Mehrab’s Musings

Since 11-January-2008 I have been continuously writing and cautioning investors that we are in a bear market for global equities. However, if we see most of the so called experts in media and otherwise they were claiming from around 19000 to around 12500 levels, just before the October 2008 crash, that this was a bear market correction, valuations were good and new theories on valuations like embebbed value, land bank value etc were being floated.

However, the market disregarded their valuation plea and gone substantially down from what they were calling as “fair value”. Having said that, however low a market may go and it may seem that it is approaching zero, the market will never become zero unless all the companies making up the stock market go bankrupt or close down, which may never actually happen. Hence, somewhere the market has to bottom out. My views are very clear and as I have been writing that the market is expected to bottom around 6200 levels somewhere over the next 1 to 6 months from today.



Investment Psychology

In one of my previous articles I had written that there are mainly 5 major factors which affect stock markets (or price of any thing which is determined by free market forces) and those are – economic factors, monetary factors, fundamental analysis, technical analysis and psychological factors. There has been lots of research, books and material available on the first 4 factors but the most important and I would say the deciding factor is the 5th one i.e. psychological factors and very little has been written or appreciated on it. Whatever may be our method of investing, whether fundamental or technical or any other, do we actually do what we had initially decided to do. What if the price goes against our decision – do we still stick to our conviction? For example, an investor after doing full fundamental research on a stock whose current price is Rs.100 concludes that its value is Rs.150 and hence buys that stock. Now, for no fault of the stock and all the original fundamental factors being intact, the stock falls to say around Rs.75 because of the overall market fall or some humour surrounding the stock etc. Then what does the investor do – does he / she panic and exit the stock at a loss or rather because the original premise for which he / she bought the stock has not changed, simply hold on to the stock or infact buy more. That deals with “Investor Psychology”. Whether in stock market or any other walk of life, beating the market is not that difficult but rather beating our “own selves” is the real difficult part. Beating ourselves simply means mastering our own emotions and the ability to think rationally and independently in the face of all the noise surrounding us.

There is a difference between just thinking about investing or trading and actually committing money because when the latter occurs, objectivity falls by the wayside and emotion mounts.

Markets have their own method of seeking human weaknesses. I have seen young people with hardly any experience or knowledge about the market just jump into it thinking that this is an quick, easy and effortless way of making money. Nothing is farther away from truth. Just imagine, can anybody imagine of becoming a CEO of a big Company by just having 6 months experience or a star cricket player by 6 weeks training / practice or a University Professor by having an under graduate degree – probably no to all of them. Then how can a young person without any experience just dream of becoming overnight rich when many times the seasoned and experience players fail to do so?

Psychology is a big subject and beyond the scope of this article but very broadly we have to understand our own selves (whether we are speculator, trader or investor, our strengths and weakness and then consolidate on our strengths and minimize the weaknesses). We have to not believe any expert or guru at face value (including myself although I don’t claim to be an expert but just a student of investing), we should have independent thinking, be patient and persistent, should know how to follow the trend and when to go contrary, how to profit from news breaks and media (rather than just getting carried away by the noise around us), should know how to deal with brokers and fund managers (remember its their “compulsion” to be always bullish or not bearish) etc. The great economist Mr. John Maynard Keynes had once commented that “there is nothing more dangerous than to follow a rational investment policy in an irrational world”. And remember that the biggest enemy of an investor is pride – the thought that he / she can never go wrong and not accept his / her mistakes (if I go wrong on any of my views then I put the confession in italics because even if the reader misses where I might have gone right, he / she should know where I have gone wrong). Market is the biggest deflator of our egos. The great Mr. Charles Dow (founder of Wall Street Journal and the all season “Dow Theory”) had once said that “ pride of opinion has been responsible for the downfall of more men on wall street than any other factor”.

I will note down some of the very common rules which an investor should follow while investing. Kindly note, this is just an illustrative list and all rules may not apply to each and every one of us.



Happy Investing

• Bull and bear markets run for several years. Hence determine the
   primary trend of the market and don’t generally go against the
   primary trend
• Market is supreme and above everybody - no Government,
   Central Bank, Industrialist or Operator can alter the primary trend of
   the market – they can only complicate the wave structure
• Once a low is made – it gets and has to be tested once or twice – if it
   gets tested again and again it means that it was not the low and
   market is eventually going to break it
• Never invest or trade more than you can reasonably afford to loose
• Put stop loss at a logical, not convenient, place and
   always adhere to it
• Cut losses and let profits run. Don’t let a profit get converted to loss
• If you wait too long to buy, until every uncertainty is removed and
   every doubt is lifted at the bottom of a market cycle, you may keep
   waiting and waiting
• Act on your own judgment or entirely on the judgment of another
• When in doubt, stay out and don’t get in when in doubt
• Don’t overtrade
• Don’t invest or trade based on hope
• Learn to accept your mistakes in the market
   (otherwise market will make you accept it in a cruel way) and
   then analyze and learn from your mistakes
• Wherever possible, trade liquid markets
• Don’t believe everything which a corporate official says about
   his / her company’s stock
• When opinions in the market are too unanimous – beware because
   markets are famous for doing the unexpected
• Never be sentimental about an asset class or individual stock
• Market is more of an art rather than science
• Simple logical things work far better in the market place rather than
   complex algorithms, theorems, valuations principles, DCF etc
• Buy the stocks of companies that have shown consistent growth in
   earnings and producing those goods / services which people cannot
   do without
• Last but not the least - Never try to catch the top and the bottom



Investing in the Bear Market

I believe that the Sensex might bottom out close to 6200 levels. This level of around 6200 has been major tops in the years 2000 and 2004 and bottom in 2005. The 161.8% Fibonacci Retracement Level of the fall from the 1992 peak of 4546 to the 1993 trough of 1980 is placed at 6133. The key Fibonacci Retracement Levels of the 1992-1993 fall have acted as critical supports / resistances during the entire Bull Run and in the subsequent downtrend as well. As such, I believe the market will bottom around 6200 levels (assume between 6000 to 6500) on the Sensex. However, that does not mean that a new bull market will commence after that. It only means that the market has seen its bottom for the current bear market. It only means that the market will not make a new “price low” after that i.e. the “price bottom” has been formed. Then there will be lots of time damage i.e. for a long period of time the market will be in trading range.

However, that trading range will be very large, anywhere between 25% to 60% for the Sensex and even 100% or more for many individual stocks. The market will re-test the low of say 6200 around 2 to 3 times over the next 12 months or so and then try to make successive “higher bottoms”. That “higher bottoms” would confirm that the low was indeed made. For example, after touching the bear marker low of 6200, the Sensex might rise by say 40% to 8800. Then it would again fall and touch say around 6600 to 7000 and then bounce back to around 45% to 9800.

Then it will again fall and touch say around 7700 and then bounce back around 40% to 10900. After that it may fall back to around 9800 and then bounce to around 12500, increase of 28%. Hence the Sensex will then make successive “higher tops and bottoms” which will confirm that the 6200 was indeed the “bear market bottom”. At the same time the market is not going to run away and start a new bull market, there will be sharp bear market rallies of around 40% or so on the Sensex and much higher on many individual stocks; many large cap stocks can even more than double in these bear market rallies. And these 40% to 100% returns will ideally come in around 1 to 3 months – otherwise they will never come in the current cycle because then it will mean that the market has not hit the bottom and may be wants to go down further.

The heartening fact is that generally bear market rallies are sharper and faster than a normal bull market advance. During the 1929-32 great depression in US where the DJIA eventually lost 89% from 381 to 41; there were six rallies which gained an average of 27%. But anybody following a “buy and hold” strategy at every fall was just butchered as the market made substantial new lows as it finally lost 89% from the peak in 3 years.

Back home and the most recent example, 42% of the best 40 days were seen in 2008 when the Sensex crashed by 53%.

To summarize, positive return can be made in a bear market by either having a directional short call on the market or trading the bear market rallies – but not by just “buy and hold” strategy which works only in a bull market. And remember bear markets can be really long and painful as in the US after the 1929 crash, the DJIA took nearly 20 years to go to the pre-crash peak and the 1966 peak was conquered after 16 years in 1982. Japan has not been as lucky because the highs have never come and even today it is trading where it was a quarter century back! I am not suggesting that India will go that way as India is still in a very long term multi decade “structural bull market” but within that there can be multi year “cyclical bear market”. Hence, it might be some years before which a new bull market starts in India and probably 5 to 7 years before which we make a new high.



Indian Equity Markets (BSE Sensex - 8955)

We will now briefly look at the current technical position of the market. I had written last time that “the secondary bear market rally which has been running for the past few weeks after the October 2008 lows seems to be running out of steam and the Sensex is ready to test its October 2008 lows of 7697 once the 8800 level breaks on a closing basis. Once, the 7700 lows are broken, which has a very high probability, then the 7200 and finally bottom out close to 6200 levels over the next 12 to 15 months”. I hold my that view.

After the October 2008 panic low, the market has been moving in a range, which is being narrower after every move and importantly it continues to make “lower tops and bottom”. This confirms that the bear market low has yet not been made and the market wishes to seek lower levels. For the past few weeks, its moving within the “line of accumulation or distribution”. It’s a matter of time before which this line is broken, either on the upside or downside. Looking at the other indicators within the overall picture, it seems more likely that it might be broken on the downside which will then lead to the resumption of the primary bear market move. Currently, its forming an “evening star” below its 50-Day MA and close to the lower end of the “Bollinger bands”.

On the weekly charts, it has made a “bearish engulfing pattern” which has taken off the support of the 12-week MA and brought it within striking distance of the lower range of its “weekly Bollinger bands”. These formations are threatening to take off the support of the “long hammer” which was formed in the second week of June 2006 (during the April-June 2006 bull market correction when the Sensex collapsed from 12671 to 8799 in 2-months). Kindly note, on the line chart its consistently trading below the June 2006 closing low of 9800 which has infact acted as strong resistance on the secondary rallies over the past few weeks.

On the monthly candle stick chart, the Sensex had formed a “long real body black candle along with a long lower shadow” in the month of October 2008 indicating a deep fall and a warning to the bears that for the “time being” it had formed a panic bottom. After that, the next few months were followed with “high wave candles” and “long legged doji” somewhat within the range of the lower shadow formed in October 2008. All this indicated that the market is pausing before another move. However, in the current month February 2009, its forming a comparatively larger “real body black candle” with “smaller shadows” indicating that the indecisiveness might be coming to an end and the market may soon enter a directional movement. Also, for the first time it is threatening to break, on a closing basis, below the 19-year long “upward sloping resistance turned support trnedline” on the long term monthly charts placed at 8700 levels on the Sensex.

The price oscillators on the daily charts (RSI, ROC, MACD, DI, KST, Stochastics) have turned weak while on the weekly charts are becoming weak. Further, there is no “negative divergence” between the oscillators and the price to signal any kind of market bottoming or turnaround.

Also, the extreme oversold position of the price oscillators on the monthly charts in the past 20-years has been slightly corrected over the past few weeks with the ongoing secondary rally / sideways movement. After that, they have now made new lows confirming that the market is ready for the larger downward primary move. The ADX, which is an excellent trend determining oscillator, has moved down to a very low reading of around 18 which indicates that currently the market is in a range or non-trending pattern. Hence, the market has to either go up or down so that the ADX moves up and attains respectable level of around 40. Reading this in conjunction with the other indicators reveals that the market might go down rather than up. The volume oscillators (PVT, OBV, ADL, ROC of Volume, Chaikin Volatility, MFI) are showing lack of any major activity.

The Indian markets have hit the important support level range of 8700 to 8900 for numerous times over the past 4 months. Generally, a support level is tested once or twice but not many times. Take the example of a boxer hitting and trying to break a wall. Either of the two things will happen – the wall will break or the boxer will get tired / hurt and back out. If the boxer (market) keeps again and again hitting at the wall (support level) it means that the boxer is not getting tired / hurt and sooner or later the wall (support level) is eventually going to break.

To conclude, the secondary bear market rally which has been running for the past few weeks after the October 2008 lows seems to be running out of steam and a decisive break below this range of 8700 to 8850 where there are multiple supports in the form of support trendline, Bollinger bands, line of accumulation or distribution, change of polarity principal, candle stick patterns etc will ensure that the primary bear market movement has again resumed. The Sensex is ready to test its October 2008 lows of 7697 once this range breaks on a closing basis. Once, the 7700 lows are broken, which has a very high probability, then the 7200 and finally bottom out close to 6200 levels over the next 1 to 6 months.

US Equity Markets (DJIA – 7271)

Now, lets shift focus to the US equity markets as represented by the Dow Jones Industrial Average (DJIA). I have been writing that the DJIA had entered a bear market below the 11700 levels. I had also written that first the US equity markets will make a new low and later it would be followed by the other world markets, including India. The first thing has already happened (the DJIA touched 12-year low i.e. below 1997 levels), the second one is a matter of time.

The US DJIA has a peculiar habit of making a new low, then bouncing back from them with bullish formations only to later on confirm the original low and weakness. From September 2008 when it was close to 11300, after confirming it had entered a bear market below my level of 11700, it has behaved in this peculiar manner. It made new lows, then bounced back sharply as indicated by the “bullish engulfing pattern” or the “long real body white candle” formed. However, the rally which lasted for a few days was then later on broke via the help of a “bearish engulfing pattern” or “evening star”. The rallies never decisively stayed above the 50-Day MA and infact were never able to pierce above the higher range of the “Bollinger bands”.

On the weekly candle stick charts, from the second week of October 2008, the trend has been very clear. It made the “longest real body black candle” in that week and subsequently the rallies were capped within 50% range of the black real body with “high upper shadows” which all indicated reluctance to sustain at higher levels. The subsequent bearish engulfing patterns, dojis, shooting star etc ensured that it never crossed the 9200 to 9400 range and make subsequent new lows.

The price oscillators (RSI, ROC, MACD, DI, KST, Stochastics) on the daily and weekly charts are looking weak and over sold. The volume oscillators (PVT, OBV, ADL, ROC of Volume, Chaikin Volatility, MFI) on the daily charts are not giving any major signals. In the case of DJIA, the ADX is showing a relatively decent reading of around 35. That indicates that the direction is going to change, if not immediately but in the near future. The current direction is downward and it may go down further say to around 6700 by which time the ADX might move up beyond 40 and then the DJIA might enter a period of range bound movement with an upward bias. After that it is likely to resume its primary downward move.

The monthly charts is looking weak with the break of important very long term support levels. On the very long term quarterly charts, the DJIA has completely broken down and unless it is able to close above around 8000 levels by the end of March 2009, it would become more weak. From the monthly and quarterly charts, we get the next downside target of around 6650 to 6900 levels from where it might witness a secondary bear market rally. However, the DJIA is set to achieve its long term price target of around 5500 to 5700 till this bear market might finally bottom out. That level will make the DJIA look similar to the way it looked in the other “great bear market bottoms” of the last century i.e. 1921, 1932, 1949 and 1982 (others being 1907 and 1974).




Crude Oil (NYMEX Crude – US$44.6)

As I had written around 8 months back, oil corrected from US$148 per barrel and after gyrating between different support and resistance levels which I had stated at different points of time, finally broke below the US$92 per barrel on a weekly closing basis, which I had written that a close below which will put it in bear market territory. Infact, the same thing has happened, oil cracked to touch a low of US$32.4 per barrel a few days back. Infact, in June 2008 when oil was around US$140 per barrel I was one of the only person telling that oil has made its top and its looking weak. At that point of time many “expert analysts” from “large global houses” were making forecasts of anywhere between US$175 to 200 per barrel in few months. Now, those same analysts are making forecasts of US$25 to 50 per barrel! I don’t understand that how can the value of an asset fall by 75% from 200 to 50, in a matter of few months, the price can surely fall which I was predicting. In fact, as early as June 2008, I had written that oil can go to as low as US$55 per barrel.

Now, I will write very briefly on the current technical position of oil. The daily chart is not giving any clear signal as it is moving within a narrow range. The weekly chart with the formation of “lower shadows” shows that oil might just be telling that it does not want to fall further in the short term.

Since after phenomenal bull run oil entered a very steep correction and bear market, the longer term monthly and quarterly charts would be more helpful. A look at the monthly chart shows that after touching the low of US$32.4 per barrel, oil has shown signs of stabilization with the formation of a “long lower shadow”, “doji” and “hammer” in subsequent months. Even on the very long term quarterly charts, after forming the “bearish engulfing pattern” (which confirmed its entry into bear market) and then “long real body candle” (which had a medium lower shadow), oil is now forming doji in the current quarter. All this indicates some stabilization for it at lower levels. It may not necessarily mean the end of the bear market for oil, but indicates that oil may not fall either in the short to medium term.

I reiterate as said earlier and in my previous notes that oil has clearly entered a bear market and its entire structure is badly damaged. This will be proved by very simple facts. If we see the long term quarterly charts of oil, then it has completed a “bearish engulfing patter” in the June 2008 ending quarter which was never the case in the past 25 years. Even during previous bear markets, it had formed “long real body black candle” in March 1986 and “dark cloud cover” in late 1990. Further, in the next quarter ending September 2008, it has formed a very “long real body candle” which has engulfed the entire gains of the past 4 years! And now, looking at the extremely long term yearly charts, oil has formed a “bearish engulfing pattern” which got completed in year 2008 which had also the “longest upper shadow” in the past 25 years.

To conclude, Oil has strong support around the US$27 per barrel while strict resistance around the US$50 per barrel levels. Oil is expected to move between these range for the next few weeks. And all rallies are technical bear market rallies unless oil is able to move above US$60 per barrel on a monthly closing basis.




Gold (US$ 940.10)

I have been writing that Gold is the strongest asset class at this point of time and most probably will make a new high in the current cycle and peak at substantial higher levels. Infact, the same has been happening as Gold has moved up by almost 45% over the past 4 months. I had also explained how Gold is looking good fundamentally, how it moves in multi decade cycles of 10-25 years.

After touching a new 52-week low of US$680 per ounce in October 2008, gold bounced back from those levels with the help of a “hammer”. Infact, I had written in my last note that “Gold has strong support around US$660 per ounce below which the bull market in it will end”. In reality, gold bounced back within striking range from that level and importantly has never tested those levels over the past few months which indicates that it was indeed a strong support for it. There had been some pressure on the yellow metal due to the strong US$.

However, because of the real value of Gold compared to paper money whose supply has been regularly increased due to the bail outs and packages being announced everywhere, Gold was destined to rebound. These monetary (printing notes) and fiscal (issuing treasury bills) by the Government will ensure that liquidity keeps getting flushed over the world and while that might temporarily lift financial asset prices but it would give a big fillip to the price of those assets which are in tight supplies (primarily gold and then may be oil).

Gold (like any other asset class) has a notorious habit of moving in long term cycles and give sharp corrections but within the overall bullish picture those are just great buying opportunities.

For example, between the end of 1974 and August 1976, Gold fell from US$196 per ounce to US$103 per ounce, crash of nearly 48%. However, that was a great buying opportunity because Gold multiplied by 8 times from the bottom and even a substantial 4 times from the peak of 1974 by the year 1980.

Now, we will see the current technical position of Gold. The yellow metal seems to have made a temporary top around the US$1000 per ounce levels with the formation of an “evening star”. On the weekly charts, it has formed “harami black” or an “inside bar” which are short term bearish. On the monthly charts, gold has formed a “high wave candle” which in the current context of high price indicates instability at higher levels. Hence, investors in gold might be better off waiting for a correction or dip for buying into it. On the way down, Gold is likely to find support around the US$890 per ounce levels (50-Day MA, candle stick patterns, change of polarity principal), US$850 per ounce (golden cross, 200-Day MA) and then around the US$775 to 800 per ounce (candle stick patterns, channel). It is very unlikely that gold will decisively on weekly closing basis move below the US$775 per ounce levels.

To conclude, Gold is one of the isolated asset classes which is still in a bull market. All corrections at close to the above mentioned levels should be looked as buying opportunities in it.

Having said this, Gold might need to consolidate for a reasonable period of time before resuming its primary upmove, but the long term primary move is upwards.




Interest Rates (10-Year GSec – 6.13%)

I start by saying that in my last article I had mentioned that “although the long term trend for yields remain downwards, it will stay in a corrective phase for the next few months” – that is what is happening over the past couple of months.

Once interest rates as represented by the benchmark 10-year GSec yield breached 7.80% on the downside a few months back, it decisively entered a bear market (i.e. bull market for bonds). The yields fell quickly from the 9.50% high levels touched in July 2008 to its lowest ever level of 4.86% breaching the low of 4.95% touched in late 2003. However, that same day it recovered intra day from those low levels and closed around 5.15%. The failure of any asset class to hold on to new highs (low in the case of interest rates) after release of good news (CRR, repo and reverse repo rate cuts) means that “temporarily” the yields have made a bottom. If something does not sustain at high levels (low levels in the case of interest rates) after very good news then it is the markets way of telling us that “look I have worked very hard for the past few weeks / months and now I am slightly tired and hence want to take some rest and breather before I again resume my primary move”. That is the secondary price movement – an important correction in a bull market or a sharp rally in a bear market. I had said in my last note that “the yields are not likely to move above 6.25% while in a worst case around 6.60% to 6.80% where there is resistance in the form of shooting star and change of polarity principal and that this correction will be a good buying opportunity since the long term primary trend is downwards”. However, as mentioned above, the yields are going through a corrective phase which could last for several months (already 2 months into it). For the next few weeks, yields might remain range bound between 5.78% to 6.70%. Once, this correction is over, it might resume its primary downward move and might bottom out at close to 4.50% for the current cycle. Having said this, looking at the Government deficit and borrowing programme, for a country like India the long term sustainable level for the 10-year GSec might be around 6.50% to 7.00% levels. Hence, whenever it traverses below 5%, it would be a good selling opportunity in bonds.

If we see the price chart of the old 10-year benchmark 8.24% 2018 paper (the new 6.05% 2019 paper does not have sufficient trading history), after touching a bottom of Rs.91.80 on 11-July 2008, it rallied by more than 33% to touch Rs.122.4 on 5-January 2009. However, the completion of a “dark cloud cover” the same day ensured that it entered a secondary price correction. The Rs.120.4 might now be a significant resistance for it where there are multiple obstacles in the form of “dark cloud cover” and “falling window”. Unless and until it is able to close above that level on a weekly closing basis, the corrective and consolidation phase is expected to continue.

Although interest rates in the economy might have topped out as represented by the GSec yields but they have certainly not topped out for the corporate sector. Even after the SLR, CRR and repo rate cuts by the RBI and the huge infusion of liquidity into the system, banks are just sitting on cash. They are still not fully lending in a normal way. Today there are very good corporates with excellent track record and good management, high quality financials etc borrowing at 10% to 14% p.a. and northwards simply because they are not getting money from the system. Till that anomaly does not get corrected, it will not solve the problem of the corporate sector and earnings.

However, history has shown that in the US, in all the great bear markets – 1921, 1932, 1949 and 1982, it was GSec yields which topped out first (except during 1949 when the US Fed was controlling the US Treasury rates), followed by corporate yields and that was followed by the equity markets bottoming. So, topping out of GSec yield for this cycle is positive news for equities but the lack of funds for the corporate sector will ensure that the process gets delayed. Until we see high quality corporate debt yields not coming down in the system, we cannot make a conclusion that equities have bottomed out.



Currency – Indian rupee (Rs.50.45)

While commenting on the Indian rupee, I had written in my previous note that “due to the global phenomenon the greenback has strengthened against all major currencies. However, the upmove in the price of the rupee (weakening of the rupee) as against the US$ looks to running into rough patch. One thing is very clear, although the rupee might become weaker in the short term; however the days of rupee’s weakness are now numbered”. Although initially it transpired the same was for few weeks but after that, I have been proved wrong by the market. However, in the same article I had also mentioned that “it may touch further higher levels of around 5% to 10% from the current levels before it tops out because any asset class which hits a new high or low can further stretch by 5% to 10% in the same direction and also because the Indian rupee is part of the overall global currency market and its strength or weakness depends on that of the US$”.

To conclude, after touching all time low levels, the Indian rupee after trading in a range for few weeks, broke above it with the help of a “long real body white candle”. On the long term monthly charts, its forming a “morning doji star” which is threatening to take out the resistance of the “bearish engulfing pattern” formed a couple months back. Kindly note, that it has been tackling the resistance of the “upper shadows” with the help of “long real body white candle” on the weekly, monthly and quarterly charts, which is bullish way of doing it and gives evidence that it might break above the all time high levels. It has been taking support around the Rs.49 levels on a monthly closing basis with the help of “long lower shadows” for the past few months which is significant because that was the high 7 years peak back in 2002. If its able to sustain above those levels on monthly closing basis then it might scale up to around Rs.55 levels over the short to medium term.