Notes from the USA (Aug 2011) – a guest post

Going through last month’s introduction to KKP’s guest post gave me a sense of deja vu. More fear-mongering from the TV channels – this time about hurricane Irene. Flashlights, batteries, drills were flying off the shelves at Sears. Home Depot had set up a ‘command center’ with a large number of computer terminals and phones (reminded me of the NASA command center!) to ensure customer requests from the entire east coast could be attended to, and supplies provided immediately through a fleet of trucks on standby.

Doomsday stories about the economy got relegated to the back pages after the damp squib from Bernanke. But KKP thinks that the economic situation is of genuine concern, with a possible relapse into a recession. At best, it might turn into stagflation – where inflation remains low, but low interest rates do not attract enough spending.

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Why is US Economic Data CRITICAL to our Financial Health?

I’m sharing a lot of information from multiple angles here…..Pay close attention since the picture is saying a 1000 words below.

A lot of readers of Subhankar’s blog might not realize it but the big-dog still is the $15Trillion engine in the US that continues to spend beyond their means every year. This is ‘huge’, and ‘unparalleled’ to any other economy. Until there are other economies that ‘spend’ as much as a percentage of GDP, AND, import it from other nations, it is going to be really hard to avoid the cold, sneeze and flu linkages (‘when US gets a cold, rest of the world gets a flu’ syndrome).

Just look at the statistics of how many people earned more than $200K per year in income! Four million tax returns showed income more than $200K per year. 26% of the big-tax-paying-people of the full US population earned $2Trillion in sum-total. This is a wealthy nation currently, and hence very spoiled with the spending patterns, debt levels, and problems arising are also of significant proportion/magnitude. Expenses are relatively low for the basic needs; in my area, milk is still $2.25 per gallon, gasoline is $3.50 per gallon, 2 piece sofa is $599, 42” LCD TV costs $399, mid-size car costs $16,000, good pant/shirt combo is $25, vegetables are $0.39-$1.50 per pound, and finally, cost of school is approx. $300 per year (housing taxes pay for school).

In researching the cause and effects, and the current state of the economy, I came across a unique chart that sums up the PFI (Philly Fed Index) and UoM (University of Michigan) Index. This chart is very interesting and thought provoking on what is coming down in the near future - especially if you map it to the previous recessions/slow-downs.

The Bureau of Economic Analysis's (BEA) second estimate of second quarter 2011 U.S. Gross Domestic Product (GDP) was reported to be 0.98%, continuing their recent trend of revising previously reported economic growth rates down. As a quick reminder, the classic definition of the GDP can be summarized with the following equation:

GDP = Private Consumption + Gross Private Investment + Government Spending + (Exports − Imports)

So, we are entering the phase of a recessionary time and we need to brace ourselves. I have been talking about this slow down since I just do NOT see:

• Job market improving
• Salaries improving
• Corporate spending improving
• Attitude of corporate buyers still very conservative
• Housing market pretty much in doldrums / recession
• Investors talking about ‘what to buy’
• Investment choices in the market improving
• Commodities still grabbing market share of available funds
• IPO market improving
• Consumers opening their purses to spend ‘openly’

Housing is still terrible. Existing-home sales were bad recently. The inventory of homes-for-sale grew, even as mortgage rates are at all-time lows. A 30-year mortgage is at 4.15%. It is possible we could see a 30-year mortgage with a “3” handle if we slip into recession. That is going to really help since it will reduce the mortgage payments for a lot of people. It is too common to hold mortgages on houses even if you are 60 years old!

If you follow the curve above, you will clearly see the Activity index going down into the deep end, and therefore, we will see the effect of this in a lower to negative GDP very soon in 2011.

The above chart is a good predictor of the recessions, along with the Laxman Achutan ECRI report that I have posted previously. Even the ECRI noted that it was because two of the financial components added to the positive numbers there seemed to be a temporary positive effect. One was the sharp rise in M2 money supply. But a lot of that is because people are going to cash (I am present in this list as a micro-drop), which is not all that positive from a macro viewpoint. The other is the steepness of the yield curve, which is being manipulated at the short end. But, the key is yield curve is inverted, and inverted yield curves are a perfect venue to predicting a recession. Without these temporary positive contributions, the index would be down and, down three of the last four months, and in a pattern that led to a recession in late 2007.

US is all about driving around for everything since it is so large and geographically dispersed without the appropriate rail/bus system (outside of the top 100 cities). It is not unusual to drive 50 to 75 miles per day to get to job and back, with the average of 12,000 to 16,000 miles per year per person (not family). Therefore, above curve down in the chart shows the true effects of the loss of jobs, which reduces the number of cars on the road and shows the reduction in activity, consumption and therefore, justifiably a lower GDP on the cards in 2011-12.

For investors around the world, this is a sign of worry that needs to be treated seriously. I have been talking about it and reflecting in my portfolio holdings (mostly in non-US currencies, fixed income investments, and a handful of small dividend paying instruments in the US). For the Indian portfolio, it is pretty much 30%-40% in cash holding, with the rest of them being part of a long term (hold) portfolio.

What do you think about your own financial health situation in 2011 and 2012?

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KKP (Kiran Patel) is a long time investor in the US, investing in US, Indian and Chinese markets for the last 25 years. Investing is a passion, and most recently he has ventured into real estate in the US and also a bit in India. Running user groups, teaching kids at local high school, moderating a group in the US and running Investment Clubs are his current hobbies. He also works full time for a Fortune 100 corporation.

Stock Index Chart Patterns – S&P 500 and FTSE 100 – Aug 26, ‘11

S&P 500 Index Chart

In last week’s analysis of the S&P 500 index chart pattern, I had observed that the index was trying to stage a rally, which would probably give the bears another selling opportunity. The S&P 500 actually closed almost 5% higher on a weekly basis. The relief rally – that is all that it can be called now – was initially based on the hope that Bernanke would surely announce some sort of QE3 at Jackson Hole on Fri. Aug 26 ‘11; and when no announcement was forthcoming, the bulls treated it as ‘no news is good news’!

The bears weren’t entirely inactive. Note that the index could not climb past the falling 20 day EMA. Can the rally continue? Positive divergences in the technical indicators, which reached slightly higher tops while the index made a lower top, may suggest so. But the rally seems to be losing momentum. Note that the slow stochastic is still below its 50% level; the RSI turned down after touching its 50% level, and the MACD just moved above its signal line but is still negative. Thursday’s (Aug 25 ‘11) down day saw the highest volumes, which is not a bullish sign. Even if the index rises above the 20 day EMA, the falling 50 day EMA and the 200 day EMA are likely to be a tougher hurdles. Bulls will hope that the recent bottom at 1100 holds – otherwise, the S&P 500 can fall much lower.

New home sales were down a bit. Initial jobless claims rose to 417,000. Q2 GDP growth was 1% (it was 0.4% in Q1) and inflation was 3.3% (vs. 4% in Q1). The Weekly Leading Index (WLI) from ECRI dropped to –2.1% from –0.1% (negative numbers mean a worsening economy). Doesn’t seem like much of a recovery, does it?

Last week, I had mentioned that the bulls will try to defend the 5000 level on the FTSE 100 index chart pattern with all their might – and so they did, launching a mini rally. As expected, the rally attracted selling. The index turned down after reaching the 20 day EMA, but managed to eke out a 1.7% weekly gain.

The technical indicators are showing some signs of bullishness. The MACD has just crossed above its signal line, but remains negative. Both the RSI and the slow stochastic are rising towards their 50% levels. But the volumes paint a bearish picture – the down days on Thursday and Friday had the highest trading volumes of the week.

The soaring cost of food, utilities and transport left UK households with less discretionary income to spend, as per this article. Inflation rose to 4.4% in July from 4.2% in June. The housing market continues to stumble, with weakening demand and falling prices. The worst doesn’t appear to be over yet, and the probability of a double-dip recession is increasing.

Bottomline? The S&P 500 and FTSE 100 chart patterns are trying to form bottoms near their recent lows, and start counter-trend rallies. But they may only be temporary bottoms, before the next wave of selling pushes the indices lower. Time to stay on the sidelines and await clearer trend indications.

European indices: crack under severe bear attacks

We keep reading and hearing about the poor economic growth and sovereign debt problems in Europe. One would expect the stock markets to perform badly. But through the past 12 months, most European indices have performed remarkably well – while the Indian stock market has been in a 10 months long down trend despite much better economic growth.

Things have changed of late. Even as our stock indices continue to struggle in bear markets, European indices have cracked under severe bear attacks. Most have dropped below their 2010 lows. Some have slipped to 2 year lows. The charts will tell the story:

Austria ATX

Austria’s ATX index peaked at 3000 back in Feb ‘11 and started correcting. The ‘death cross’ in Jul ‘11 confirmed a bear market. A vertical fall has dropped the index to a 2 year low in Aug ‘11. A ‘dead cat bounce’ has been followed by more selling. The index has lost more than 30% from its peak.

France CAC 40

France’s CAC 40 index has fared marginally better than Austria’s index. It dropped just under 30% from its peak, but also to a 2 year low.

Germany DAX

Germany’s DAX index had been a spectacular performer, till the first big crack appeared in Mar ‘11. The index went on to touch a peak of 7500 in May ‘11. A period of sideways consolidation concluded with a vertical drop to the Feb ‘10 low. The index has lost about 28% from its peak.

Holland AEX

Holland’s AEX index has fallen to a 2 year low, losing about 27% from its Feb ‘11 peak. The ‘death cross’ confirmed a bear market in Jun ‘11, so the recent crash should not have come as a big surprise.

Norway OSEAX

Norway’s OSEAX index has corrected more than 25% from its Mar ‘11 peak, but found support near its Aug ‘10 low. It is trying to consolidate before resuming its down move.

Sweden OMXSPI

Sweden’s OMXSPI index has also corrected more than 25% from a double-top at 375 to levels last seen in Oct ‘09.

Switzerland SMI

Despite the strength of the Swiss franc, Switzerland’s SMI index has been correcting since hitting a peak near 7000 back in Apr ‘10. More than a year’s sideways consolidation within a rectangle culminated in the ‘death cross’ in Jun ‘11.

Some experts on business TV channels have opined that FIIs will have no choice but to buy in India and other emerging markets - to chase growth that is lacking in their home markets. I have my doubts. FIIs would be less interested in chasing growth. Their main job will be to protect capital. That means booking profits in emerging markets to cover up the losses in their home markets. Their selling in India may continue till the global economy starts showing clear signs of recovery.

BSE Sensex and NSE Nifty 50 Index Chart Patterns – Aug 26, ‘11

Last week, I had analysed the two gaps (labelled GAP1 and GAP2) on the chart patterns of the BSE Sensex and the NSE Nifty 50 indices. The following conclusions were drawn:

1. GAP1, a ‘breakaway’ gap from a bearish descending triangle pattern, was unlikely to get filled in a hurry
2. GAP2 was a ‘common’ gap that both indices were likely to fill on an upward bounce over the next two trading days
3. Bears would use the upward bounce to sell
4. Both indices would consolidate for a while before resuming the downward journey.

Some times, technical analysis can be almost prophetic. ‘Almost’ because the first three events happened exactly as per expectation; but not the fourth. GAP2 got filled during the first two days of the trading week. The down trend resumed immediately, and ended the week by breaking below the May ‘10 lows (15960 for the Sensex and 4786 for the Nifty).

BSE Sensex Index Chart

How important is the break below the May ‘10 low of 15960? Not very – other than indicating that the Sensex is ready to fall lower. During down trends, supports occur at previous tops. While a previous bottom is like a milepost on the way down, it usually acts as a resistance during future up moves. It may be worthwhile noting that.

Which are the previous tops from which the Sensex can seek some support? The Jun ‘09 top of 15580 is the nearest one. Below that is the likely support from the May ‘09 top of 14930. That is barely 5% below this week’s closing level! Can the index go down further to fill the big gap formed in May ‘09? The top level of that partly-filled gap is at 13220. Nothing can be ruled out. A fresh look can be taken if and when 14930 (the May ‘09 top) is breached.

The technical indicators are looking very bearish, and oversold. Note that the ROC, the RSI and the slow stochastic reached higher bottoms as the Sensex dropped to a new low. The positive divergences should lead to an upward bounce. The way FIIs are selling at every rise, any rally may be short-lived.

NSE Nifty 50 Index Chart

The weekly bar chart pattern of the Nifty 50 index clearly shows five straight lower weekly closes. It is a good time for a counter-trend rally. Will it happen?

The weekly technical indicators are looking oversold, so a rally is a possibility. Note that the weekly RSI hardly spends any time in the oversold zone. In the past year, it had spent only one week in Feb ‘11. Now it has remained in the oversold zone for two straight weeks.

Please remember that the ‘death cross’ of the 20 week EMA below the 50 week EMA has confirmed a bear market. That means, any counter-trend rally will be a selling opportunity. For likely lower Nifty levels, check out my post of Aug 24 ‘11.

Food inflation seems out-of-control. Daily use vegetables (except potatoes) cost Rs 40 – 60 a Kg in Calcutta. Last year, they were in the Rs 30 – 40 a Kg range. The Anna Hazare anti-corruption demonstration has tied up the Parliament in knots - to the point where important and necessary policy decisions are not forthcoming. Unless the Lokpal Bill is tabled soon, stock markets will slide, as FIIs will continue selling.

Bottomline? The BSE Sensex and NSE Nifty 50 index chart patterns are falling deeper into bear markets. Any upward bounce next week may only prolong the pain. Stay on the sidelines and start brushing up on analysis and stock-picking skills.

Which stocks are dragging the Sensex down?

The Sensex closed well below its May ‘10 low today, and the talking heads in the business channels had grim looks on their faces and kept saying “It’s a very bad day”, and “It’s a terrible start to the Sep series”! They should have said: “What a great day for the bears”, or, “What an opportunity for those who sold at higher prices”. Guess they are pre-programmed to feel sad when the market falls.

I took a quick look at the weekly charts of the Sensex constituents (except Coal India, which is a recent listing and doesn’t have adequate trading data).

Only seven stocks are trading above their rising 50 week EMAs (equivalent to the 200 day EMA on daily charts) indicating bull markets. These seven have prevented the Sensex from falling much lower. Here are the ‘Magnificient Seven’ (you can check out a terrific Western of the same name featuring Yul Brynner, Steve McQueen, Charles Bronson, over the weekend; the movie is based on a Kurosawa classic: ‘Seven Samurai’).

Stocks trading above rising 50 week EMAs

1. Bajaj Auto
2. Bharti Airtel
3. Hero Motocorp
4. Hind. Unilever
5. ITC
6. Mahindra and Mahindra
7. Sun Pharma

The balance twenty-two stocks are trading below their 50 week EMAs indicating bear markets. These are the stocks that are dragging the Sensex down.

Stocks trading below 50 week EMAs

1. BHEL – at level of Apr ‘09
2. Cipla – at level of Oct ‘09
3. DLF – at level of Mar ‘09
4. HDFC – still above Feb ‘11 low
5. HDFC Bank – still above Feb ‘11 low
6. Hindalco – near Jun ‘10 low
7. ICICI Bank – at level of May ‘10
8. Infosys – at level of Oct ‘09
9. Jaiprakash – at level of Mar ‘09
10. Jindal St. and Power – at level of Jul ‘09
11. L and T – still above Feb ‘11 low
12. Maruti – at level of Jul ‘09
13. NTPC – at level of Dec ‘08
14. ONGC – still above Feb ‘11 low
15. Reliance – at level of Mar ‘09
16. SBI – at level of Feb ‘10
17. Sterlite – at level of May ‘09
18. TCS – at level of Sep ‘10
19. Tata Motors – at level of May ‘10
20. Tata Power – at level of May ‘09
21. Tata Steel – at level of Aug ‘09
22. Wipro – at level of Aug ‘09

What conclusions can be drawn from the above two lists? The seven that are still in bull markets will probably be the next target for the bears. The ones that have fallen the most, can give bigger percentage rises when the market turns eventually. Provided of course, that their fundamentals haven’t worsened. It does not mean that they can’t fall even further from current levels.

Small investors who do not own large-cap stocks can use the lists to short-list the fundamentally stronger ones and start accumulating slowly. But have a two-three years time-frame in mind. Please do not expect to get rich quick.

Stock Chart Pattern - Tata Chemicals Ltd (An Update)

A technical update on the stock chart pattern of Tata Chemicals was posted exactly one year ago. The stock had closed at 396 after touching a high of 412 on Aug 19 ‘10. The technical indicators were looking overbought, and I had expected a correction.

A look at the one year bar chart pattern of Tata Chemicals reveals three stock market ‘truths’:

1. Stocks can remain overbought (or oversold) for long periods
2. ‘Higher they climb, harder they fall’
3. Fundamentally strong stocks in boring businesses are better portfolio picks than glitzy momentum stocks.

The stock price did correct a bit, but only down to its rising 20 day EMA, where it received good support and resumed its up move – which continued for another two months. Note that the stock rose to touch a new high of 441 on Oct 28 ‘10, but three of the four technical indicators reached lower tops – indicating negative divergences.

The new high was also touched on a ‘reversal day’ (higher high, lower close), but not supported by strong volumes. However, the combination of negative divergences with the reversal day was a warning signal that the bull run was coming to an end. This was confirmed two days later by a volume spike as the stock dropped below both its 20 day and 50 day EMAs.

As often happens with sharp falls, there was an upward bounce that gave exit opportunities to savvy investors. A roller-coaster ride followed, as the stock dropped below the 200 day EMA in Dec ‘10, jumped up to almost reach its Nov ‘10 high in early Jan ‘11, and then sunk like a stone below the 200 day EMA down to 302 in Feb ‘11. The stock corrected 31.5% from its Oct 28 ‘10 peak, significantly underperforming the Sensex (which corrected about 18% from its Nov ‘10 high to its Feb ‘11 low).

It is interesting to see what happened next. While the Sensex formed a bearish descending triangle pattern from which it has broken downwards well below its Feb ‘11 lows, the stock price of Tata Chemicals has been consolidating within a rectangular sideways pattern well above its Feb ‘11 low.

Through the month of Aug ‘11, the stock price has been struggling to remain within the rectangular pattern. But the bears appear to be getting the upper hand. The technical indicators are looking bearish.

The MACD is entangled with its signal line in negative territory. The ROC has dropped below its 10 day MA into negative zone. The RSI emerged from its oversold zone, only to face resistance from its 50% level and has turned down. The slow stochastic is falling towards its oversold zone. The 50 day EMA is about to cross below the 200 day EMA, and confirm a bear market.

Bottomline? The stock chart pattern of Tata Chemicals has fought a brave battle against the bulls so far, but is about to lose ground. If you are still holding, keep a strict stop loss at 330. Use the subsequent dip to accumulate.

About Nifty Fibonacci retracement levels

During the previous bear market in 2008, I had written a post: ‘How low can the Sensex go?’, where the concept of Fibonacci retracement levels was introduced. Now that the Indian stock market has entered a bear phase once more, it may be a good time to revisit Fibonacci levels to get an idea of how low the Nifty may fall.

The assumption here is that the entire bull rally – from the closing low of 2573 on Mar 9 ‘09 to the closing high of 6312 on Nov 5 ‘10 – is being ‘corrected’. The Nifty had an up move of (6312 – 2573 =) 3739 points, which can be rounded-off to 3740 points.

The respective Fibonacci retracements are:

1. 38.2% of 3740 = 1428 points
2. 50% of 3740    = 1870 points
3. 61.8% of 3740 = 2311 points

So, the retracement levels are:

1. 6312 – 1428 = 4884; say, 4900
2. 6312 – 1870 = 4442; say, 4450
3. 6312 – 2311 = 4001; say, 4000

These levels have been marked on the Nifty closing chart below:

How sacrosanct are these Fibonacci retracement levels? No level is sacrosanct where the market is concerned. It can go anywhere and stop anywhere. But after studying hundreds of charts over many many years, the gurus of technical analysis discovered that markets tend to turn around near Fibonacci retracement levels – both in bull and bear markets.

So, how far down will the Nifty go? The 38.2% retracement level is where we are at now. Can it bounce up from here? Looking at the state of the global and Indian economies, and the weakness in the Nifty technical indicators, the answer is ‘no’.

The next likely support is near the 50% retracement level of about 4450. If that is broken, then the Nifty may go down to the 61.8% retracement level of 4000. Interestingly, 4000 is not only the downward target from the break out below the large descending triangle on the Nifty chart, it is also the top of the huge gap formed on the chart in May ‘09 (not visible in the closing chart). Such ‘coincidences’ make technical analysis a lot of fun.

Can the Nifty fall below 4000 to close the gap? Very unlikely, but not impossible. In Oct ‘08, the Sensex dropped to 7700, which was well below the 61.8% retracement level of 9900. What is the likely level where the Nifty may find support?

Note that the Fibonacci retracement levels are just some numbers calculated on the basis of empirical observations. More realistic support levels are at or near previous tops. The Jun ‘09 and Aug ‘09 tops occurred near 4700. The top on May 18 ‘09 was 4323 and that on Jul 3 ‘09 was 4424 (very close to the 50% retracement level). So, we can expect the Nifty to turn around from the zone between 4300 and 4700.

What should small investors do? Avoid buying or selling in a panic. If you didn’t book profit at 6300 or 5900, don’t start selling now. If you are planning to invest in an index fund or Nifty BeES, start accumulating below 4700. As far as individual stocks are concerned, carry out this same exercise on their respective charts to decide on entry points.

Gold and Silver Chart Patterns: an update

There is an old stock market saying: When in doubt, stay out. But in current politically and economically turbulent times, investors appear to have created a new maxim: When in doubt, buy gold (and silver).

Gold Chart Pattern

Gold is being bought as if the financial world is going to collapse tomorrow, or latest by next week. What else can explain a vertical $200 surge from 1700 to 1900 in the two weeks since my previous post?

Admittedly, there is sovereign gold buying, and Venezuela created a flutter by planning to repatriate $11 Billion worth of gold held in overseas banks. The sorry state of Eurozone banks is a major concern. But ask yourself: Is the global economy in a worse situation than it was in 2009?

One can debate the state of the global economy till the cows come home. The bottomline is that the parabolic rise in gold’s price over the past couple of months is unsustainable. The chart is looking extremely overbought, with the 14 day SMA (as well as the 30 day and 60 day SMAs – not shown in the chart above) climbing away from the rising 200 day SMA. A sharp correction, if not a crash, is around the corner.

If you are an investor who would rather buy gold (instead of Colgate or ITC shares), use the likely dip to buy gold ETFs. My preference is for the hefty dividends that Colgate and ITC shareholders receive – not to forget the occasional bonus shares.

Silver Chart Pattern

After a four month lull, during which silver’s price went through a decent correction, prices have risen sharply to touch the 44 mark. I had recommended that investors use the recent dip to buy, or to wait till the 42 level is crossed convincingly.

If you missed out on the buying opportunities, wait for a likely pullback towards 42 to enter. The 14 day SMA is turning upwards. The 200 day SMA didn’t stop rising right through the four months of price correction. The bull market in silver is alive and well.

Stock Index Chart Patterns – S&P 500 and FTSE 100 – Aug 19, ‘11

S&P 500 Index Chart

The S&P 500 index chart was expected to regain some lost ground last week. It managed to close above the 1200 level on Mon. Aug 15 ‘11 and went above the 1200 level intra-day on Tue. and Wed., but that was all that the bulls could manage against sustained selling.

The falling 20 day EMA was supposed to provide the first level of resistance to any up move, and the 50 day EMA was expected to cross below the 200 day EMA – the dreaded ‘death cross’ that confirms a bear market. Like a good Hollywood film director, the bears ensured that events followed exactly according to the script. Friday’s fall was accompanied by the highest volumes of the week – an ominous sign. The only silver lining (for the bulls) is that the 1100 level has not been breached as yet. But that may be a temporary respite.

The technical indicators are turning bearish again. Both the slow stochastic and the RSI emerged from their oversold zones, but are turning back well before reaching their 50% levels. The MACD is below its signal line, and sinking deeper into the negative zone. At the time of writing this post, the index is trying to stage a rally. It will be another selling opportunity for the bears.

Economic news remained dismal. Initial jobless claims rose by 9000 to 408,000. Existing home sales dipped by 3.5%. Philly Fed’s regional growth index dropped sharply from +3.2 in July to –30.7 in August (negative number means contraction). Morgan Stanley cut its global GDP forecast to 3.9% from 4.2% for 2011, and to 3.8% from 4.5% for 2012.

FTSE 100 Index Chart

The FTSE 100 index closed above the 5350 level on Mon. and Tue. last week before the bears decided enough was enough. Friday’s (Aug 19 ‘11) high volume selling pushed the index below the 5000 level intra-day, but short-covering helped the index to close above 5000.

The FTSE 100 last closed below the 5000 level more than a year ago – so the bulls are trying to defend the level with all their might. The technical indicators have started to weaken, with the RSI and the slow stochastic heading down towards their oversold zones once again, and the MACD is falling in negative territory. Any up moves will attract more selling.

Unemployment is rising again. No wonder retail sales are falling. The stock market is finally realising that there will be a prolonged period of little or no growth and low inflation. Stocks are being dumped for safer havens like gold and treasuries.

Bottomline? The S&P 500 and FTSE 100 chart patterns are in confirmed bear markets. Selling on every rise and buying back on the dips should be the strategy - till the charts show clear signs of reversal. No such signs are visible now.

BSE Sensex and NSE Nifty 50 Index Chart Patterns – Aug 19, ‘11

In a post back in Sep ‘09, I had written about the four different types of gaps that form in stock and index chart patterns, and their implications. There is a common myth that gaps should get filled. While eventually most gaps do get filled, this is not a ‘rule’. Gaps can remain unfilled for months and years. Some times they get partially filled (as in Jul ‘09). On rare occasions, they do not get filled at all.

We can now see two distinct gaps – marked by light blue ovals and labelled GAP1 and GAP2 – on the one year BSE Sensex bar chart pattern below. What can be the implications of the two gaps?

BSE Sensex Index Chart

GAP1 is obviously a ‘breakaway’ gap. Why? Because it marked the break out below a prolonged descending triangle pattern. It was also accompanied by strong volumes. That means two things: 1) the break out wasn’t a ‘false’ one; 2) GAP1 may not get filled in a hurry, though it may get partially filled.

What about GAP2? Note that prior to forming the second gap on Fri. Aug 19 ‘11, the index spent about 9 trading sessions in a small rectangular consolidation zone. The gap was accompanied by strong volumes, which makes it another ‘breakaway’ gap. But we already have one ‘breakaway’ gap (GAP1).

Can GAP2 be a ‘runaway’ (or ‘measuring’) gap that marks the mid-point of a move? Unlikely, because ‘runaway’ gaps tend to form at the mid-point of almost straight line moves (up or down). This gap came after a brief consolidation.

Can it be an ‘exhaustion’ gap marking the end of the current down move? Anything is possible in the market – but ‘exhaustion’ gaps are rarely the next gap after a ‘breakaway’ gap.

The process of elimination leaves us with a ‘common’ or ‘area’ gap, which forms within a consolidation zone. That means, GAP2 will probably get filled soon. The Sensex may consolidate sideways between 16000 and 17300 for a while, and raise bullish hopes before resuming its southward journey. If GAP2 is not filled within the next two trading days, then the downward slide will continue.

Please remember that technical analysis deals with possibilities and probabilities – not certainties. There is no rule that says GAP2 can’t be a second ‘breakaway’ gap. It can also be a ‘runaway’ or ‘exhaustion’ gap. These are interesting times for chart pattern watchers, even though they may be painful for investors.

NSE Nifty 50 Index Chart

The Nifty 50 chart tested the May ‘10 intra-day low of 4786 when the index dropped to 4796 on Fri. Aug 19 ‘11. The strong volumes indicate bear dominance. There is stronger support at 4730, which corresponds to the Aug ‘09 top.

The technical indicators are looking very bearish, pointing to a deeper correction. The MACD is falling below its signal line, further into negative territory. The ROC is below its 10 day MA and also falling in negative territory. Both the RSI and the slow stochastic are inside their oversold zones.

There is a sliver of silver lining. The ROC, RSI and slow stochastic didn’t touch lower bottoms even though the Nifty dropped to a new 52 week low. The positive divergences could lead to an upward bounce to fill the gap between 4932 and 4894 formed last Friday. But any such upward bounce will be a selling opportunity.

July inflation figure came in a bit lower at 9.22. The June figure was 9.44. But the May figure was revised upwards from 9.06 to 9.56, so the market took the lower July figure with a pinch of salt. Another 25 bps rate hike in Sep ‘11 is a distinct possibility. Market experts made a song-and-dance that the current FII selling is only due to the continuing economic turmoil in USA and the Eurozone, and has no connection with India’s economic situation.

The fact is, our domestic situation is not very conducive for buying shares. Higher interest rates have trimmed corporate margins and slowed down growth. A series of scams have put much-needed economic reforms on the back-burner. The Anna Hazare anti-corruption agitation has struck a chord among the youth, and come as a ‘manna’ from heaven for the hitherto sidelined opposition parties. The government has pushed itself into a corner with its ham-handed treatment of the agitators, and is desperately trying to project a ‘zero tolerance to corruption’ approach.

To cut a long story short, the near-term outlook is uncertain; and investors hate uncertainty. No wonder FIIs are selling big time, and investors are flocking towards gold and gold ETFs as comparatively safer havens.

Bottomline? The BSE Sensex and NSE Nifty 50 index chart patterns are now in technically confirmed bear markets. You make money in a bear market by selling short and then buying back at lower prices. But this is a strategy suitable for experienced investors only. Newer entrants should sit out the correction.

Two market breadth indicators

The Advance-Decline (A-D) line (or ratio) is an important technical indicator used to measure market breadth. I had covered the indicator in a post on Mar 23, ‘10 – but wasn’t able to provide a practical example. I propose to ‘fill the gap’. The TRIN (Short-term Trading Index) will also be covered in this post.

The Sensex and Nifty are in firm bear grips with no end to their corrections in sight. The two indices comprise 30 and 50 shares respectively, and are supposed to be representative samples of the entire stock market. Are they?

Thousands of shares are traded at the BSE and NSE every day. Isn’t it possible that the two indices may not be revealing the true picture? Well, mostly they do – however strange it may seem. But there are occasions when the indices may be moving up when the broader markets are heading down, and vice versa.

These are the ‘divergences’ that are of interest to the astute investor. Contrary behaviour can point to likely reversals in the prevailing trend. Market breadth indicators like the A-D Line and TRIN can be of some help in spotting likely reversals. As with any technical indicators, they are not fool-proof. Use them in conjunction with other indicators.

Nifty A-D Line

Note the period between Sep ‘10 to Nov ‘10 (left-most portion of above chart). The Nifty kept rising and reached a new high, while the A-D line was falling. This negative divergence indicated in advance that a correction was likely to follow. What it didn’t indicate was when the correction was going to begin, and how long it was going to last.

Since the Nov ‘10 top on the Nifty chart, the A-D Line has mostly tracked the Nifty’s fall – as it is supposed to do. A couple of interesting negative divergences occurred in Feb ‘11 and Jun ‘11. The Nifty made two bottoms in Feb ‘11 – the second one slightly higher than the first. But the A-D Line touched a lower bottom. Again in Jun ‘11, the Nifty fall stopped at the level of the second (higher) Feb ‘11 bottom, but the A-D line fell to a new lower bottom. The divergences indicated that the subsequent rallies (in Apr ‘11 and Jul ‘11) will be short-lived.

Now, both the Nifty and its A-D Line are falling together and touching new lows. One can look for the A-D line making a higher bottom while the Nifty falls lower. That would be a positive divergence indicating a possible change of trend. But the A-D Line is better at signalling a market top than a market bottom. So, both may start rising together, without giving any advance signal of a trend change.

Nifty TRIN

The TRIN measures the amount of buying and selling pressure in the market. The formula is:

The TRIN can also be used as an overbought/oversold indicator by using its 10 day Moving Average, as has been done in the chart above. A 10 day moving average value of 0.75 or below means the market is in overbought zone, and ready for a correction (note the period between Sep ‘10 and Nov ‘10). A value of 1.2 or higher indicates the market is oversold, and ready for a rally (like in Feb ‘11).

In spite of the Nifty touching a new 52 week low on Fri. Aug 19 ‘11, the 10 day moving average value of TRIN is below 1.0 – not quite in oversold zone yet. Any bounce up from current level is likely to attract selling pressure.

(Note: Charts from www.icharts.in)

Stock Index Chart Patterns – Hang Seng, Singapore Straits Times, Malaysia KLCI – Aug 19 ‘11

Two weeks back, downward gaps occurred in the Hang Seng, Straits Times and KLCI chart patterns. Since the gaps were below support levels and accompanied by strong volumes, they were ‘breakaway’ gaps – signalling deeper corrections. I had suggested that investors should not try to be brave, and should sit out the corrections. Fortunately, the suggestion turned out to be judicious and timely.

Hang Seng Index Chart

The Hang Seng index chart dropped sharply on rising volumes to an intra-day low of 18868 on Aug 9 ‘11. Such sharp falls are usually followed by upward bounces, which are used by the bears to sell. The index couldn’t even reach its rapidly falling 20 day EMA, before heading downwards. Note that volumes reduced during the few days of rally, indicating that the rally would be short-lived. Today’s gap-down day on higher volumes has put paid to any lingering hopes of recovery by the bulls.

The technical indicators are bearish. The ROC crossing above its 10 day MA is a slight positive. The low of 18868 was a ‘panic bottom’, which means it is unlikely to hold. If you are still holding on, brace yourself for another 1000 point fall.

Singapore Straits Times Index Chart

The Singapore Straits Times index chart has two gaps – as if one wasn’t bad enough! The sharp fall on high volumes was followed by a ‘dead cat bounce’, which failed to prevent the ‘death cross’ of the 50 day EMA below the 200 day EMA. Today’s gap-down day on a volume spike means that the bears are taking complete control.

All four technical indicators are bearish, to the point of being oversold. That doesn’t mean that they can’t remain oversold for a while. The index has entered a strong support zone between 2700 and 2740. If it drops below 2700, the next support level is at 2430.

Malaysia KLCI Index Chart

The Malaysia KLCI index has exhibited a classic break down and pullback pattern. The drop below the support of the 200 day EMA was accompanied by a sharp rise in volumes, which means that the support would turn into a strong resistance. And so it did, when the index bounced up from its ‘panic bottom’ of 1423 (touched on Aug 9 ‘11).

The upward bounce led to the ROC crossing above its 10 day MA and the slow stochastic climbing above its 50% level. But the MACD failed to cross above its signal line and the RSI has slipped back into its oversold zone. The 50 day EMA is still 23 points or so above the 200 day EMA, but the ‘death cross’ appears inevitable. Time to head for the exit door.

Bottomline? The chart patterns of Asian indices bounced up from ‘panic bottoms’, but the worst isn’t over. Sentiments have taken a huge hit, and the FIIs are leaving in droves. Await lower levels to re-enter.

Stock Chart Pattern - 3i Infotech Ltd (An Update)

The previous technical update of the stock chart pattern of 3i Infotech was posted exactly one year back. The stock had dropped from an intra-day peak of 103 in Oct ‘09 to close at 63 on Aug 17 ‘10, and was in a bear market. My concluding comments were:

‘If you are still holding the stock, get out at the earliest opportunity. The stock can fall much lower.’ 

And so it has – as a look at the one year closing chart pattern of 3i Infotech will confirm:

Shortly after I wrote the previous update, the stock price slid to a low of 58 on Aug 31 ‘10. Note the oversold conditions in the RSI and slow stochastic. A rally ensued, which found initial resistance from the 20 day and 50 day EMAs. Strong volumes enabled the stock price to reach the falling 200 day EMA, with a few isolated closes above the long-term moving average.

On Nov 11 ‘10, the stock touched an intra-day peak of 72 but it turned out to be a high volume ‘reversal day’ that extinguished the last flickering bullish hope. The stock dropped to an intra-day low of 38 on Feb 10 ‘11, and then started a ponderous rally that touched an intra-day high of 54 on Jun 6 ‘11 – just above the falling 200 day EMA, only to close much lower at 48.

It has been all downhill ever since. All four technical indicators are looking extremely bearish and oversold. But a stock can remain oversold for long periods. At today’s closing level of 28, it is just 10% above its bear market low of 25 – touched on Mar 12 ‘09. There is every possibility of the stock price falling below 25 and turning into a penny stock.

The company is still grappling with a huge debt burden, and had to sell off one of its US acquisitions to help clean up its balance sheet. But there is a long way to go. The slow growth of the US and Eurozone economies will continue to hamper its export business.

Bottomline? The stock chart pattern of 3i Infotech is an example of how a company with good pedigree and business model can come unstuck because of over-leveraging in an effort to become too big too fast. This is not a contrarian pick. Stay away.

A good time to feel ‘Gilt’y – a guest post

The stock market is in a strong bear grip. Even blue-chip stocks are feeling the heat and sliding down at the first hint of trouble. Mid-cap and small-cap stocks have been hit hard.

What can small investors do to protect their capital and get decent returns? In this month’s guest post, Nishit suggests that investors take a look at Gilt funds.

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Last month, the RBI hiked interest rates for the 11^th time since March 2010. The Repo Rate is now 8%. When will the RBI signal a pause?

The Repo rate is the rate at which the RBI provides short-term loans to banks. At 8%, it is about 1% below the peak which it achieved three years back. The hike in interest rates by about 3.25% has put pressure on interest rate sensitive sectors like Banks, Automobiles and Real Estate.

It’s a classical economist’s dilemma. If you hike interest rates you lower inflation but sacrifice growth. So, do you want high GDP figures or lower inflation? There is no correct answer. It has to be a mix of both.

The IIP numbers are high and so are the inflation figures. The latest Inflation number was a bit lower than the previous month, but continues to be high. Expect one more round of rate hike in September. The 1 year T-Bill is already quoting at 8.47%.

How do we play this rate hike in our favour? It is time to buy some Government Security (Gilt) funds. This is a time to very easily lock in about 20-25% returns over the next 12-18 months. This is based on the following factors: a) The government will eventually end the rate hike cycle starting with a period of pause and then a gradual reduction in interest rates; b) The 10 year bond yield will drop by about 200-300 basis points (2-3%) over a period of time.

Government Securities are freely traded in the Debt Market. A 10 year G-Sec having a face value of Rs 100 gives a yield of about 9%. After, say 12 months, the yield goes to 6%. The traded price of each bond goes up from Rs 100 to Rs 150, an increase of 50%. This is the optimistic best price scenario. Looking at entry and exit it is safe to expect about a 25% gain.

If we visit www.valueresearcholine.com, and do a search for Birla Sunlife Government Securities Fund, its best annual performance was from May 2008 to May 2009 when its yield was almost 26%. If we co-relate with the chart above, in June 2006, the Repo rate was 8% which went up to 9% before being brought down to 4.75% in April 2009. So, a net reduction of 3.25 % in the Repo rate was good enough to give the above returns.

Strategy:

Should we wait for further rate hikes before investing? It is not possible to always time the markets, so allocating about 50% of the investible funds now and rest after the September RBI policy announcement may be a prudent course of action.

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(Nishit Vadhavkar is a Quality Manager working at an IT MNC. Deciphering economics, equity markets and piercing the jargon to make it understandable to all is his passion. "We work hard for our money, our money should work even harder for us" is his motto.

Nishit blogs at Money Manthan.)

Use a Stock Screener to make a ‘buy’ list

The down trends in the Sensex and Nifty index charts have completed nine months, and are showing no signs of reversals. In fact, relentless selling by the FIIs in August ‘11 has turned a bad situation (from the bullish point of view) even worse.

Any sensible investor would stay far away from buying in a stock market that is showing all the signs of a full-fledged bear market. So, why a post about making a ‘buy’ list? If you have participated in the Boy Scout movement, then you wouldn’t need an explanation. The motto of the Boy Scouts is: ‘Be Prepared’.

Just as all good things must come to an end – like the heady bull run from the Mar ‘09 low did when it peaked out in Nov ‘10, bad times don’t last forever. In the not too distant future, inflation rates will start to moderate and interest rates will be lowered. The stock market will ‘discount’ the good news in advance and start to rise much earlier. That would be a good time to buy – provided you are ready with a ‘buy’ list.

Small investors face a big problem. With thousands of company stocks traded in the stock market, how does one begin to make a short-list of stocks for more detailed research? This is where a Stock Screener can come in handy. What is a Stock Screener? It is a software that allows you to use certain fundamental criteria to make a short-list of stocks that meet those criteria.

Which Stock Screener should you use? Every financial site probably has one, so there is a lot of choice. You have to do a bit of trial and error to find out one that works well for your style of investing. You can start with the Stock Scanner available at the BSE web site:

http://www.bseindia.com/stockscanner/stockscanner.aspx

It is quite rudimentary, and has only four fundamental criteria that you can use: Last traded price (LTP), Market Capitalisation, EPS and P/E. Each of the four criteria has a range of values to further fine tune your search. Try out with different permutations and combinations to arrive at a short-list from all the stocks traded on the BSE.

Edelweiss has a Stock Screener (as do many other such sites):

http://www.edelweiss.in/Tools/screener.aspx#

This also has four fundamental criteria, with Dividend Yield in place of LTP. An additional feature is you can short-list by specific sectors. If you don’t mind registering at the site (it is free, but you will get periodic mailers), then you can add more criteria for your short-listing.

Let me add here that I’m not a great fan of Stock Screeners – mainly because the criteria I use for short-listing are not available in most of the free software. In any case, you have to do a detailed study of each short-listed stock to find out if it merits a place on your ‘buy’ list.

A Stock Screener can be a good first step for short-listing stocks for making a ‘buy’ list. Be sceptical of unknown stocks that get short-listed. Don’t think that you have ‘discovered’ a hidden gem that the whole world has missed. If you keep trying different combinations, you may get lucky and stumble upon an undervalued stock.

Happy hunting!

Stock Index Chart Patterns – S&P 500 and FTSE 100 – Aug 12, ‘11

S&P 500 Index Chart

After the steep fall in the S&P 500 index chart in the previous week, I had made the following comment in last week’s analysis: “Such sharp falls are usually followed by an upward bounce. If you are still invested, use the likely bounce to exit.”

The bounce was expected, but not the extent of volatility. The index bounced up and down like a yo-yo, but managed to stay above the long-term support level of 1100. The index lost 20 points (1.7%) on a weekly basis.

The technical indicators are reversing from oversold conditions. Both the slow stochastic and the RSI have emerged from their oversold zones. The MACD is below its signal line in negative territory, but has started rising. The S&P 500 is likely to regain more lost ground this week, but it may be more of a selling opportunity.

The falling 20 day EMA may resist any up move, with stronger resistance expected from the 1250 level and the 200 day EMA. The 50 day EMA is about to cross below the 200 day EMA. At last week’s intra-day low of 1102, the S&P 500 dropped almost 20% from its May ‘11 peak. A bear market is looming.

The economy is faring better than this time last year, but not by much. Corporate earnings have been good and valuations look attractive, but hiring is tepid; initial unemployment claims was just below the 400,000 mark; retail sales in July rose by about 0.5% – its biggest gain in 4 months; AAII survey of bullish investor sentiment rose from 27.2% to 33.4%. But Univ. of Michigan Consumer Confidence index fell to 54.9 from 63.7 in July – its lowest level since 1980.

FTSE 100 Index Chart

A volatile week of trading, during which the FTSE 100 index chart dropped well below the 5000 level intra-day (Aug 9 ‘11) on strong volumes, ended with the index bouncing up to close above the 5300 mark – gaining 73 points (1.4%) on a weekly basis. That was the good news.

Friday’s (Aug 12 ‘11) bounce up was on the lowest volumes of the week – a bearish sign. What is worse is that the at its intra-day low of 4791 on Tue. Aug 9 ‘11, the FTSE dropped more than 20% below its May ‘11 top. The ‘death cross’ of the 50 day EMA below the 200 day EMA has confirmed a bear market.

The technical indicators are trying to correct from oversold conditions. The slow stochastic has emerged from its oversold zone. The RSI is still struggling to do so. The MACD is below its signal line in negative territory, but has stopped falling. A further up move is likely to face resistance from the 5600 level and the three falling EMAs.

The UK economy is struggling. Unemployment is going up. Real incomes fell last year for the first time since 1981 and are on course to fall again this year. Consumer confidence has slumped to levels seen in the depths of the recession. High street retailers are sending out profit warnings.

Bottomline? The S&P 500 chart is on the verge of falling into a bear market. The FTSE 100 chart has already entered a bear market. High volatility is a sign of uncertainty – and points to a deeper correction. Time to stay on the sidelines, and wait for better buying opportunities.

BSE Sensex and NSE Nifty 50 Index Chart Patterns – Aug 12, ‘11

BSE Sensex Index Chart

The weekly bar chart pattern of the BSE Sensex index has several points of interest, and I will take them up one by one. The first is the ‘diamond’ reversal pattern that formed during Sep ‘10 to Dec ‘10 – marking the end of the strong bull rally from the low of Mar ‘09 to the peak of Nov ‘10. The diamond is quite a rare formation, and can be thought of as a head-and-shoulders pattern with a bent neck line. The downside target after the break out is the height of the diamond – which was met when the Sensex touched the low of Feb ‘11.

Reversal patterns should have ‘something to reverse’. That condition was amply met by the rally from 8000 to 21000. The diamond morphed into a large descending triangle pattern, from which the expected downward break out occurred on Fri. Aug 5 ‘11. Note that the break out coincided with the ‘death cross’ of the 20 week EMA below the 50 week EMA (marked by blue arrow) that confirmed a descent into a bear market. The week’s low of 16432 was 22% lower than the Nov ‘10 peak of 21076. A 20% fall from the peak – though it has taken a considerable amount of time – is another confirmation of a bear market.

The technical indicators are looking bearish. The MACD is falling below its signal line in negative territory. The ROC is also negative, and below its 10 week MA. The RSI and the slow stochastic are at the edge of their oversold zones. The next support level for the Sensex is the zone between 15000 and 16000. A breach of that zone can push the Sensex down to 14000 - the downside target of the break out below the descending triangle.

A wave of FII selling in Aug ‘11 has caused the breakdown; their buying can change the situation quickly. LIC is sitting on a pile of cash – around Rs 40,000 Crores – which they are deploying to prevent a bigger fall. But the bears are in no mood to give up their stranglehold on the Indian stock market.

NSE Nifty 50 Index Chart

In Wednesday’s update of the Nifty 50 chart pattern analysis, I had made the following comment: “The strong volumes on the downward break last Friday (Aug 5 ‘11), followed by two more down days on good volumes should make the 5200 level a strong resistance to any up moves in the near term.”

The bulls tested the resistance of the 5200 level through the week, but was unable to pierce it. High volume selling pressure on Fri. Aug 12 ‘11 finally overwhelmed them. The technical indicators are pointing to a deeper correction. The MACD and ROC are in negative territory. The RSI is inside its oversold zone. The slow stochastic tried to emerge from its over sold zone, but is slipping back in.

The IIP numbers pleasantly surprised on the up side. But inflation rose again – which may mean another 25 bps interest rate hike in Sep ‘11. Q1 results of India Inc. are indicating a slow down in profit margins. The overhang of the debt problems in USA and the Eurozone are making the FIIs jittery, and Asian stock indices are facing the brunt of their selling.

Bottomline? The BSE Sensex and NSE Nifty 50 index chart patterns have entered bear markets. The good news is that the indices haven’t collapsed yet. But there is every possibility of deeper corrections. Mid-cap stocks, and even a few large-cap ones are beginning to look attractive. If you are brave enough, start accumulating. Sitting out the correction may be a more sensible approach.

Stock Index Chart Patterns – Jakarta Composite, Korea KOSPI, Taiwan TSEC – Aug 12 ‘11

Jakarta Composite Index Chart

The Jakarta Composite index has been an outperformer in the APAC region, touching its all-time high of 4196 on Aug 2 ‘11. But it formed a ‘reversal day’ pattern (higher high, lower close) and started to correct before the index got hit by last Friday’s (Aug 5 ‘11) global sell-off. Usually, a reversal day marks the end of an intermediate top (or bottom); sometimes it can mark the end of a primary trend.

The comparative strength of the index can be observed from the rising 200 day EMA. The index did fall below the 200 day EMA intra-day on Tue. Aug 9 ‘11, but found support at the level of the Mar ‘11 top and closed well above the long-term moving average. The index nearly recovered its weekly loss – falling short by 31 points (less than 1%).

The technical indicators are bearish, but showing signs of recovery. The slow stochastic dropped below the 50% level after spending the entire month of Jul ‘11 inside the overbought zone. The MACD is well below the signal line and is falling in negative zone. The ROC bounced up a bit but is still deep inside negative territory. The RSI has turned around after dropping below the 30% level.

Expect some consolidation, and a probable test of the recent low.

Korea KOSPI Index Chart

The Korea KOSPI index has been consolidating within a ‘pennant’ (a narrow triangle) since bouncing up from the 200 day EMA back in Mar ‘11. The 20 day and 50 day EMAs had become entangled in the process. The index broke down below the ‘pennant’ with a gap on Wed. Aug 3 ‘11 on a volume spike. That was the first warning of a bear attack.

On Thu. Aug 4 ‘11, the KOSPI closed below the 200 day EMA for the first time in more than a year. The selling on Fri. Aug 5 ‘11 on a volume spurt caused another gap. This week the index dropped like a stone on a huge volume surge and has closed below the 1800 level for the week – its lowest close in 15 months.

The technical indicators are very bearish, and looking oversold. Any bounce up can be used to sell.

Taiwan TSEC Index Chart

The Taiwan TSEC index is attempting a recovery but is in pretty bad shape technically. It was struggling to stay above its 200 day EMA for the past 2 months, closing below the long-term moving average on several occasions.

Last Friday’s heavy selling caused a big gap in the chart. This week’s selling has been on increased volumes that has pushed the index into a bear market – confirmed by the ‘death cross’ of the 50 day EMA below the 200 day EMA.

All the technical indicators are bearish. That means the correction is going to continue for a while.

Bottomline? The chart patterns of the Korea KOSPI and Taiwan TSEC indices have been mauled by the bears. Both economies are heavily dependent on exports to the western world. The chart pattern of the Jakarta Composite has not been hurt by the bears as badly – yet. Time for investors to stay on the sidelines.

Is this a good time to buy stocks/funds/gold?

Many small investors must be thinking about this question. Anecdotal evidence from the emails and comments I receive suggest as much. The answer is quite simple: It is a good time to buy if you have the money.

Experts will tell you that timing the market is not a sensible approach to investing. It is how much time you spend in the market that counts. That is because most small investors are happy to book small profits, and miss out on the big profits that can be made by holding on for the long-term.

So, why is Jim Rogers, an acknowledged guru of the commodity markets, advising caution about buying gold; and ace stock market investor, Rakesh Jhunjhunwala, suggesting that it isn’t time for bottom fishing yet? Why this apparent contradiction?

The dichotomy arises due to the different viewpoints of two different groups of investors. For the multitude of inexperienced retail investors, timing the market is not recommended. They just do not have the knowledge to put together all the little pieces of a vast economic jigsaw puzzle. Professional investors like JR and RJ know what they are doing, and can go in and out of markets with surgical precision.

When our Finance Minister said that the recent fall in stock prices was a result of western disturbances and had nothing to do with India, he was deliberately speaking a half-truth to try and prevent a bigger crash. Why? Because uncontrolled inflation and consequent hikes in interest rates had already slowed down the profit growth of India Inc., and pushed the stock market into a down trend.

Resolution of the economic crisis that gripped USA and Europe through tough policy measures by central banks was postponed by rounds of quantitative easing and bailouts. Now the sovereign debt problems are coming home to roost.

Global stock markets, India included, had a heady rise from the bear market lows of Mar ‘09. It is time for a reality check, and the picture isn’t pretty. No wonder gold prices are shooting through the roof, as fearful investors are dumping stocks and funds to buy the yellow metal.

The good news is that the Indian economy is in far better shape than those of the developed countries. Growth has slowed, but remains strong. However, inflation is still rising. Another couple of rounds of interest rate hikes are almost a given. That means more pain for investors in stocks and mutual funds in the near term.

But, as I mentioned in the beginning, if you have the money and a long-term view, this is a good time to buy. Don’t bet the barn. Invest 20% of your available surplus every month for the next 5 months. Things should start improving by then. Avoid individual stocks if you haven’t mastered stock-picking skills. Split your investments between a good balanced fund (like HDFC Prudence or DSPBR Balanced) and a good large-cap fund (like HDFC Equity or DSPBR Top 100).

I’m not a great fan of buying gold, because it gives no regular returns. The flight to gold is assuming panic proportions, and panic buying leads to severe corrections. If you must buy gold, buy a gold ETF during the next price dip.

Related Posts

"Time in" vs. "Timing" the market

Should you invest in Balanced Funds?

Gold and Silver Chart Patterns: divergent directions

Nifty has dropped below 5200 – what next?

In last Wednesday’s post - ‘Will the market crash if Nifty falls below 5200?’ – I had mentioned a worst case scenario of a drop to 4020, based on the theory of break outs from descending triangles. A more likely support level was mentioned as 4840 – the May ‘10 low.

I want to revise the support levels, based on the theory of supports and resistances – covered in my post of Sep 3 ‘09. Support levels usually coincide with previous tops on the way down, and resistance levels tend to occur at previous bottoms on the way up.

Resistances, when broken, become supports; supports, when broken, become resistances. Volume action during a break of support or resistance determines how strong that particular level is going to be in future. Since 4840 is a previous bottom, it is unlikely to act as a support and will probably be tested and broken.

So, where are the Nifty supports? Let us look at a longer-term bar chart (from May ‘09 till date):

Note that the 5200 level, which formed the bottom of the large descending triangle, was the resistance level for the tops in Oct ‘09 and Dec ‘09. After crossing above 5200 back in Jan ‘10, the index dropped to the support level of 4700 in Feb ‘10. 4700 was the resistance level for tops in Jun ‘09 and Aug ‘09. It once again acted as a support in May ‘10 – when the Nifty dropped to 4840.

Below 4700, the next support is at 4500 – which corresponds to the resistance level for tops in May ‘09 and Jul ‘09. It subsequently acted as a support in Oct ‘09. In other words, the zone between 4500 and 4700 should act as a good support for the Nifty, and can be used as a ‘buy’ zone with a strict stop-loss at 4350 (3% below 4500). However, the descending triangle target level of 4020 is not being ruled out as yet.

Now, a few words about what transpired in today’s trading.

Take a look at the volume bars for the last few day’s trading. The index pulled back to the pierced 5200 support level today, but closed a little lower on reduced volumes. Such pull backs are quite common after a break out, and is a good selling opportunity for those who missed out earlier.

Can the Nifty move back up inside the triangle? There are no rules in technical analysis that haven’t been broken – so it is a possibility. Even if it can climb back into the triangle, will the index be able to close the gap? Yes, but not any time soon.

The strong volumes on the downward break last Friday (Aug 5 ‘11), followed by two more down days on good volumes should make the 5200 level a strong resistance to any up moves in the near term. Note that the RSI and slow stochastic are yet to emerge from their oversold zones.

I’m not in the prediction business – but odds are favouring a test of the zone between 4500 and 4700.

Gold and Silver Chart Patterns: divergent directions

In my previous update of gold and silver chart patterns, both precious metals had bullish upward breakouts. Gold broke out from a rectangular consolidation pattern to touch the 1600 mark. Silver broke out from a symmetrical triangle pattern to reach the 40 level. However prices have taken divergent routes in the past three weeks.

Gold Chart Pattern

Gold’s price had risen almost vertically to the 1600 level, and I had expected a pullback to 1550 (the top of the rectangular pattern). The price did dip, but only to 1580, before resuming its rally. It has once again climbed almost vertically past its 14 day, 30 day, 60 day and 200 day SMAs to 1717 and is looking overbought.

The debt ceiling wrangle followed by S&P’s downgrade of US credit rating has caused a flight of safety to the yellow metal. According to data from the Commodity Futures Trading Commission, gold purchases leaped to more than 18 million ounces over the past month - from 8.4 million for the entire year up to July. Is it too late for investors to enter now?

Yes and no. No, if you believe the US and Eurozone economies will take a long time to recover, and the US dollar will continue to lose its value. Yes, if you think stock prices have come down to reasonable valuations can provide better percentage returns in the long-term.

If you are paralysed by fear because of the sudden, sharp fall in global equity markets, hold on to your cash. You are not in the correct mental frame to take rational buy/sell decisions. If gold forms only 5-10% of your portfolio allocation, past three week’s rise in price coupled with the fall in equities has probably pushed your gold allocation above the limit. Book part profits. If you are a new entrant enticed by the prolonged bull rally, wait for a dip below the 14 day SMA to buy.

Silver Chart Pattern

Silver’s sharp price rise was followed by a sideways consolidation during which it touched a high of 42 but slipped below the 14 day SMA to a low of 39. It is struggling to cross above the 14 day SMA, and may correct some more.

The dip may be used to buy. Conservative investors can wait for a convincing cross above the 42 level. The rising 200 day SMA indicates that the bull market is intact.

Stock Index Chart Patterns – S&P 500 and FTSE 100 – Aug 05, ‘11

S&P 500 Index Chart

The S&P 500 index chart pattern cascaded down like a waterfall – first below the rising 200 day EMA, and then below the lower boundary of the trading range between 1250 and 1370. Stop-losses got triggered and margin calls led to panic selling. At the time of writing this post, the S&P 500 is trading at levels not seen since Oct ‘10.

Probable causes of the crash were flying around – Eurozone debt crisis, a last minute face-saving formula for raising the debt limit, downgrade of US credit rating from AAA to AA+, withdrawal of QE2. But the bull market had lost its fizz and was trading sideways within a 120 points range for 6 months. It finally fell due to its own weight.

The technical indicators are looking oversold, with the slow stochastic and RSI in their oversold zones, and the MACD deep in negative territory. Such sharp falls are usually followed by an upward bounce. If you are still invested, use the likely bounce to exit.

The US economy is still making painfully slow progress. 154000 non-farm payroll jobs were added in the private sector in July ‘11, but 37000 government jobs were lost. The weekly leading index (WLI) growth indicator of ECRI rose marginally to 2.1 from 2.0. The PMI index dropped from 55.3 to 50.9. Below 50 would mean a contracting manufacturing sector. The GDP growth in the first half of 2011 was just 0.4%.

FTSE 100 Index Chart

In last week’s analysis, the technical indicators had hinted that the FTSE 100 index chart will not be able to cling on to the support from its 200 day EMA for long. The sharp sell-off on increasing volumes pushed the index well below its 6 months long trading range between 5600 and 6100.

The ‘death cross’ of the 50 day EMA below the 200 day EMA will confirm a bear market. The technical indicators are very bearish, pointing to a deeper correction. The slow stochastic and RSI are in their oversold zones. The MACD is well inside negative territory. Use any upward bounce to sell – if you haven’t done so when the 5600 level was breached.

A lower-than-expected GDP growth rate of 1.3% in 2011, weakening employment, and muted consumer spending may push UK’s sluggish economy into a double-dip recession - as per this article.

Bottomline? The chart patterns of S&P 500 and FTSE 100 indices are in danger of falling into bear markets. Panic selling is usually followed by a bounce up and then a gradual grinding down to lower levels. This is not a good time to bottom fish. Stay in cash.