What is happening with the Sensex?

After Sensex hit the low of 7700 on Oct 27, we saw a sharp bear market rally that took the Sensex up to 10950 in 6 trading days. Thereafter the downward movement resumed again and we saw a higher low of around 8400 odd.

If we draw an upward sloping trend line connecting the two lows of 7700 and 8400, and a downward sloping trend line connecting 10950 with the next lower top of around 10500, we get a 'symmetrical triangle' pattern. Today's (Nov 26) trade penetrated this triangle's downward sloping trend line.

What does this imply? The bulls, grasping at straws, may think this is a sign of reversal and an up trend will follow. But the bears have several aspects on their side.

A triangle is a period of consolidation, caused by indecision amongst bulls and bears. It rarely indicates a reversal of trend. Also, the upward 'breakout' was on thin volumes (barely higher than Tuesday's low down day volumes). The advance-decline figure was negative. All these point to underlying weakness.

Since the previous trend leading into the triangle was down, the likely next movement will also be down. The up ward breakout looks like a 'false' move. After a few days, this rally ought to peter out. May be after Thursday's (Nov 27) settlement.

Technical analysis - as I keep harping - is an art and not a science. The same chart patterns are open to different interpretations, depending on the different methodologies used by the analyst. Ultimately, Mr Market knows best. We can only attempt to make some sense of his movements.

Five more things to avoid in a Bear Market

A lot of investors who joined the party from 2004-2005 and haven't really experienced a bear market bought a lot of stocks during the current downturn - specially after the Sensex breached 12000 and then 10000. They are now realising that just because the market has fallen a lot from its peak it doesn't mean that it can't fall even more.

So here are five more things you should avoid doing in the current market situation.

6.  Don't be swayed by the occasional bullish news. They should be noted and filed in the memory, but no action should be taken yet. Instances include the US bail out, the Chinese bail out, reduction of CRR/SLR/repo rates, slowing of inflation. These may appear to be good news and the market usually reacts positively to them. But you must understand that most of these are actually measures to put some upward impetus to the crashing economy and markets.

7.  Don't blindly trust your stock picking skills. You may have picked some real winners during the bull run. So did every one else. Bull runs lift all stocks - good, bad or ugly - to stratospheric levels. Be very careful in preparing your buy list in a down market. Do some 'paper' trading to see if your chosen scripts are going up, down or remaining static during the brief rallies. After some time you will realise which stocks should remain in your buy list.

8.  Don't assume that past performance will get repeated in future.  Just because certain stocks did very well in the later stages of the bull market doesn't mean that they will do well again when the market turns. Realty and cement stocks come to mind.

9.  Don't confuse inflation and capital protection. At times like these, you may be better off locking your cash into a two year fixed deposit at 10.5% and opt for monthly or quarterly interest. You may think that tax adjusted return will be 7% which will be eaten away by inflation of 9%. But a year hence, the inflation rate may fall below 6% (mostly due to higher base effect) and you will actually gain. Plus your capital will be safe. The periodic cash flow from interest income can be used if some unbelievable buying opportunities come by (like TISCO falling to Rs 100 or Bharti going below Rs 400).

10. Don't do some thing silly on a hunch because you are getting bored. This is a great time to actively learn the importance of patience. If you have targeted some interesting stocks (I'm looking at Maharashtra Seamless and Yes Bank), buy a small quantity and keep actively tracking it. When it breaches a previous low, don't jump in. Wait to see how far down it'll go. When it goes lower, wait some more. Till you see volumes almost disappear. Then buy some more.

The Investment World according to JP Morgan

Last Friday (Nov 14, '08) I attended an investor's meet arranged by HSBC at the Taj Bengal, Calcutta. The featured speaker, Harshad Patwardhan, Fund Manager of JP Morgan Asset Management, gave a slick presentation with lots of charts and graphs titled "Invest with Conviction".

Here is a gist of what he said.

* The worst is behind us; however, the pain is far from over

* Economies will contract world wide; there will be deceleration of growth

* Inflation is coming down; interest rates may come down also

* Indian GDP growth may moderate to 6.5 to 7%; China's GDP may be around 8 to 10%

* FII selling has been more intense in small and mid caps; likely reversal of FII flows in '09 with increased allocation to India and China

* Large part of the hedge funds' selling is over

* There seems to be a mood change in the market; 12 months down the line, things will look better

* This is once in a decade - if not once in a lifetime - opportunity; increase allocation to equities

* Invest in companies with 'robust' balance sheets and 'robust' business models

That was the good news. Now the bad - the floor was opened to Q&A.

* The Company Secretary of Exide said that he had visited three different banks including two private sector ones earlier that day. All had been very considerate and welcoming, only to quote terms that no self-respecting organisation could accept. So how can the worst be over? If this is happens to a company of the stature of Exide, what must be happening to smaller companies?

* An elderly investor said that he had listened to his funds advisor at HSBC and invested in JP Morgan's Equity Fund and JP Morgan's Opportunity Fund. Now that he is losing heavily in both and has no funds left, how can he invest more?

* A merchant exporter said that overseas buyers have stopped delivery of orders and there is hardly any movement of outward or inward cargo. So where is the mood change?

There were several other questions in a similar vein. Finally Mr Patwardhan had to accept that things were not quite 'hunky dory'; however prices of shares had reached 'mouthwatering' levels and investors should consider putting some money back into the market.

His plea would have been more credible if he had said that investors should protect their capital by putting their money in a 1 year FD and get back into the market when the first signs of a turnaround was visible.

As the Finance Director of Nicco Corp. quipped: Poor chap, he is only trying to earn his keep. If we don't start buying, he may lose his job!

Five things you should avoid in a bear market

Now that the last of the disbelievers has given up hope, we should have no further doubts that we are in the midst of a raging bear market. So what does a smart investor do in this situation? Avoid making a bad situation even worse.

1. Don't Panic: One can well understand that you may be losing sleep if you entered the market in late 2007 or early 2008. You must be facing serious losses. But do not panic. The world has not come to an end. Your loved ones still love you. And unless you are overleveraged, you will eventually get out of this tough  situation, and hopefully, learn from it.

2. Don't Average down: Just because you had bought stocks at higher prices, you may be tempted to lower your average price per share by buying at lower prices now. That will be like throwing good money after bad, as you may be turning a smaller loss into a much bigger one. No one knows how much lower the market or individual stocks may go, and how long they will stay there.

3. Don't Buy on rallies: Bear market rallies are usually sharp and swift. But bear markets do not provide great entry points, because it is difficult to call a bottom. (Bull market corrections provide better entry points.) You make money in a bear market by selling short. I'm not advocating short selling for small investors because it is a risky proposition for the inexperienced. But bear market rallies can, and should, be used for disposing off non-performing stocks.

4. Don't Buy second or third rung stocks: They may appear cheap and a bargain. But such stocks get even cheaper, that is, if they manage to survive at all. Remember, if you bought a stock that has fallen 50% and now looks cheap, it will need to rise 100% just to get back to its earlier price.  When the next bull market begins, the market leader stocks will be at the forefront of the up move.

5. Don't Trust the media: They broadcast or write what they think will 'sell', and therefore get market situations all wrong. If you have been hearing (or reading) of late that the market has capitulated and we are close to a bottom, chances are that the market will fall some more. Bear markets come to an end when every one has lost all interest in what is happening in the markets.

A Reversal Day

While the the whole world rejoiced at Barack Obama's victory as the first ever African-American President of the USA, the Sensex suffered a reversal day.

A reversal day is a 1-day price pattern usually signifying a short-term trend reversal. We had 5 days of a 'V' shaped move that propelled the Sensex up from the 3 years low of 7700 and was typical of a bear market rally.

Today, the day started at almost the 10950 level but ended at 10120. So, the high of the day was higher than yesterday's while the close was not only near the low of the day, but considerably lower than yesterday's closing level of 10630.

This indicates a strong reversal, which was confirmed by the higher volume of transactions on the BSE. I would avoid buying for the time being.

What the CRR-SLR-Repo cuts mean for investors

Economics and monetary matters are not my strength areas, but a lot of investors must be wondering how all these different rate cuts may affect them. So here is a 'dummies guide' to the triple rate cut dose.

But first, some of the basics.

The Repo rate is the rate of interest charged by the Reserve Bank of India (RBI) to commercial banks who may need to borrow some short term funds against securities. (The Reverse Repo rate is the rate of interest paid by the RBI to the banks who may park short term funds with it. Usually the RBI pays a lower rate.)

The Cash Reserve Ratio (CRR) is a percentage of the total deposits with commercial banks that they need to keep with the RBI.

The Statutory Liquidity Ratio (SLR) is a percentage of deposits that commercial banks need to invest in government securities.

What purpose is served by such means? It is for the safety and security of the funds available in the banking system (which in turn helps investors like you and me). It is also for controlling the supply of money (or liquidity) in the country's financial system.

The Foreign Institutional Investors (FIIs) were lured by the growth prospects of the Indian economy and brought in huge funds (by Indian standards) to purchase shares of Indian companies. Indians working overseas also channeled money back to the country for investments because of the comparatively higher interest rates.

As demand for products and services kept rising, capacities got stretched, and prices were hiked. Industries went in for capacity expansion availing cheaper overseas funds. With higher production the GDP kept rising, attracting more foreign funds.

The increased liquidity - mainly from overseas - and higher prices caused inflation to rise. Initially the government kept ignoring the rising inflation rate till it hit double digits. To curtail inflation, the RBI squeezed the supply of money by gradually increasing the CRR, SLR and Repo rates.

Unfortunately, the sub-prime crisis in the USA hit the world's financial system like a whirlwind. Many of the FIIs who had lost heavily in the sub-prime derivatives markets, started to sell aggressively in the Indian share market.

The outflow of foreign money caused two problems. First, it caused a reduction in liquidity - which had already been tightened by RBI's policies. Second, it caused a fall in the value of the Rupee - which the RBI tried to stem by buying foreign currency, further reducing liquidity.

The banks started feeling the pinch and started offering higher interest rates for deposits and, therefore, charging higher interest rates to borrowers.  Industry found the easy-money taps getting closed - both in India and overseas, and started slowing down their growth plans.

Speculators who borrow money to invest felt the cost of doing business was too high and started selling off. This compounded the selling pressure already exerted by the FIIs. The downward spiral in the stock market got exacerbated when small investors also started selling off.

The several rate cuts over the past couple of months is the RBI's and governments rather belated effort to inject liquidity in the market so that banks can resume lending. Hopefully that will lead to rejuvenating the growth plans of industries and eventually lead to reduction of interest rates.

That would be the first indication that the stock markets are ready to stop falling and starting their next upward journey.