NIFTY: Reverse Logic Asia Technicals Strategy: Charting The Course

Misaligned fundamental and technical setups are, at the minimum, a reason to pause and question the prevailing view. Eventually, prices and fundamentals need to align – the popular approach is to question the price given a set of fundamental views. In “Reverse Logic”, we adopt the opposite approach by questioning how the fundamentals may evolve, given what the market is saying through price action. At the core of this argument is a belief that markets move in anticipation and often presage non-obvious developments.

NIFTY is discovering new highs, even as macro fundamentals (deficits, inflation, growth, asset quality risks etc) are nearly at their most challenged. A common view is that the market is led by political euphoria (even though the rally from 1st Sep’13 was led by easing “tapering” fears) and that irrespective of political outcomes, any new government will have a tough task to resolve macro issues. Technicals suggest that NIFTY new highs need to be traded long and that the INR will strengthen further. If the market is right, then macro fundamentals will need to get aligned. IS THE MARKET RIGHT?

Technical View – Trade The Highs (see figures 3-7, pages 2-3),

· NIFTY – Open gap on 13th May will likely be filled. New highs need to be traded long, protected with trailing stops (6600).

· RUPEE – 50% retracement/ Jun’12 high and “Point & Figure” charts triangulate to give a 56-57 target for the USDINR.

· ROTATION – Rotational momentum in favor of cyclical/ domestic stocks remains attractive.

· RISKS – Disappointment (vs. expectations) on election results.

Fundamentals – Misery to Hope? (page 4)

· MISERY INDEX (inflation + unemployment + interest rates) shows the collective impact of weaker currency/ current account deficits, tighter monetary policy and a weak economy.

What Can Go Right

· Inflation & Investment Cycle – Divestment and private investment can address chronic under-investment - needs policy willingness

· Interest Rates - Currency is Important – FDI driven currency strength is stickier as well as gives RBI headroom on monetary policy. Monetary policy headroom eases asset quality risks too.

· GDP – Investment, jobs = cyclical revival.

Figure 1: NIFTY: Weekly Chart

Source: Bloomberg.

Figure 2: INR - Weekly Chart

Source: Bloomberg.

Figure 3: NIFTY: Weekly Chart

Source: Bloomberg.
· NIFTY – Trading literally in “uncharted” territory, we see no divergences (momentum or volume) to look for immediate reversals. MACD and RSI are supporting the move. New highs need to be traded long, protected with trailing stops (6600.).
· RUPEE – A “death cross” adds to a stronger Rupee view. A 50% retracement and the Jun’12 high give potential 56-57 range target on the Rupee, further corroborated by a “Point & Figure” projection. Charts point to a stronger Rupee.
· ROTATION – Over the last 2-3 months, there is a clear outperformance by beaten down cyclicals (including PSU banks) while defensives have lagged. This rotational momentum in favor of cyclical/ domestic stocks remains attractive.

Figure 4: PSU Banks vs. NIFTY

Source: Bloomberg.

Figure 5: IT SERVICES vs. NIFTY

Source: Bloomberg.

Figure 6: SECTOR ROTATION - MSCI INDIA – CYCLICALS HAVE MOMENTUM

Source: Bloomberg.

Figure 7: ROTATION - SENSEX COMPANIES

Source: Bloomberg.

Positive Technicals – Will Fundamentals Match Up?

Fundamentals – “Misery Index”

Chronic inflation, partially a structural phenomenon reflecting under-investment has limited RBI’s monetary flexibility. Tapering fears further added to the “misery”. Combined with slower GDP growth, (cyclically challenged and structurally capped), the “misery index” for India captures the macro challenges particularly well. While this index has eased recently, in a broader historical context, it remains elevated.

Fundamentals – Bond Yields

Triggered initially by tapering fears (May’13), bond yields remain elevated in India and limit borrowing options in the domestic market. This partially reflects inflationary pressures and partially elevated deficit financing. Elevated interest rates and depressed stock prices (infrastructure companies) have limited financing options.

Fundamentals – GDP

At 4.7%, economic growth has slumped to near GFC levels. Below trend growth is the price of excessive and unsustainable growth in the recent past – this has created pressures on asset prices, jobs and overall confidence.

REVERSE LOGIC - WHAT COULD CHANGE THE FUNDAMENTALS?

At the minimum, fundamentals and equities need to be aligned. While equities could correct to reflect a weak macro backdrop, the following are potential fundamental changes that could sustain equity performance beyond election outcomes.
· Inflation & Investment Cycle – Under-investment caps sustainable economic growth rates through structural inflation. An asset rich but cash-flow poor country can address this through a combination of divestment and private participation – both need policy willingness.
· Interest Rates - Currency is Important – FDI driven currency strength is stickier as well as giving RBI headroom on monetary policy. Financing options open up as bond yields ease and capital flows open up de-leveraging opportunities.
· GDP – Investment optimism creates jobs and can help a cyclical revival. “De-bottlenecking” potentially uplifts GDP on a sustainable basis.

Figure 8: MISERY INDEX