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Friday, January 20, 2012

5 reasons why this is a sucker’s rally and not a change of trend

P. T. Barnum, a 19th century American circus owner, had apparently said: “There is a sucker born every minute.” Translated into English, that means that the world is full of gullible people. Any idea, however ridiculous and unbelievable it may be, is sure to find a few takers.

Crazy ideas - from ‘the world is flat’ and ‘the sun moves around the earth’ to ‘Suzlon is the next GE’ and ‘RJ is the Warren Buffett of India – follow his portfolio if you want to become rich’ – always find believers (a.k.a. ‘suckers’).

So, what is a “sucker’s rally”? It is a sharp price rise in an index or a stock without the support of fundamentals – usually during a bear market. Here are 5 reasons why the current rally in the Sensex and Nifty indices is a sucker’s rally:

1. There is a ‘gut feeling’ among small investors that the worst is over. Gut feelings are seldom right, unless the guts belong to some one called Warren Buffett. Even Buffett is known to make mistakes. Keep your guts where they belong. Use your brains instead. The problems in Europe haven’t been solved yet. China’s economy is struggling with slower growth. The worst may not be over yet.

2. A general consensus among market players is that RBI may start reducing rates soon; even if the interest rate remains where it is, there is likely to be a cut in the CRR to increase liquidity. The RBI has not indicated any such thing. They have only paused in hiking interest rates further. That means, interest rate remains just as high as it was a month ago when the Sensex and Nifty hit their lows. Stock markets can’t sustain in a high interest rate environment.

3. Though food inflation has started coming down, it may be more due to a high ‘base effect’ and seasonal availability of vegetables. Core inflation has moderated a bit, but still remains high. RBI has made it quite clear that controlling inflation is their top priority. Unless core inflation drops below 5%, interest rate cuts may not be effected. Inflation won’t come down as long as the government spends recklessly on various schemes to buy votes.

4. The government’s policy inaction will continue till the annual budget is announced in mid-March – thanks to the impending elections in five states. The only bit of good news for foreign investors in recent times has been the Supreme Court’s judgement in the Vodafone case, stating that the Income Tax department has no jurisdiction over a transaction between two overseas entities. But that judgement is more in the nature of removing an unnecessary irritant than paving the way for any fresh investments. The government has to be far more proactive on the policy front to change the commonly held perception that it is bureaucratic and inept.

5. Technically, both the Sensex and Nifty are in 14 months long bear markets. Bear markets (and bull markets) don’t turn around suddenly. They usually form some sort of a reversal pattern, which takes a few weeks to a few months to form. No such reversal pattern is visible as yet.

The recent spate of FII buying has begun to attract inexperienced small investors who don’t want to miss the bus. Technical indicators are looking overbought. The stage seems set for the big boys to get out. The suckers may get stuck with shares bought at higher prices.

5 comments:

N said...

Subhankar,

Another brilliant post!

As every dog has his day, every bull and bear market has its suckers.

It is said that you cannot make someone a fool all the time and to reflect this, we have new fools who enter the market and then pay the heavy price of getting "educated" - for some of them, the "education fees" are so high that they never return.

One can either make a killing in the stock market or get killed. The ecstasy in both cases is limited.

Keep up the good work. We love you!

Nasir

Jasi said...

I would not only like to second what 'N' but in fact id stick my neck out and claim this to be a very brave post. :) As you have pointed out in your post itself, to be writing market's epitaph when it is poised to move higher, or it seems, take some guts! On second thoughts, i think it takes a lot of brains :) We can let our guts do their job and not di-worsify them :P
Super post!
Let me dust my to-sell list now :)

Sanjeev Bhatia said...

Dear Subhankar Da,

A briliant post as always. Loved the incisive analysis....

1. "gut feeling of small investors" is in fact the perfect contrarion indicator. Typically, small or retial investors gets in nearer top of the rallies and gets out at lowest levels just before turnaround. Also, markets have a sadistic trait of not obliging, not falling when EVERYBODY says its going to fall (remember just few days ago everybody was waiting for 4300 to happen) and similarly not rising when EVERYBODY says its going to rise. I remember a quote from Lynch in One Up on Wall Street that "when a doctor at a party tells ME what to buy, its time to sell everything and run".

Points 2,3 and 4 are bang on since nothing fundamentally has changed on these fronts. Some people are saying that market has already factored in bad results of Dec Quarter and once these are out of way, it can only move higher. I persoanlly believe markets are slave to earnings and till that improves, there does not seem to be much hope of sustained higher markets.

Point 4. Don't consider myself to be qualified enough to talk on technical indicators, will still hazard some analysis. Market is still very much in between the downward sloping channel as shown in your weekly nifty chart posted on 15 Jan. Market can go up to the top of that channel (ard 5240) and still follow the pattern of lower tops and lower bottoms, implying this is nothing but bear market pullback.

If we take the last leg of fall from high of 5399 on 28 Oct 2010 to low of 4531 on 23 Dec 2010, the current pullback rally has already traversed 61.8% (Fibonacci level) of this fall (comes to about 5068, close enough - high on friday was 5064).

So can it be that the current rally will face resistance and begin its downward journey again?

TRIN (as mentioned in the same post) is also now at 0.5 levels. Stochastics on daily charts are at 94% levels while RSI is still not in overbought but close enough(68.3%). More importantly, 200 day EMA is at 5130 levels and should act as strong resistance if 5068 is taken out on closing basis.

All in all, it does seem that, as Jassi has mentioned, it is time to shake out the sell list and shake out the lemons and duds in our portfolios.

Thanks once again.

Sanjeev Bhatia

Ram Kumar said...

Hi Subhankar,

A really good post and rational thinking. I believe we are in the world where everyone is looking for instant gratification. The fear is that this has almost become a norm and hence the reality ends up being considered just as a blip.

Ram

Subhankar said...

@Nasir: Thanks for the comments, Nasir. FII buying may yet turn my analysis topsy-turvy!

@Jasi: Thanks, Jasi. I write what I see - but it was just an opinion, not an epitaph! The stock market lives forever.

@Sanjeev: Appreciate your comments and excellent technical observations. I love to play contrarian, because it helps to induce discussions.

What is interesting is that several professional technical analysts have expressed 'surprise' over the strength of the current rally. Guess they have selective amnesia - specially if their calls go wrong.

@Ram: Thanks for your comments. The stock market is treated like a casino by the majority of participants who want to try their luck and make some easy money - unaware that the odds always favour the house!