None...yes almost all the bears were dead last month. But the long term lessons must be re-learnt. The slow poison has destroyed many portfolios by now. And this takes you to an important lesson especially if you are an investor. Traders can quickly change their course and adjust to the market realities however investors often get stuck in a mindset.
One common mistake made by market men is to become unable to distinguish between the short term and the long term. For many including advisors, fund managers and portfolio managers their long term view is just as good as their short term view. But I don't blame them and often its not their mistake because its an occupational hazard of being a part of this industry and being answerable everyday. Also the conflict of interest between the stated long term objectives and the demands by distributors and sales to meet short term performance commitments.
What I am getting at here is that when thinking long term it does not matter what is happening in the short term. When you take a macro market call it does not matter when you sold but that you did and are safe. It has been my view that we are entering a Kondratieff winter bear market and that has meant to sell every rise since 2008 from a long term perspective. This is different from trading all the ups and downs.
To make this argument clear I am going to start with an example. This is a portfolio that was brought to me in March 2008. The person was related to the family a widow retired aged women, son who needed medical help. And this portfolio was left behind by her husband. Maybe the background was not needed but this is, it was a long term investment held for years so the view to take was whether to hold on for another 5 years if growth was going to happen or not. By March 2008 I had decided that the bull market was over. In a days time I called her broker to sell everything. Now what I was analysing this week was that the index came back to the 6000 twice in the last 5 years, and when I sold out it was Nifty 5000. So was my action right considering a long term investor? The result is below, note these are not midcaps and unknown managements, these are promoters who don't need research.
The loss to her wealth would have been magnanimous given her situation if the sale was not made. Now the smarter among you will argue that assets should have been reallocated to different sectors for performance. Maybe FMCG stocks. But what we are looking at is the performance of diversified portfolios in general. This is the case for most long only MFs and PMSs. How many have even managed to use right asset allocation to protect/create wealth? Very few I believe. I did a lot of travelling last month and the common feedback I got from investors was that their portfolios were down 40% and with the Nifty at 6000 they were waiting for an exit.
Moral of the story: When the macro trend is down only 10% of stocks outperform, if you know how to find those bottom up stocks and sectors, great you are home, but if not the macro call has to be get out and stay out till the macro trend changes. And the bigger question is how many are comfortable putting all their eggs in one basket, I mean a few stocks or sectors. Most investment advise goes against it. My thinking is that its all about the odds. If you are not into timing the cyclical tops and bottoms every year then you want to hold a good diversified portfolio when 70-80% of the stocks are going up year over year and not otherwise. This also applies to short term trading. In trading we trade the direction of the trend of one higher degree and avoid the counter trend moves. So if overall trend is up buy the declines, but don't try shorting the declines in an up trend because fewer stocks will move against the trend and the odds are against you. Trend moves are straight and counter trend moves are erratic.
Its unfortunate that because the short term trend is positive and news flows also follow in, that is mistaken to make a long term bull market call. I feel analysts in general are in a hurry to call the next bull market, maybe they think they will get special marks for it, maybe its a missed out feeling at work.
Why am I getting worked up about this? Here is the big question that I have been trying to Answer.
Are we in a bull market?
With all the rhetoric about reforms when the trend stretches against you, you have to consider the question seriously. And the answer lies in the answer to the question "What are the characteristics of a bull market"? So recently I plotted a chart of the Sensex/Midcap/Smallcap over each other not just for the short term but for several years and I got an answer which I shared in all my presentation with customers in Jan during by travelling so let me share it here. Using these charts I make the same point above that you want to hold a good diversified portfolio when 70-80% of the stocks are going up year over year and not otherwise. The chart below shows the performance of the 3 indices and you can see that from 2008 onward most stocks are not performing falling more in downtrends than going up during rallies. The Nifty itself coming back to 6000 therefore loses its meaning.
At this point the standard response is that this time things are different. A equity sales person also recently responded to me that that the market is selling stocks that are not doing good business anyway and funds are going into quality, FII flows are going into good stocks. I don't know what they are buying but my definition of a bull market is when the economy in general does well due to which all stocks in general go up and in fact mid/small caps do exceedingly well irrespective of their fundamentals.
The chart of the Nifty and CNX Midcap index during the 2001-2008 bull market above shows that the CNX Midcap started below the Nifty and went far above it a huge outperformance.
Some time back while considering a bull market I used the phrase a late Autumn bull market. So here is what I was talking about. Having lived the previous cyclical bear market or business cycle downturn during the 90's I made similar observations to the ones above and the chart below confirms it. During the 90s we did not have an index with the name Midcap but the BSE 200 was a proxy for the small stocks and is plotted along with the Sensex. The chart shows the BSE 200 that was outperforming till 1994 underperformed all the way to 1998 falling more than the index. It took the IT bubble to bring the fire back into that segment to take it to an all time high. So during the last segment as steps were taken to trigger bullish sentiment the only hope was that loose monetary policy is used to trigger a bubble that would have the same impact as Y2K. That did not happen and the opportunity appears to be behind us now. Such a bull market at this stage would have been a late Autumn bull market, like the ones triggered by monetary policy in the US.
Where do we go now?
So enough history lets get down the the technical position of the market and the forecast. We are in budget month and the markets will always try to build some pre budget momentum but given that we just witnessed a 5 wave decline in the market the rally before the budget should turn out to be another selling opportunity.
The medium term trend has reversed clearly. Many stocks are supporting trend reversals by breaking key support levels. The market made a top which is as expected an X wave. With that we have entered a new bear trend that should last for at least 12 months. Given that the index is now in wave Z down and that the last 2 years we have spent a lot of time at the upper end near 5000-6000, the lower targets below 4700 that were forecast and not achieved before will all be achieved at once. Speed on the downside should slowly increase as in Z the last bation of the bulls should cave in leaving no place to hide. Of course defensives can out perform but that does not mean they will go up but just fall less.
The updated wave counts are shown below. The overall pattern since 2008 is a triple top with higher bottoms like in a triangle, the lower trendline is at 5500 in the Nifty.
Getting to more exact immediate targets. There are two channels at play as shown below. The target of a broken channel is the size of the channel below the break down point. The first channel target is near 5537. The 4th wave low is also 5548 and the lower Bollinger band on the weekly charts is 5535. So this is a good cluster support where the market might try to bounce back in a counter trend rally. The bigger problem is the potential of the market to break the larger channel for 2012. Some stocks in the metal sector and the midcap index have already reached the lower end of the one year channel and the small cap index became the first to break the lower line. The wave count suggest that that the next leg down should eventually break the channel and the line is at 5250 and the target is 4400. We will review this situation in the months ahead as it develops. Right now 5550 is the first target and support level to overcome.
Will Midcaps do well in the year ahead. The RS chart below shows that midcaps remain weak performers since 2010. And after the recent rally the RS faced resistance at the same level from where midcaps sold off again. There is a lot of room till the RS falls below the lower end of the 10 year range for the indicator of relative strength. An interesting time phenomena for the above trend was that wave 1 was a month long wave 3 was two months long and wave 5, 3 months long.
The currency[USDINR] I repeat for the nth time is in a long term bull market. Wave 3 started in 2011 and is spitting. The splitting just pushes up the potential of the long term target over 3-4 years to 90+. But in the near term it took support at exactly 61.8% where I have marked wave 2 for a second time. Note each of the rallies during the last 2 years were 4-5 months long so the next wave 3 up will take a similar 4 months to form up to May 2013. Target should be minimum 62 Rs. and in case of extensions which in wave 3 are likely up to 68 Rs. The trendlines make the pattern below look like a triangle but triangles do not occur in wave 2 and the wave count is impulsive for the rallies.
Globe trotting
Lets start with our favorite bouncing bad. China. Some say its in a recovery but I think its going to test that theory soon. Near the wave 2500 levels from where it fell. Since the decline was impulse I have marked it as A and current rally B. If the Shanghai composite stays below 2500 I would be right and wave C would take it down to much lower levels before a real bottom in the Chinese stock market closer to its low point before the bubble started in 2005.
We love to look up to the US so here is a US chart which has achieved the target of 1520 near the upper end of the ending diagonal identified in November. This pattern is complete however the trend will reverse only when it reverses. The recent weeks the S&P has made very small moves near the upper line as momentum indicators roll over into sell and diverge from price. So we need to be patient.
Several measures of sentient in US markets confirm this possibility. The following graph courtesy the February Elliott wave Financial Forecast will in one look tell you how dangerously poised the US markets are.
US Dollar made a series of impulsive rallies last year which I marked as a leading diagonal. Wave 3 has finally started and should mean a 12 month long dollar rally. A breakout above the triangle at 80.5 means start of wave 3 with a minimum target of 90.5. Note how a currency at a time is falling off against the dollar. The Yen and Sterling are leading the way. The Euro just joined the party and the Aussie dollar Canadian dollar Singapore dollar are waiting in the wings.
Lastly US 10Year T-Notes completed a wedge like formation missing to reach the upper line. The structure appears complete on wave counts at a lower degree and yields have accordingly started going up. As this trend matures and confirms more upside in interest rates it will become a source of worry for the markets in the current year and needs to be watched closely as a fear indicator rather than a risk on indicator. In the past lower bond prices meant a risk on trade. But given the size of the bond market and the need for lower interest rates this trend will be self defeating.
Conclusion
The medium term trend is down. The trade is sell on rallies. We enter the worst phase of the 5 year old bear market where the last bastion of the bulls gives up. Investors need to prepare for equity asset protection by an exit or appropriate hedges. The global equity markets are overstretched based on sentiment indicators and will fall fast once the rally completes. The currency and commodity markets have taken the lead in reversing trends. US interest rates and US dollar are going to be the biggest threats in the months ahead to asset prices. The only investment I recommend is USDINR and one way of holding it is by opening a foreign bank a/c which today allows you to move upto 200,000$ outside, use the facility till RBI permits it.
