strength is something called the Breadth Thrust. A powerful rally is one that is driven by strong participation from stocks from the broad market. When that happens the Advance/Decline average goes through the roof. After a bear market ends often the first rally is accompanied by a Breadth thrust where even junk rallies like crazy for once on the hope of a comeback. This strength indicates that the worst is over. There is a history to this and we can see many such thrusts on this chart of the 40 day average of the A/D ration from 2000. The current thrust has brought us back from the lowest reading since 2008 to near the horizontal orange line. If the midcap indices continue their moves up as they have been doing then this indicator will end up at new highs. So there has been a thrust but it is still not showing up on the 40 day average of the A/D ratio below
How about the 20 day average of the A/D ratio. yes very high and that can give you short term peaks. But same conclusion. After strong thrusts the rally goes on even as A/D has negative divergences.
The strong reversal in breadth comes after a 2 and a half year midcap bear market that ended at the lower end of the Relative strength cycle. This chart shows the RS of Nifty Midcap to Nifty 50. So the cycle peaked in 2018 and is now at the bottom end with a positive divergence in the ratio of the two. Time for a reversal upward again.
The above 2 charts of A/D and RS have promted me to consider the long term case for a pending 5th wave in the BSE Midcap index with a rising channel as follows. This is the long term picture on the monthly chart. It does not account for near term volatility due to news flows etc but looks at the larger fractal based on where we are on so many counts and indicators. Like the recent low is at the monthly lower Bollinger band as well.
Similar pattern is seen on the Auto index
This makes me look at a wider index that includes more stocks like the BSE Allcap index on a yearly chart and it shows wave 4 complete and wave 5 up could be next.
The long term chart of the Sensex shows the changes in wave count. Wave 2 remember ended in the 1950s and we started a 3rd wave in India that ended in 2000. Wave 3 ended for many sectors by 1994 itself. Wave 4 ended from 1998-2001 for stocks and the index. That is also called the Economic Summer phase. The Autumn bull market based on Consumption started in 2001 and is going on in stock market terms. The economic winter is already here in economic data but the stock market and economy have been going opposite for years now. We are getting into one more round of that in wave 5 of 5 that can make new highs in the Sensex or Nifty again. After that the real Supercycle bear market may return. The event based on the dollar cycle could be 2-4 years away.
On these lines the long term wave count on the Nifty is as follows. Holding the lower 2-4 channel line which is now closer to 8200 can go to the top channel line near 18500 is everything turns out well. 5th waves can end early but lets see. Since wave 3 circle was smaller than wave 1 in size [not time], wave 5 will be smaller than wave 3. However given the change in the volatility regime we may get there faster. So expect a swift and fast wave 5 up once it takes off.
The main hurdle to the swift and fast 5th wave is in the short term where we are dealing with the pandemic and some geopolitical headwinds. Once we get past that phase of noise and a few wild corrections we should be on our way to higher highs.
The long term view on the dollar changing I might also change my wave counts on the USDINR to a valid outcome that ends the bull market that started in 2008. Note that the last bull market ended in 2001. After that the dollar index was in a bear market and the USDINR went back to 38. The 2008-2020 bull run in the USDINR may have ended with the 5th wave forming an ending diagonal as shown. I did not consider this earlier for some reasons but it is the best wave count that completes this 5 wave advance. Even better is that if I take it this way wave 5=1. So while the dollar index has its bear market so can USDINR go for a retracement of this 5 wave move. Only later a new USDINR bull market will start. This ending pattern explains the 3 wave up move from the 68 bottom made a year back. Wave E is 3 waves. The implications of this wave count are that we can go back to the swing low of wave D or B or even the wave 4 low of previous rise near 68, 63 or worst case 58.
The implications for this long term for US stocks is also similar. The S&P might have a 5th wave up pending. The chart of the NASDAQ is marked accordingly. Now on this chart you are at the top end of the channel again and that can cause a lot of concern. Is the 5th wave over?
I do not want to jump to conclusions as 5=1 can go much higher but also because what the chart below shows is that markets and earnings can deviate for long periods. That is happening right now. is that a reason for the crash to start tomorrow morning. The last time that happened was the tech bubble and it went on.
So here is a quarterly chart of the candles for the Nasdaq. Before the last multi month crazy rally of the tech bubble started in 1998. What you see is an unusual candle set up. An engulfing bear followed by an engulfing bull candle. That was a steep correction as well but the bull candle took it out for a final crazy move that as above chart shows was not logical fundamentally. The quarter ends in 2 days from today and we may end up with a similar candle setup. A Engulfing bull candle after an engulfing bear candle. The bulls just eat up the bears into a new illogical rally. Illogical on fundamentals but as I stated there is the dollar reflation to consider.
This months note spends a lot of time on India as that is my immediate concern. Will post an update soon as a follow up for long term counts on Gold and other asset classes separately.
It is very clear to me based on Sentiment data and my feedback loop that everyone is bearish and that is the best reason to remain on the bull side of the argument. Add to that the idea that Midcaps have bottomed and the breadth is very strong on the upside. Add to that Global Macro, the dollar is starting the 3rd wave of its 7 year bear market that means 4 years of no dollar problems. All this together is a very bullish mix for the medium to long term. All you have to do is mange the near term risk that comes from news flows. Keep an eye on exogenous events if any and manage them with levels for the rest of this year but any knee jerk reactions should still end up being part of a larger trend on the upside. Something really big has to happen to break this bubble as of now. Else bubbles will end on their own weight when the time is right. Not when everyone is short but when everyone is long to the moon. That is the opposite end of the spectrum.
Can I be wrong? Always any day and will always look back at my risk management tools to manage that or change my view. But till these broad factors are in place the larger bias is now for the upside. In the near term watch out for the possibility of the greatest short squeeze rally globally if the position data is anything to go by.