Dowjones V/S Nifty

DAILY CHART OF NIFTY
DAILY CHART OF DOWJONE.

Weekly CHART OF NIFTY

Weekly Chart OF DOWJONES

I have pasted four charts. The first two charts are daily charts of Nifty and Dowjone. We can clearly see the similarity of pattern in both these charts. Both Charts are forming a triangle after a steep fall. Currently both indices are trading at the upper end of triangle pattern and faces stiff resistance at current levels. Therefore we will see some correction(not very Sharp) in days to come probably withing this week. Triangle is a consolidation pattern and if Nifty is able to sustain above 5400 level(the corresponding level for Dow jone is 12700-12800) we will see some quick gains in both the indices. I expect that there is more than 65 % probability of markets rising in the month of March.

Next two charts represents weekly charts of Nifty and Dowjones respectively. We can clearly observe that Nifty has been successful in closing above 5000 level during last four consecutive weeks. Similarly Dowjones have been able to sustain above the most important level of 12000 since last five weeks. These levels represents a very important long term support level for Nifty and Dowjones. The market will not enter a long term down trend till Indices trades above these levels.

Nifty Weekly Review as on 18 Feb 2008

My last week’s assessment on Nifty was exactly right and market made a low of 4803.60 and after trading around this support level for three days the market turned around. (The short term scenario is very much uncertain. What I feel that there is a higher probability of a relief rally in US and that will give a relief to Indian as well as global markets – From last weeks review) Nifty moved up by almost 10% form the low’s and it closed up by almost 4% form previous week’s closing. This up move in our market was adequately supported by an up move in Dow Jones, which also showed some strength (although not as vigorous as our market) and it closed up by 2% form previous week.

I am pasting the Monthly chart of Nifty here. We can clearly observe that Nifty is taking support at lower band of the channel which lies near by 4800 while 5500 is acting as a stiff resistance. If we carefully observe candlestick pattern, we can observe that the market seems to be forming a Doji pattern this month. So if a Doji pattern if formed (according to me the probability of forming a Doji is very high close to 65-70%) the markets will be range bound for rest of the month I expect the market to close in between 5000 to 5250. So according to me we will still witness very high volatility during the rest of this month. Since this is also a budget month. (Although Budget’s are now merely a shadow of their past and the influence on economy has reduced significantly form what it used to be during controlled regime). Its importance can not be underestimated for a mixed economy like India. Therefore unexpected moves on Charts always remain highly probable.

Will the Fed Rate Cut Save the US Economy.

Let us understand the effect of Fed rate cut on US economy. But before that lets us understand what is Fed rate. Fed rate is the rate of interest at which US banks can borrow form each other. For example if one bank is facing temporary shortage of money to fulfill its reserve requirements it can borrow form other banks at this rate. Fed rate is also an important bench mark which decides the lending rate in the US economy. Something similar to our PLR.

By cutting Fed rate the Federal bank want to ensure that the short term lending rate declines in order to stimulate the short term demand in the US economy in order to save US from recession. As lower rate will induce people to borrow and spend more.

More importantly Fed is cutting rates to stem the current wave of foreclosures in US housing markets and to save the US financial institutions form going default because of the loss form sub-prime mortgages. Because of decrease in Fed rate the Housing loans EMI will reduce and more people will be able to afford to make payments and this will result into decrease in housing foreclosures.

Now here a question arises that the Fed had cut rate form 5.25% to 3.00% and still the loss form housing foreclosures had increased manifold instead of decreasing as per the argument. The reason behind this is that monetary policy has lag effect on economy. It will take 6 months or even 9 months for the effect of a rate cut to filter into economy and to kick start the process. But during this time the pain is inevitable. Although there is a huge fear of inflation going out of control I support the decision of Fed to cut rates to save the financial world form getting into Chaos. The effect of a big institution in US going default on the world economy is unimaginable. It may create a global turmoil which may take years to get shorted and the entire global financial system is at a grave risk of breaking down. Compared to this the risk of inflation although great is not as grave as risk of Financial system breaking down.

Although I believe that because of present cut in Fed rates the situation of housing markets will improve form here in next coming 6 -9 months but unlike the previous time fed may not be able to save US economy form recession. The only effect of Fed rate cut is that Fed will be able to save the financial institution and financial system form breaking down.

Before exploring into the reasons why the Fed won’t be able to save US form recession just like other times I would like to give you a brief facts sheet about US economy.

1. The US GDP is around 13 trillion US dollars.
2. The US GDP constitutes 20% of the Global GDP.
3. US population is around 220 million people which is roughly around 3.5% of global population.
4. US consumes around 48% of Global natural resources.
5. US is the largest borrower in the world. It borrows around 700- 800 billion dollar annually.
6. US consumes 22 million barrels of crude oil daily which is roughly 25% of global production.

Here we can clearly see reason for the affluence of Americans, 3.5% people of the world are consuming 48% of global natural resources and 20% of global GDP is dependent on them, and they are sustaining their higher standard of leaving by borrowing form the world. In order to consume more and more they keep on printing US dollars and the world accepts that value in each new dollar which is being printed.

I will give you a small example to make things clear. There is small village with only one shop keeper (representing the rest of world) who produces and sells all the goods and services. And there is only one wealthy man who buys all the goods and services produced. Now what is happening here is that the shop keeper has to sell its goods and services and there is no buyer expect that one person. So if that person don’t have cash to pay for Goods and services the shop keeper lends him money so that he can afford to buy those goods. This way wealthy man is able to consume the goods by only giving a promise (in the form of Debt) to pay in future.

This is a big paradox. Because the Wealthy mans ability to repay his debt is limited and sooner or latter the shop keeper will realize that this wealthy man will not be able to repay him and he will stop giving loans to him and he will stop consuming there by reducing his standard of living.

This is what is happening on the global scenario. Sooner rather than latter people will realize that US ability to repay the loans is limited and they won’t give them cheaper loans. The US will have to pay high rate of interest in order to take loans, so they will take less loan and decrease their consumption which will put their economy into recession. Or they will have to increase their exports and falling value of Dollars is good for their export sector as it will make their goods and services more competitive.

Other factors affecting this problem is because of recent large losses because of sub prime the US banks has tightened their lending standards. The cheap credit which was driving the consumption and the economy is not available any more. Moreover the banks have seen considerable erosion in their capital which has limited their ability to take risk and make riskier loans. There has been a complete change in the lending mentality of institutions which are now afraid to make loans to people of questionable credit, so we will see a period of credit contraction which will again lead to a recession in US economy.

What I believe is that recession in US economy is not bad for long term health of global economy. We all know that the world have been excessively dependent on US consumption for growth. The result of it was the US citizen was experiencing a higher standard of living compared to the citizen of country which was producing all the goods and services but was still experiencing a low standard of living. The result of prolong US recession is that the US GDP as percentage of Global GDP will decrease. This will give an opportunity for rest of the world improve the living standards in their own country if they focus more on internal consumption or export to other nation. All thought this sounds very smooth but the adjustment in global pattern of consumption isn’t going to be smooth. The US won’t accept a low standard of living for its citizen and it will do everything possible to preserve its status in the world. It will also be hard for other countries to believe in their own potential and stop looking at US for world growth. There are many assumptions which goes into my conclusion and the most important of them is the Global GDP will still continue to expand and grow inspite of a US recession. I believe this assumption will hold good as more than 60% of global growth is driven by two countries India and China.

Decoupling:- Reality or a Myth.

Most of us are by now familiar with the word Decoupling. While most intelligent minds in the financial world have expressed their opinion on it, I still want to put my perspective into picture. When we see Indian Economy 20% of our GDP is generated form Exports. Out of that if we remove low value added products like petroleum refining and gems and jewellery polishing and Low value IT services. Therefore only 12% of our GDP which constitutes of high value exports will be adversely affected. Out of total Exports US accounts for almost 20% of our total exports. So we can see that only 2.4% of high value added Indian exports are dependent on US. Now even if we are expecting a slow down in US markets, the demand for only these exports will be adversely affected which accounts for only 2.4% of Indian GDP. (Source UBS report)

Here it is clearly evident that Indian GDP is not that dependent of US like China or Taiwan for growth. Much of our growth is domestic consumption driven. Therefore I believe that Decoupling is inevitable. But than why there was a big plunge in Indian markets when US markets felled. The reason behind is market inefficiency. Efficient market hypothesis says that the market price all securities to perfection. The basics assumption of perfect market is that all people have same information and same interpretation. They have same risk and return expectation. This is completely wrong and is not observed in even the most developed markets of the world.

Here we must understand that Decoupling is not a short term phenomena. For last 50 years the world was dependent on US for growth and only recently the world has started decoupling form US. Therefore Decoupling is not going to happen overnight. It will take decades for the results of decoupling to be evident. And the most conclusive evidence of decoupling will the shrinking share of US GDP as a percentage of world's total GDP, while the share of emerging countries GDP will increase as a percentage of World GDP.

As I already mentioned it might take decades for the results of decoupling to be evident but markets are known for their efficiency to price future into present although not to perfection but to extreme. So the markets should have priced Decoupling by now and the value of Indian and other emerging market securities should have skyrocketed. But clearly we are not seeing this happening. And the reason behind this is it’s a long term process. It may take another five years for markets to price the effect of global Decoupling. So if you are a long term investor in emerging markets I believe that the effects of decoupling will inevitably benefit you in the long term. But in short term our and other emerging markets will swing along with US markets and perhaps the magnitude of the swing will be much more than it is in US. And this is the reason for nifty to fall by 30% compared to a 20% decline in US.

I was grossly wrong on my assessment of Nifty on 14/01/2008. (I still expect the markets will continue to show strength and there will no major correction in the front line Indices. Although market may consolidate at these levels for this current week and resume the upward journey form the next week. From Nifty weekly Review as on 14/01/2008) On the contrary markets lost more than 10% in that week and the fall was even worse in the next week. But my assessment of the global scenario was fairly right and Dowjone Index fell to 12000 and made of low of 11640 levels before bouncing back to 12764. Currently it is trading into range form 12800- 12000. As per my expectation there was global sell of in equities in all the major markets of the world. (Refer to my last blog on Will Dowjone Spoil the party on 14/01/2008). If I got the global situation right than what went wrong with my analysis of Nifty. I underestimated the impact of global sell of on Indian markets. Since Indian markets were showing extreme resilience till then, I expected that to continue in the face of adverse global situation which was contrary to my own expectation that money will flow out form Emerging markets at lightening speed. This was a valuable lesson to be learnt. But as Warren Buffet says "The market like Lords helps those who helps themselves, but unlike Lord the market don’t forgive those who don’t know what they are doing."

Current Scenario:-

I am pasting long term quarterly chart of nifty. From the chart we can observe that the markets are trading at the most important support zone since the rally started in 2003. And if this uptrend has to continue the market must not trade below 4800 levels for considerable period of time. Now the question arises will this happen. The answer lies in Dow Jones and American economy. I am afraid that Dow chart is still looking very scary and if the down trend has to reverse Dow Jones must not break below 12000 levels. I am expecting a relief rally in US markets sooner or latter. We should also remember the fact that US markets had already fallen by 20% form its recent peak and now are trading at a P/E of 14 -15. Which don’t look terribly over valued. Although I accept that there are very serious problems with US economy and the recession is unavoidable and it will be good for the world economy in long term. But the short term pain is inevitable and we have to bear with that. We should also remember that US companies generates revenues not only form US but form across the globe. Companies like Qualcom or Intel which generates 50-75% of revenue form outside of US are available are really attractive levels.

The short term scenairo is very much uncertain. What I feel that there is a higher probability of a relief rally in US and that will give a relief to Indian as well as global markets. But on the contrary if 4800 is broken on Nifty than there can be a further fall upto 3700 levels. Now only time can tell the markets will turn.

Small caps and mid caps had washed out of all the gains they have made since last one year. And fundamentally good stocks are also available at attractive prices. But looking at the global uncertainty I will advise traders and short to medium term investors to stay away from them. Even long term investor should consider keeping their 25% of portfolio in Cash to take benefit form a potential fall in the markets.