SENSEX POSITIVE SERIES

image courtesy: indiabulls

So finally markets have risen... thankfully to the relief of many of the investors and traders alike. It was long awaited and least anticipated. Crude falling and politics is being cited as the factors, but actually are they the real factors? Well crude to a certain extent does help in improving the situation, wherein the prices are coming to more reasonable levels, but other factors I am not so sure about. In my opinion its a question of series play as well, wherein a particular series is set up in such a way that it has more chances of going up rather than going down. If you read my post written on June 24, titled RBI Rate Hike and its Effects, I had mentioned that we must not lose hope on the markets and the July series might surprise us on the positive. Well thats what exactly happened. The trades (of Futures and Options) in the July series had become so tempting that it was a jackpot time for people to make money going against the trend. Also at the same time individual stocks had become so tempting that it was impossible not to buy into them.

Even after the fall of Friday, which was because of factors outside the business purview, the trend is not broken. The MACD for 14 days is finally coming from a negative to a zero zone, and thats the good news. Once it breaks into the positive zone it will be a good signal. Some of the stocks have already moved into the positive zone and in the fall of Friday those stocks actually did not go down. This is not to say that markets cannot go down, but the technicals arent looking bad for a upmove so lets hope that the August series as good as the July one!!!

Jesse Livermore

“Markets are never wrong, opinions often are”

image courtesy: Wikipedia

Perhaps the greatest trader of all time. Born in 1877, Jesse Livermore ruled over the trading markets in early 1900's. He was touted as the biggest bear and could accurately predict the bear markets. The most famous story about Jesse is that J P Morgan himself had to ask Jesse to stop shorting the markets!

Jesse success was perhaps unparalleled. At a very young age he had achieved what others could not throughout their entire trading careers. Jesse always advocated that markets are always correct.

In his famous saying he quotes 3 rules.

a) You lose money when you are wrong

b) You make money when you are right

c) Hence you are right only when you make money and wrong otherwise.

This might sound simple, but it has a very deep rooted philosophy, that traders often feel that they are right and the markets are wrong ( or the markets are not playing with them). Markets never play with the traders, the traders have to play with the markets...

Jesse always stressed on the financial discipline that one must observe while trading. He believed in the fact that trading and emotions need to be separated from each other. And Jesse was particularly good at it too, but Jesse always maintained that he lost only when he actually broke his own set of rules.

Also another interesting rule that Jesse followed was pyramiding upwards. That basically meant that he did not advocate building on losing positions. His thought was to build up on positions that were profitable since start of a trade. Averaging loses was a strict no no.

Although Jesse was not very educated, yet his strength to analyse the markets came from his amazing tape reading skills, which he acquired by carefully reading the markets from start to finish. This amazing ability of Jesse earned him a reputation of knowing what the markets are about to do. Jesse made amazing amounts of money in both the falls of 1907 and 1929, but the irony of the situation is that he lost most of it also, not because of wrong calls but because he could not stick to the rules he had set for himself!

Bear Market Corrections & Sensex

Today there was a very good interview in CNBC of Mr Ridham Desai, MD Morgan Stanley India. The topic of discussion was the current Bear Market in India and how long will it pan out before we can resume our rallies again. Well according to it, the bear markets usually end when we have higher tops and bottoms. And as pointed out the past 2-3 bear markets have lasted from anywhere between 1-2 years. Going by the same logic, the current bear market is already 6 months old, so we still have atleast 6 months to a year more left to go. Although the view point was that we would see the end of this bear market much before the 2 years period. Also another interesting point noted was that bear markets end when there is a screaming valuation in the market. Usually that happens when the retail also capitulates and there is wide spread selling, so the stocks would fall from their fair value and there is tremendous opportunity to buy. As recalled by Mr Desai, a point wherein one would want to sell ones house and buy equities!!!

In 2003, when the current bull market started we were quoting a PE of around 8, now if we are to end this bear market at a multiple of 8, that would mean a sensex of 8000!!! That in my opinion will not happen, but a multiple of 10 odd cannot be ruled out as pointed by many experts (though personally I feel even that will not happen), so the worst case scenario projection is 10,500 as pointed out by experts. Also point that was noted was that bear markets usually end with 50% fall from the top of the bull market. Going by the same logic again the figure comes to 10,500 for the sensex.

One more fantastic point that was mentioned was that Bond Yields and PE are inversely correlated to each other. The bond yields currently are at a very high level, I think quoting at close to 10%, which is very very high, so a PE contraction cannot be ruled out as we are currently witnessing.

My own opinion is that if we see markets at 10,500 or below it would indeed be a very very lucrative option to buy into equities from a fundamental perspective.

Could we go to sub 10 PE Levels?

Well we have been traditionally trading in a PE range on the sensex of around 13-21 for many years. When it goes down to the 12-13 levels it bounces back and tells us that the bottom is near, whereas on the top end of 20-21 its time to be very cautious. The PE for the sensex is usually calculated by adding the earnings of all the cos listed on the sensex, dividing the same by the value of the sensex. For e.g. if the sensex is at 19,000 and the combined earnings of the cos listed on the sensex is 1000, the PE comes out to be 19000/1000 = 19.

I was just hearing some investment gurus speak on the Indian markets and they were suggesting that the markets might see sub 10 PE's. The kind of PE's that were there in the 1990's. One cannot rule this scenario out completely. However there are some differences that are there between the markets then and markets now. One basic fundamental shift is the growth rates. Our growth rates are much much higher compared to the era then.

This brings me back to a more basic question, should we see PE at all. A much better ratio to see is the PEG ratio. PEG ratio is PE ratio divided by Growth rates in EPS. What this basically means is that a very high PE ratio company might not be as bad as it is made out to be if the EPS growth is also spectacular. So for e.g. a company is quoting a PE of 50 but is also growing at 50% will have a PEG of 1. Whereas a company that has a PE of 15 but has a growth rate of only 10% then the PEG becomes 1.5. The lower the PEG the bette it is. Hence the company 1 is not bad at all, when compared to the company 2.

So when in the 90's our markets might have been quoting PE's of 8-10, it might also have been linked to the growth rates which were less. So I think we might not slip to 8-10 PE's in the current scenario at all. Else there would be spectacular screaming buys at those levels.

Technical Bounceback of Sensex

Sensex and Nifty were long overdue for a technical bounce back. The 14 day RSI had gone below 30 and the markets were still not looking like bouncing back. All this added upto the pressure on the shorts and the valve erupted with a 750 point odd bounceback. Its a different story that the very next day 500 odd of it was shaved back. So where are we now. Well the picture still hasn't improved a lot. Still the MACD is below even the average trend line, so even in the overall negative territory we haven't moved into the relief zone. But I have noticed one thing that is good. All the stocks post the rally of 700 points are showing increasing accumulation pattern. That is definitely not bad news for the markets. How it pans out over a couple of weeks is to be seen.

Chart of Nifty with RSI rebounding from lows of 25

Image courtesy: Indiabulls

The Oil shock – and the Inflation double whammy

Oil prices have increased by a record 120% in the period from January 2007 to May 2008 and the trend continues. And this trend of increasing prices has been evident in every other commodity – China’s largest steelmaker Baoshan Iron and Steel recently agreed to an 85% increase in the price of Iron Ore which it bought from BHP Billiton and Rio Tinto. Inflation has reared its head through out the world. Euro Zone inflation for June was 4% a record for that area much above the ECB’s recommended guideline of just under 2%, while it reached 11.42% for India for the week ended June 14th and is expected to go still higher.

Oil, Steel and many other commodities whose prices have increased by record margins are basic ingredients for most companies and this increase would undoubtedly lead to increase in prices for consumers. However this will also lead to higher input costs for most Companies and could lead to higher costs and lower profits for most. There is also a stream of thought which is talking of China loosing its manufacturing edge because of the burgeoning cost of transporting good from there to other parts of the globe.

Although people have different opinions about this present situation and a lot of think tanks blame the explosive growth of China and India for this, I would like to add my two cents worth of explanation about the situation. I agree that my beliefs and ideas can be similar to a number of writers and may also go against some, but these are my own and open to questions, comments etc.

Inflation can be because of a basic imbalance between demand and supply, which could define the increase in prices of some commodities. But there is a money supply angle to it as well. When too much money chases very few goods, it is reasonable to expect an increase in the prices of those goods. Interest rates were kept at historically low levels by the Central Bank in US for far too long between 2001 and end of 2004, which flooded record amount of money throughout the market. This glut of money led to the increase in prices of homes in US and also other places as a subsidiary effect. Huge amounts of FDI poured into India as well and the Indian Reality market also jumped similar to the US market. Indian companies also used other channels like ADR listings to gain more of this abundant capital.


To be continued......