Friday, January 29, 2016

Outlook For CY 2016

Belated season's greetings to all. Due to personal reasons, I could not update the December post on time. This post not only aims to give a perspective for Jan '16 but overall for 2016 as well

The Nifty opened 2015 at 8272 and ended 2015 at about 7950. The high was almost 9100 and the low was 7540. In statistical terms, this effect is called regression to the mean. 2014 was an outstanding year with gains exceeding 40% on both index level and stocks were a different ball game all together and midcaps were roaring. After such a fantabulous 2014, it was fairly logical that the index will take some time to pause [The normal 5 year trend on Nifty is about 15% to 20% CAGR]

We see this all the time in day to day life as well as specific sectors in the industry. Sometimes core manufacturing is the darling of the market and IT lags behind or sometimes it is the other way around. People are talking about GST kicking in and benefits due to accrue etc but most of all that is already in the price. The commodity crash has been severe though India has not been able to reap too much benefit due to significant rupee depreciation against the dollar. 64.25 was a firewall breach and 60 is the new 40 [in the 2008-2012 cycle, 40 was the base when breached first assaulted 44.25 and then 48.25 finally finding an interim top at 52.25]

Even before I get to the specifics for Nifty, I must mention that commodities are in their last phase of the downturn. The dollar index has in all likelihood topped out for now and will make a slow retreat towards 85 levels and that will boost prices. Crude almost always works around a weighted average price of 65 dollars a barrel in a 5 year cycle. That was the reason why I was bearish on crude when it was in 3 digits in dollar terms and was anticipating a move towards 65 last year. However, the accelerated fall after that was certainly not anticipated and I can stick my neck out and say that it is not sustainable.

The cost of production itself in most countries is almost 30 dollars a barrel whilst in regions like North Sea, it is much higher than that. Fundamentalists can talk all sorts of BS about fracking and demand slowdown but it doesn't cut ice. Then there are conspiracy theorists who talk about prices being artificially kept low to tackle Russia, IS etc etc and that also is BS. Prices will find their way up and we should soon be looking at crude hovering around the 65 to 75 dollars a barrel mark.

For the base metals as well, prices are in the last phase of fall and the only way is a gradual upward move. Note that upward moves take much longer as compared to falls.

Let us start with Nifty first
Nifty typically has its cycles timed as per general elections. We saw that when it made a top of 6357 in Jan '08 [a bull market uptrend that started with UPA 1]and the technical bottom for that was around 3900. The Lehman brothers crisis took it to almost 2250 levels and prices quickly bounced back towards the technical bottom. May 2009, UPA 2 comes into picture, QE1 comes into picture and Nifty again made a top of 6339 in Nov '10.
The corrective phase continued for a long time, a bottom finally formed at 4550 odd levels and the fresh upmove began. The next major phase of  upside came post-May '14 when NDA came into power again. Time and again Nifty has proven to go through the general election schedule with large moves coming when a new powerful government assumes office and then go through a corrective phase in terms of price as well as time.

I think that is going to be the case again this time and whilst there will be a lot of quarterly swing peaks and troughs, I have my reservations as to whether Nifty can make a fresh high in 2016. Its all about individual stocks for now and based on my commodity evaluations, stocks with core commodity products are the ones that have the highest alpha factor i.e. gains in these stocks will most likely outperform the index by a huge margin over the next couple of years.

The problem with most people in general is 'wrong anchoring'. Most people have anchored themselves against the 2014 performance and are feeling jittery about the way markets have panned out in 2015. Also, the index level is masking a critical fact that there are a lot of stocks that have corrected upwards of 20% to 30% in 2015 and hence a weekend review of the portfolio shows blood red returns. On the other side, the IPO market is booming with gains upwards of 20% to 40% on the day of listing. Whilst our television anchors are cheering that and business writers are gung ho about the arrival of the retail investor market, I would take this as an alarm bell.

Although I did not participate in markets till 2011, the signs that I see are ominous. Every possible red flag is being ticked on my fundamental radar
IPO market boom: The 2005-2008 period saw an IPO boom. Stocks were valued like crazy; remember the like of Shri Renuka, Educomp, Suzlon, DLF, HDIL etc etc? Where are they today? It was on the basis of these stocks that trade pundits had signalled the arrival of the new age of retail investors. Most of them vanished by 2010
There is a strong correlation between retail investors entering the market with imaginary clubs and swords to conquer their way to wealth and then see the market correct big time. [Statistically, only correlation can be established not causality]

Then there is this frenzy about anything and everything digital and online. We saw what happened in 1999-2000 with the dot com bust. Anything and everything with a dot-com was valued in hundreds of millions and billions. Then came the big crash. This time, a lot of people are talking about how it is different and we are looking at an app-based mobile themed users, better awareness etc etc etc. Whilst I totally believe that technology is an enabler and that it can help us do many things with minimal effort, I am not convinced about the crazy valuations being attributed to the firms engaged in this business. We have already seen what happened to Zomato, Tiny Owl, Housing etc.

For every Flipkart or Snapdeal that is successful, there are at least 90 other failures out there. Last but not the least - all support services and businesses like retail, facilities management, capital markets are fundamentally dependent on core industry performance. Unless brick and mortar businesses do not thrive, there won't be a financial economy for services! Another thing that is bothering a lot of 'fundamental analysis' experts is that why are stocks going down when low commodity prices are not triggering a gain for stocks as margin expansion is so very evident

There are 2 parts to answer this question
1] Markets discount the future well in advance; most of the perceived gains by low input costs were factored in stock prices well in advance

2] Velocity of Money: Remember that at the end of the day, all major commodity settlements [Gold and Crude Oil being the highest] are done in USD. The low oil prices and relative dollar strength have depressed significantly due to the commodity price crash. The lesser the dollars flowing through the economy, the lower the liquidity in the system.

Although it sounds counter-trend but money flow is very critical to prop up markets. A lot of positive returns on stock and bond markets have been already deployed into real estate globally. The lower commodity prices have taken liquidity flow out of the global economy like a sponge that absorbs water. Remember that both governments and banking systems are heavily dependent on commodity prices. The oil revenues maintain flow of dollars and are an easy source of tax revenues for governments. Oil exploration being a capital intensive project means that debt levels of upstream oil companies are significantly high. A large chunk of recent loans were raised with expectations of oil not breaching $75 dollars on the downside. With the current oil prices, firms are not able to breakeven on their variable costs; forget taxation and debt servicing.

So for fundamentalists who expect lower oil prices to fuel the economy, its not going to happen. And time and again I would like to remind readers that we have been through this commodity price crash. 2001 was the lowest point for commodities and so was 2008-2009. Neither the bonanza of upside can continue uninterrupted nor the gloom at the lower end. Last but not the least, certain minimum prices of commodities are vital to keep liquidity in the government, banking systems and also for jobs

Now let us come to Nifty and BankNifty

Nifty has very strong support in the 7200-7400 as rightly pointed out by a lot of experts. Now some of the top notch experts have been calling for 6900, 6600, 6300 etc. Whilst I cannot say with certainty that it will not happen, that would be a Black Swan Event. There are a couple of experts who have rightly likened the correction to that in the 2010-2012 period

Recap: Nifty made a top of 6339 in Nov'10 and went into a corrective mode. The large moves unfurled as follows
6339-5690-6181-5177-5944-5196-5740-4728-5400-4531 over a period of 13 months from Nov '10 to Dec '11
[13 months of correction]
Also note that barring a few large swing sessions in either direction, bulk of this correction period was actually spent in a range of 5400-5600


In the current scenario, Nifty topped around 9100 levels in Mar '15 and has been making lower lows and lower highs. Based on similarity of patterns, I am inclined to believe that 7200-7400 [give or take a few points] is the most likely technical bottom for now and corrective bounces are likely from here.

In terms of time, 13 months from all time highs will be in mid-April
Now recoveries may take time as moving up is always difficult compared to moving down. I also do not believe the contrarian view that we can see a fantastic year for equities and old highs will be taken out etc.

For those who are crying bearish; the last time we saw USD-INR in the 68 price range was in Aug-Sep '2013. Nifty was at 5100-5200 levels at that time. Today it is at 7200-7400 range
It all depends on where one is anchored
The bond markets and banking liquidity is largely a factor of confidence. At the same pitiable USD-INR exchange rates, current index levels are much higher and that speaks for itself. The problem with the bears is that they are anchoring themselves in the 8600-9100 [and perhaps a lot of retail investors too as they tend to buy at tops]

On the other hand, there are some leading stocks that are back to price levels when Nifty was correcting earlier in the 2011-2012 period
SBIN - From highs of 3200 in 2010 came all the way down to 1500 levels but spent most of its time in the 1800-2200 range

Taking into account the 1-10 stock split, it is exactly doing that now

Tata Steel: It did not break 195-200 range on a weekly basis in the previous correction. Right now also it has shown no signs of breaking down below 200

So what do we really expect for 2016 here on now that Jan is almost over

The Bear Camp: Shankar Sharma, the Big Bear of India [who rightly called the crashes earlier as well] has said that we must not rule out Nifty retesting the old top of 6338-6357

The Bull Camp: Mahendra Sharma, a perma-bull has called for a Nifty top of 9500 in 2016

My humble 2 cents
Barring Black Swan events, I neither see any significant downsides from current levels nor do I see any new highs being made. My unequivocal stance is that things are not as bad as they are pointing out to be nor things are as hunky dory

In terms of price we may have bottomed out for now or maybe - just maybe have one more flick down before starting a counter-trend rally to the larger correction of 9100-7200
A minimum 61.8% upside will mean that we should be able to visit 8200 levels over the next 6 months. Barring some large swing sessions, we are likely to trade in the 7400-7800 range [lowered from my earlier range of 7800-8200 based on current price action]

The large upside trigger in the short term for India is the Union Budget and GST
Another major trigger will be the USD-INR exchange rate
Time and again I have mentioned in my tweets that 64.25 was a firewall breach.
Now, the faster we move back to 66.25 and ideally 64.25, the faster will be the recovery in indices

FMCG will not be that big a game changer now as it was earlier
Patanjali has made great inroads into rural markets where it has a dominant price and perception advantage. Also the entry of Patanjali has sparked off volume, price and margin contractions on the urban front. So yes FMCG is still going to be a safer haven but the rate of growth will be much lower and slower

Likewise for pharmaceuticals, they will be safe havens but with price controls coming in, the best return days are history

Another thing that one must be cautious about is the stupid commentary that is doled out on tv. Every now and then, there will be an expert talking about 'delivery based buying' and 'delivery based selling'. I have covered this point earlier as well and will repeat it; delivery based can be a large transaction only. If a large delivery based buying has taken place, it means that somebody has offloaded a large chunk of holdings. Unless there is stock available in the market, how can one complete a delivery based transaction?? Similarly, if delivery based selling has happened, somebody has offloaded a large chunk and the transaction is through, there have been buyers. Delivery based volume always is 2-sided i.e. there is a buyer and there is a seller.

Yes delivery based values are critical as it gives an indication whether the security is really changing hands for good or one is just using the leveraged system to trade. At approaching bottoms, usually delivery based transactions gain steam. At major tops, it is rare to see large volume transactions as the big fish like to slowly distribute and palm off their holdings.

'Never ever let yourself be misled by commentary about delivery based buying or delivery based selling has taken place. It is just a high volume delivery based transaction with willing buyers and sellers' [Who is smarter of the two, that only time can tell ;)]

For traders, this is a good time and to gauge medium term trend, one good indicator is the Stock PCR based on FnO BhavCopy released by NSE at EoD. The index PCR is largely a lot of noise as there are crazy option contracts for far strike options on both call and put sides. Stock Options being relatively illiquid in India with only select stocks having large volume transactions on both calls and puts

The piece below is what I use for getting some clue on swings based on Stock PCR
<0.48 -> Bearish. Smart money is betting big on the short side of the market and are transacting heavily on the call side to protect themselves. Note that even the large market players can't predict which way things will go due to numerous uncontrollable events. With the power of big money, they can build short future positions, buy in the money calls and short out of  money calls

Between 0.48-0.54: Rangebound and sideways. In this range of Stock PCR, on a daily basis, one may see a large upside day or a large downside day. However, extrapolate on the weekly basis and one can see that actually the market is not going anywhere big time.

Between 0.55 and 0.62: Bullish - this usually happens when markets are at extreme lows on multiple time frames. Smart money is bottom fishing and buying big time. They are buying in the money puts in abundance to protect the portfolio. Like the bearish case scenario, the risk-reward starts favoring the long side

>0.62: Bearish At such large levels of stock options, it is extremely bearish. Even smart money is in panic mode and is desperate to protect the portfolio and minimize losses

Note that these are some guidelines I use basis some inputs from a very good friend. It is not a bible and not cast in stone. If one observes the falls that started in early Dec '15, large downswings started from the day Stock PCR hit 0.68. Just when things were beginning to look good with retracements of falls, Stock PCR nudged towards 0.45 triggering the next major fall.

This is just one cursory indicator - the main paramters will always be Price, Volume, Time and technical indicators like MACD, RSI. However, Stock PCR does help to keep a nimble approach. And the fact of the matter is that almost 50% of trading days are in range-bound sideways trades!

Now one of the critical questions is what to buy???
This is a time to be stock specific and some stocks are in sweet spots for accumulation

SBIN - 140-180 is accumulation zone for targets 300+
ICICI Bank - 150-225 is accumulation zone for targets 400+
Axis Bank - 250-350 for targets 600+
Tata Steel - 150-250 for targets 350+
Hindalco - 50-80 for targets 150+
Cairn - 80-150 for targets 250+
ITC: 270-320 for targets 425+

Note that these are on a longer term basis with a 3-5 year horizon. There are many more that I will keep posting through Twitter. Also note that I have personal holdings in some of the counters mentioned and have advised people in my network to consider accumulation in the given counters

So enjoy the roller coaster ride of 2016
There will be some more updates on the basis of Statistical correlations that I will post in the first week of March post-budget

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