Inflation, Deflation, Both? - Sainik

aka Alice in Wonderland...

True to script, the Indian markets vaulted over 5500 levels to close at around 5915, which is just 8 percent below the previous all-time highs of 6340 attained in January 2008. If this level is crossed, India would become a part of a handful of countries trading at all-time highs-the Indonesian and Malaysian markets are already trading at all-time highs.

Clearly, the surge has been led, predictably, by FIIs, whose appetite for Indian equity never seems to end. Local institutions have been heavy sellers, but to no avail.

Banks and tech stocks were the leaders in this rally. It is surprising that tech stocks are hitting new highs despite negative vibes coming out of the US and the growing fear that Europe is a disaster waiting to happen, and the rupee strengthening against the US dollar. Sounds illogical? The RBI has come out with a very hawkish economic policy which should have affected banking stocks but this was just brushed aside by the relentless optimism. Well this is the stuff that runaway bull markets are made of!

While we are on a tear, there seems to be confusion in other markets. Just consider this: the US and Europe markets are going nowhere because consumers are just not biting; hence the talk is about possible deflation. With the Bond market rallying a while ago, and yields hitting new lows, the case for deflation is justified. However, a look at the Gold market which presents a different picture-the precious metal hit a new life-time high last week, and looks set to cross $1300 per ounce in the near future. Traditionally, a rally in gold means that inflation is around the corner.

So what's it then? Inflation or Deflation? Some more head-scratching to do if you observe the currency markets. Japan intervened in the currency markets for the first time since 2004 and bought dollars to weaken the yen, so as to help its exporters. On the other side, the US is asking China to strengthen its currency and threatening to label China as a currency manipulator.

What does one make of the Japanese action? Manipulation? While this going on in broad daylight it has been ignored by everyone. The whole scenario resembles something straight out of Lewis Caroll's 'Alice in Wonderland'.

The US equity markets are totally devoid of volumes and large swings can materialise without any rhyme or reason. The markets to watch are the US bond market, gold and the dollar index. These are large markets with huge number of players and cannot be manipulated by any one entity, including the Government, for an extended period of time. The direction of these markets will determine the fate of the underlying economies.

Right now, the markets are indicating that all is not well, at least in the developed economies, whatever Obama, Bernanke and other political leaders of various countries want us to believe.

Coming back to our own markets, while all the analysts are unanimous in their opinion of the indices hitting new highs and the markets continuing to flare up higher and higher, we would like to play the contrarian card and issue a short-term Sell on all rallies during this week. We would recommend lightening up on at least 50percent of the holdings, if not the entire portfolio.

Very rarely would one like to issue a Sell call, because if it goes wrong, all one hears are curses. But we are ready to be cursed. Do note though that I am not advising shorting the markets as yet, since it is very risky in markets which are irrational such as these.

If one were to sell in a calibrated manner over the next few days on all rallies, we believe one would get some good bargains in end October, just before Diwali.

The sectors which look ripe for profit booking are the banking, technology and cement. One would be able to buy ITC, Satyam, Maruti, Bhel, L&T, and TVS Motors, on a decline of 5 percent from current prices whenever it happens.

Whatever, you choose to do, hope it is profitable.

All Hopes for a Blowout Rally

The indices last week have broken out of the trading range of 5350-5550 conclusively, and even 5600 held comfortably, on Thursday, ahead of a long weekend.

The announcement of blowout IIP numbers over the weekend, and stable global markets, should add fuel to the fire of the impending rally in the week ahead.

Big players are all expecting a huge rally of around 10-15 percent in the next few months. Hence the mad rush by the FIIs to woo India.

This was the Buying Panic which a few commentators were expecting some time ago.
The standout performing sectors were the Financials and Cement. It is a known fact that cement companies are struggling to make profits in the past 4-6 months mainly due to a lack of demand.

However, the market buzz is that cement prices would be increased by around 20-25 percent during the festival season. Interestingly there are good scrips still available at reasonable prices, even at these lofty index levels.

Just check out my favorite, Satyam Computers, which is hovering around Rs 90 and it has just started hiring from the campuses, after a layoff of nearly two years.

Even Reliance Industries and Bhel look reasonably priced versus the index. ITC is another blue chip which can be bought on all declines. TVS Motors and Maruti should do well going forward. Among dark horses, sugar stocks are looking good.

Watch out for Punj Lloyd. It seems to be stabilizing at around Rs 110 level, similar to Suzlon which is forming a nice base at around Rs 50.

The only risk to all these recommendations is that if the blowout rally does not happen, the we know what should our stoploss be: Nifty 5350.

Whatever you are up to, hope it is profitable.

Laborious Markets - Sainik

September 6 is celebrated as Labor Day in the USA. In a strange sort of way the Indian markets also seem to be celebrating it, in spirit, for the past so many weeks, with the Nifty being rangebound between 5350 and 5550.

Every time the Nifty appears near either of the numbers, the excitement is palpable; everyone in the market who is technically inclined is left wondering whether it will break the shackles this time at least.

The Nifty, like a cruel mistress flatters to deceive, again and again. Last week it happened at the lower end of the band, when the Nifty briefly went below 5350, and then bounced back, to close the week out at a respectable 5480 levels.

September was quite a bullish month last year, and a very bearish month during 2008. Which way will this September be?. Will it be another heartbreakingly slow month like this August was. Only time will tell.

There is a well-observed phenomena in the US markets leading to Labor Day: The markets are bullish and then become bearish after the day. This year, the first part of the phenomena has remained true. Will the second part too fulfill the observation? Only time will tell.

As a reader of the article, it is justifiable to expect that the writer would stick his neck out and make some prediction-any prediction-but as our late PM, Narasimha Rao demonstrated very well: No decision itself is in itself a decision. Hence, no prediction itself is in itself a prediction.

However, looking at the market internals, here are some interesting tidbits:

1. FIIs have been selling of late and their purchases have reduced in quantum.

2. The advance-decline lines have been in favour of declines.

3. The mid-cap index looks a little more vulnerable than the frontline.

4. There seems to be a "rotation" of scrips which are leaders in volumes (This has bearish implications).

The pick of the week was Satyam Computers which seemed to have risen from the Ashes, literally. If this week the strength continues, it would certainly be a very good candidate to accumulate at all levels. While Rs 94 is a strong resistance, watch it, and buy it anywhere close to Rs 85. If the results get announced as per schedule then we may see some interesting times for this scrip.

BHEL and Punj Lloyd also look interesting.

Reliance Industries is ready for a short term pop till Rs 980.

ITC will continue to remain an evergreen favorite below Rs 160.

The tech stocks look ripe for a significant correction.

Sugar could be the dark horse going forward for the festival season. Watch Renuka for a quick spurt some time soon.

Patient investors can wait and keep their powder dry since the "best prices" are yet to come and there could be many "Diwali bargains". Until next week then, whatever you do, hope it's profitable.

Yours, friendly neighbourhood analyst...

The Emperor Has No Clothes - Sainik

Watching TV nowadays, especially the business channels makes me wonder whether the talking heads, have become followers of Joseph Goebbels, the propaganda secretary of Hitler, who believed the dictum: A lie told a thousand times becomes the truth.

Well, strong words you may say. But, lets check the facts:

1. Inflation is under Control.

"Inflation would be around 5 percent by the end of the financial year" - RBI Governor Subbarao. "Inflation to drop to 5 percent by the year-end" - Montek Singh Ahluwalia.

Both gentleman made these comments in August 2009 confident of achieving this by March 2010. We saw inflation crossing double digits in March for the first time in nearly two years. However, Ahluwalia, unfazed by the Inflation Monster, further predicted in March 2010: "Inflation to drop in two-three months". We all know what's happening on the inflation front.

2. India is Decoupled from the rest of the world.

Based on the relative strength of the Indian markets, every talking head is convinced that we are in our own orbit and nothing in the world would affect us negatively.

Three years ago, China's stock market peaked out in August 2007. The US market peaked out in October of that year and Europe followed soon thereafter. November was the turn of Hong Kong. The Indian markets ignored this till January of 2008. We all know what happened to the Indian markets in 2008.

3. There is money waiting on the sidelines.

Everyone seems to be convinced of this argument. However, a cursory glance at the cash held by the Indian Mutual Funds across the board reveals that most funds hold ONLY 3-7 percent of their assets in cash. (source: National Stock Exchange )

This is similar to that of the situation in Dec-2007/Jan-2008 and April-May 2006. We all know what happened thereafter.

4. The market will trade sideways.

Analysing the Sensex range for the past 10 years shows that there is an average swing of 50 percent between the highs and lows of the year.Only once in the last decade has the Sensex has swung in a range of 37 percent. This year the difference between the highs and lows is just 18 percent.

With so much uncertainty around, and looking at the historical swings of the Sensex, it requires a brave person to predict that the Sensex will swing within this narrow range.

5. The Retail Investor is missing.

It is a general belief that the retail investor comes in at the Top of The Market. Therefore, the argument seems to be the retail investor has not yet appeared, the market still has some more distance to go.

The retail investor is still nursing his wounds since most of the retail stocks bought in the frenzied days of the last bull run are still trading at steep discounts to the prices prevailing at that point of time. Remember the frenzy in DLF, Unitech, Suzlon, GMR Infra, Punj Lloyd, Aban Lloyd , RNRL, Reliance Power, Reliance Infrastructure, etc.

Even in 2009-10, "retail favourites" from the sugar sector, such as Renuka, Balrampur Chini etc. and the from education sector-Educomp, Edserve etc.-have failed them.

Huge volume and a run-up was seen even in the Tech sector stocks, just a couple of months ago, which now are slowly drifting down. So, in one way, the retail investor has already done his duty: bought at peaks. To expect retail to perennially come and get slaughtered may be asking for too much.

6. The Indian corporate sector is performing well.

It is a well-documented fact that first-quarter results disappointed the market. The earnings expectation for Sensex companies in 2010-11, was around 1060-1070, which is nearly 30 percent higher than 825 achieved last year.

In the first quarter, the topline of Sensex companies was robust but the bottomline was up by around just 10 percent. So, to achieve expected growth rates, the corporate sector has to show a profit growth not seen in the past ever.

7. The Direct Tax Code Bill is good for companies.

The Direct Tax Code Bill will be introduced in the Parliament this session and barring any unexpected delays would become applicable for the year 2011 onward. While this has many welcome features, it will hurt corporate profitably for sure. The tax rate is being brought down to 30 percent, which is laudable, but currently the effective tax rate for the corporation is in fact lower, at 22 percent.

In the direct tax code regime, even IT companies would be in the tax net. This is because these companies currently use the standard deductions which will not be available with the new Direct Tax Code. Reliance Industries currently pays an effective rate of around 15 percent.

So, to achieve higher growth rates in profits , corporations would have to work that much harder and they cannot oppose the Direct Tax Code so easily, since they are the ones that asked for it in the first place.

Gentlemen Prefer Bonds? - Sainik

Tim Geithner, the US Treasury secretary is reported to have said, “If I am reborn, I would like to be the bond market.” What he was implying was that the US bond market is the most powerful force in the world.

The bond market is supposed to indicate the direction of the economy, and as of now it is on a tear. Everyone seems to be loving bonds: gentlemen and ordinary folks too.

The bond market is indicating that there is deflation ahead, and the flight to safety has begun. While the Fed would like yields to be low because of the high amount of debt being issued – yields move inversely to the prices – there is a tipping point when the strategy becomes counterproductive.

When there is a stampede in the bond market, there is risk of a bubble forming and when the direction reverses, there is an equally mad scramble for the exits.

Data over the weekend reveals that fund flows in to bonds over the three month period is more than three times that of the fund flow into equity during the dotcom craze. So shouldn’t you worry? Granted the bond market is far bigger than the equity markets and the demand for bonds may still outstrip the supply in the near term, but we need to keep this information in the back of our minds when we look at the equity markets.

Coming to the equity markets, the Indian markets continue to defy gravity for yet one more week. While globally the markets all fell, we made highs that were last seen in February 2008. This is a remarkable feat, considering factors like high inflation, indifferent monsoons, and lacklustre corporate results are here to stay.

The continuing rise is led by consistent foreign buying, around Rs 400- Rs 600 crore on a daily basis. DIIs have been selling an almost equal amount but the last couple of days have seen DIIs cooling off their sales a bit; hence the strong rise witnessed on Wednesday and Thursday.

I had indicated a range of 5350 -5550 for the Nifty which was almost reached almost Friday. While the mainline indices are hitting higher peaks, the Bank Nifty has remained the stronger of the two.

There is a huge appetite for banks of all kinds and shapes. Even laggards like cement and real estate have joined the party. The big guns of the market are all targeting 6000 by Diwali. While it’s quite possible that the Indian markets may hit these levels on sheer FII buying, it would be prudent to note that we are the most expensive market in the world today and we are getting more expensive each passing day.

If an investor were to sell all of his holdings he could be disappointed to see the market trading stubbornly higher in the foreseeable future. Therefore the investor has two choices: either sell on all rallies or prepare to sell all his holdings if 5350 is cut on huge volumes.

I remember in 2007 October when the Nifty hit 6000, I asked one of my clients to sell ALL his holdings because I felt the market was becoming expensive. The client listened to me –a very rare occurrence –and acted promptly. Then the Nifty went on to trade above 6000 for the next three months. During this time I had had a very difficult time facing the client. It’s a different matter altogether that the Nifty came down as low as 2300 by October 2008.

At this time, no fresh recommendations; whatever you do in the next one week, let it be profitable.

The Vulture is a Patient Bird - Sainik

It's that time of the year when everyone expects things to happen; it does not happen, and then the frustration sets in. Will this time be any different? Up until now it's playing perfectly to the script.

The last of the results of the Sensex have come in. Tata Motors and SBI stole the show, Bharti and Tata Steel were average. Twenty six of the 30 companies have reported their results and they have shown a growth in operating profit of less than 10 percent.

Analysts have been quick to downgrade sensex 2011 earnings, by around 10-15 percent, but are the estimates still too high? This quarter will be most crucial for the economy as the cumulative effects of large base effect, inflation, tight money conditions, skewing of the monsoons (Large parts of East and North-East are suffering from drought) will all come in to play.

This will be contrasted with the still positive money flow from the FIIs, making it a heady cocktail for high volatility.

The NSE Vix, which is a gauge for volatilty, has hit a new low last week. This means that the market men are very complacent about the direction of the market. Most market watchers are still sticking by the 5350-5550 range.

Usually the market proves the consensus opinion wrong. Something has got to give. Which way?

The answer may come from overseas, the movement of the US dollar could be a give away. There is some correlation between the movement of the dollar and fund flows to risky assets, i.e. stocks.

For the past eight weeks the US dollar index was relentlessly coming down from a high of 89 to a low of 80. Then last week there was a quick rebound and now it stands at 82.5 levels.

My personal take is that the US dollar index will scale the previous highs of 89 in a matter of time. Watch the widening of spreads in the bond markets of Italy and Greece last week.

So what do we do now? Adopt the same strategy of the last week? Be alert, if the nifty starts trading below 5350 with high volumes.

The smallcap and midcap index has outperformed the main index the last few weeks. Time to definitely book profits in the scrips which have had a runaway rally.

Wait patiently for the prices to come down. The Vulture is a patient Bird. Whatever you do, hope it's profitable.

When Good News is Bad News - Sainik

The global scenario is getting murkier by the day. The economic data coming out regularly, especially out of the US, is dismal to say the least, yet the US markets are bucking the trend by having sharp intraday reversals to the upside.

Yesterday's movement in the US markets was a case in point. The June employment data was worse than expected and the markets promptly tanked in the first hour, with the Dow down by nearly 160 points at one time. But the slide was reversed by late intraday gains and finally the Dow managed to close only 20 points lower.

Are markets being resilient to bad news? Or is it something else?

Astute market observers have been detailing these sharp intraday swings on machine-based trading. It is believed that more than 70 percent of trading on US exchanges is taking place through complex algorithms (computer programs) and models designed by "nerds" where the computers trade against each other. Here price, velocity and volatilty etc. are the variables. News and fundamentals are not captured in this scenario.

Alogrithmic trading was said to be the principal reason for the "Flash Crash" which occurred May 6, this year, when the Dow lost nearly 1000 points intraday. It is surmised that we will have many more flash-crash kind of days in the future, except that we could see flash-rallies too,when, for no explicable reason, the Dow could spurt 1000 points intraday.

So, be prepared.

On another front, the currency markets are presenting a very interesting picture. The US dollar has become a dog, with everyone shunning it versus all other currencies. Just last month the Euro fetched $1.18, now it buys 1.33 dollars. At the start of the European crisis, everyone expected the Euro to achieve parity with the dollar. How a few weeks can change the perceptions of analysts?

I was watching TV where analyst after analyst was saying they were disappointed with the quarterly earnings of companies in India. I was wondering whether it was the companies which disappointed or the analysts who got it all wrong.

Some brokerage houses have reduced their Sensex earnings for this year to around 1015-1025 from earlier 1060-1080. This translates in to more than 20 percent year-on-year (YOY) growth. However, going by the first quarter results, even this number looks unattainable, since the base effect will begin to kick in for the next three quarters and inflation remains at stubbornly high levels.

So to labor the point, the Indian markets are fully valued at these levels of 18,000 going by historical standards. The next rally, if and when it comes, will place us squarely in bubble territory. It is not improbable if we are already in bubble territory considering the relentless buying by FIIs as witnessed through the week.

Now it begs the question as to who are these guys were, buying so aggressively at these levels? It was intriguing to hear the viewpoints of a couple of well-respected market commentators as well as FIIs who were themselves surprised, since the old India hands (FIIs who have been here for a long time) were not getting any inflows.

We are unlikely to know the "mystery" buyer. Be that it may, we can look forward to a very interesting week.

The Fed meeting is on August 10 and global markets, including ours, are likely to react to the Fed's meeting. After a very long time, this meeting of the Fed assumes significance to asset markets as some market-moving announcements are likely to be made. The next big one is likely to come on August 17 from the US government, regarding its strategy on the Housing issue.

On the Indian corporate front, we have yet to hear of results from the Tata biggies, Tata Motors and Tata Steel. The markets range on the Nifty is still 5350-5550. As oulined last week, it may be prudent to book profits in the investment portfolio as the Nifty is trading above 5425 levels. Short-term traders could be going long on all declines keeping 5350 as the stoploss.

Among the heavyweights ITC, Gujarat Ambuja and TCS look interesting.

The capital goods sector: LT and BHEL look weak.

Bharti, ICICI Bank, Infosys and Tata Motors look ripe for a significant correction. IFCI lost heavily on Friday. It would look attractive below Rs 55.

Buying on declines looks attractive in Punj Lloyd, SBI, Reliance Industries, City Union Bank, Dhanalakshmi Bank and IOB.

Whatever you do, have a successful week ahead.