Market Musings

Nifty has been moving in a very tight range since last few months. My tactical trading call on nifty given on 12^th June had hit the stop loss. I have been continuously bearish on markets and Indian economy since November 2010. Performance of Indian economy has deteriorated as per my expectations but markets have failed to slide along with economy. Extremely high inflation is a major reason behind the conflicting performance of economy and market. Stock prices are correcting in real terms but due to high inflation nominal prices don’t correct. 

Below is the monthly chart of Nifty. We can see that since Nifty started moving up in 2003 it is following a trend line. This trend line was tested during the bottom of 2008. The same trend line is providing support to the market. Despite spending months near the trendline market could not break below this trendline.

Unless Nifty breaks below this trend which is at around 5100 on monthly closing basis markets will not correct severely. More over the current month’s candle stick pattern suggest that this month can be good for the market. Investors should go long on index with 5050 as stop loss on weekly closing basis.

Nifty Monthly chart

Current global macro situation is very perplexing. On one hand we have the Damocles sword of European crisis hanging on the head while on the other hand we have constant quantitative easing done by Central banks globally.

In February 12, I wrote “I think the basic case for deflation/depression or a big fall in asset prices is now almost over. Previously I would give it a probability of 65% -70% but now I would only give it a probability of 20%. Unless something catastrophic happens I see the price of risk assets moving upward form here in nominal terms but in real terms price of some risky assets may correct when adjusted for inflation”  

I think central bank have won this battle hands down. Once the ECB in principal has accepted quantitative easing as legitimate then there is nothing which stops ECB from printing a trillion or two Euro to stabilize economy. On Thursday Mr. Daraghi announced that ECB will start buying short term debt for peripheral countries in order to bring down their debt cost. Spanish 10 year yield fell from high of 7% to 5.75% in this week. 

I think it is useless to expect any meaningful correction in asset prices. Even if there is a correction it will be temporary and it will only result into more QE by central banks. Ultimately it will fan inflation in these economies which is the only way to get out of such huge debt levels. Ultimately this decade will be a decade of stagflation.

But there are reasons not to be overly optimistic on markets. One reason is that earnings growth in US has slowed down considerably. In the next chart we can see that in Q1 Earnings growth reported by S&P500 companies was 6.54% while revenue growth was 5.82% YOY.

S&P500 Q1 Earnings Growth

In Q2 Earning growth of S&P500 is 0.06% while sales growth has been 0.53% YOY.

S&P 500 Q2 Earnings growth

  

If we look at YoY earnings growth for S&P 500 companies. We can see that EPS for S&P500 were growing by 20% YOY has come down in last three quarter and recent quarter EPS growth is approaching 0. If this trend continues EPS growth may go into negative and one of the biggest pillar which has supported US markets will crumble. 

Earning Growth time series

The following chart shows the number of companies reporting EPS YoY EPS growth from S&P500. Out of 500 companies of S&P 500 till Q3 2011 approximately 80% companies were reporting EPS growth. This trend has deteriorated significantly in last three quarters. In Q2 2012 only 59% companies have reported earnings growth YOY. 

% companies reporting Earnings growth in US

Next chart shows the 10 year yield of Spanish government bonds. We can see that last week yield collapsed on ECB announcement in which they principally agreed to debt monetization to keep cost low. I also think that all the opposition from Germany is just a lip service to keep domestic audience happy.

  

Spain 10 year Treasury rates

Looking at all these factors I think market will continue to grind higher. US markets looks the most attractive, EU markets are trading very cheap and if ECB is indeed going to print trillion Euros markets should move higher. Deteriorating earnings are a real cause of worry. If earnings and macro data improves in next six months we will see new highs in US markets in 2013. China will continue to face hard landing and its growth rate will slip towards 5% mark. India is a lost case as long as the current government is in power.