[Premium] Signs Of A Long-Term Bottom Emerge

Before we get into where we are potentially going, let's review where we've been: The last few months have been a bit of a "hot mess" at both the index and individual stock level, chopping us up on both the long and short side of the tape after a very successful November of buying stocks.

In our February Conference Call we were still erring on the long side of the stock market, particularly looking for some mean reversion in mid and small-caps from their 2018 lows, which we got, but we also had a number of short ideas that worked initially but are now back above their risk management levels.

So what's next? This post is going to outline our thoughts based on the current weight of the evidence.

First let's start off with the Nifty Free Float Smallcap 100 that recently undercut its 2018 lows. The thesis last month was that if this was a successful retest of the lows with far fewer stocks in the index making new lows, that would be a signal of massive breadth improvement. Well, those lows held and this bullish divergence is now confirmed.

Click on chart to enlarge view.

We're also seeing that bullish divergence in the number of stocks within the Nifty Free Float Smallcap 100 Index hitting oversold conditions. Again, fewer stocks are seeing intense sell pressure as the index makes new lows, a very positive sign.

In addition to breadth divergences, we also saw a very large bullish momentum divergence on the weekly chart of Smallcaps.

We saw this divergence on the daily timeframe as well, with momentum now very close to getting overbought as prices mean revert toward our 6,505 target and its downward-sloping 200-day moving average.

We saw similar breadth and momentum divergences in the Nifty Free Float Midcap 100 Index as well.

Here's the weekly chart showing that divergence.

And here's the daily chart.

So why are these breadth and multi-timeframe momentum divergences so important? Because we often see these types of conditions at sustainable lows in the market, so when they happen we pay attention.

The other thing to note is that during this two-week rally in the small and mid-cap indexes, large-caps as measured by the 10 largest names in the Nifty 500 are flat over that time period. This is a change worth noting and the next two charts will explain why.

The ratio of Nifty 100 performance vs the Nifty Free Float Smallcap 100 has been in a steep uptrend since bottoming in early '18, but we're now seeing a huge bearish divergence in momentum being confirmed by a failed breakout in price. While this could be worked off through time rather than price, typically failed moves lead to fast moves in the opposite direction.

And if Smallcap relative performance has bottomed, that's a major development for the broader market. If money is flowing into the riskier, more speculative Small and Midcap sectors of the market then that means institutions are becoming more optimistic about the market as a whole. While Mid and Smallcaps were getting crushed, these money managers were hiding out in the Largecap names that weren't falling as much.

The Nifty 500 is still a hot mess (rangebound), sitting near a flat 200-day moving average. It's still got a lot of work to do, but a breakout to new multi-month highs would certainly build on improving market internals.

The last thing I'll note is the ratio of the Equally-Weighted BRICK Nations on local currency basis, relative to the same basket without India. This essentially isolates the performance of India, and this ratio is finding support at its breakout area as momentum diverges.

If prices are going to continue their uptrend (meaning India outperforms the other countries), that reversal has the highest probability of success if it occurs from here under current conditions.

So now that we have a big-picture view of the market, let's look at the individual sectors to see what other information we can gather.

First up is the Cap-Weighted Nifty Bank Index which is pressing up against resistance around 27,500. The more times a level is tested, the more likely it is to break and this looks ready to go. If it does break above that level, our next intermediate-term upside objective is up near 33,000.

It's tough to be too bearish with the largest sector of the market attempting a breakout to new all-time highs.

The Nifty Private Bank Index has already broken out above 15,520 decisively and looks ready to make a run toward 16,840.

Even the Public Sector Banks, which have been the worst of the bunch, are putting in a bullish momentum divergence as prices successfully retest their 2018 lows. Again, not something we want to be buying yet, but definitely an improvement and not a short candidate either.

Things aren't all peachy in the sector though, as the Nifty Bank Index confirms a bearish momentum divergence relative to the Nifty 500. This suggests some near-term underperformance is likely from the index.

Several Energy names mean reverted quite aggressively over the last two weeks, breaking to new multi-month highs in many cases. With Reliance Industries sitting just off all-time highs, this sector looks poised to retest its 2018 highs near 16,245 if prices stay above 14,700. Again, a positive for the broader market.

IT remains a concern as it continues to stall at former highs. While not something we'd want to be short, it's an area that looks likely to chop around for a while and not something we're interested in buying again until it makes new all-time highs.

Part of that concern is due to Infosys, which met our upside target near 772 as momentum diverged and has stalled. The more time it spends up here without breaking out, the more vulnerable it is to reversing to the downside and retesting 640.

Even fresh breakouts like Tech Mahindra are experiencing bearish momentum divergences. Waning buying pressure is a bad thing.

Until Tata Consultancy gets some wind under its sails, we think the IT Sector is going to struggle to gain any upside traction.

One area we highlighted for mean reversion in the February Conference Call was Infrastructure, which has bounced nicely and confirmed a massive bullish momentum divergence of its own. Hard to be short that type of setup if we're above the year-to-date lows.

The Cap-Weighted Nifty Auto Index, which we had been shorting since it broke 10,500 late last year, confirmed a massive bullish momentum divergence by getting back above its October lows. Again, not a super clean long setup, but very hard to be short with conditions the way they are.

One stock we highlighted for potential mean reversion off long-term support was Tata Motors, which has rallied roughly 30% from testing 150 a few short weeks ago. Structurally the stock is still very broken, but the momentum divergence and successful test of support make it tough to be short. If you didn't make money as it went from 560 down to 150, probably not the time to force it.

Even the Nifty Commodities Index confirmed a failed breakdown below support, with momentum maintaining its bullish range! Again, a lot of work to do structurally, but we cannot be short this type of chart.

Metals are back above support as well, though momentum remains in a bearish range. Above 2,830 we cannot be short. It's that simple.

Even Pharma saw a massive bullish momentum divergence at its recent lows and is now pressing up against the top of its multi-month range. It's right near a flat 200-day moving average so there's no trade here, but the point is that even the weakest of sectors are seeing waning selling pressure and reversing higher in an aggressive fashion.

Here's the Nifty Media Index with a massive bullish momentum divergence on the weekly. Again, not something to go out and buy right now, but not something we want to be short either.

Even the Nifty Realty Index, which has been among the worst performers for a while, has stopped going down! It's consolidating through time, rather than continuing to correct through price. That's very constructive action.

In this type of environment we think it's best to take a look at stocks that previously attempted breakouts to new highs, but failed because of weakness in the broader market. If stocks as a group continue to build on these very constructive improvements from the last few weeks, then the next breakout attempts in these names are more likely to succeed. If stocks start rolling over again and we're back to a choppy trading environment, then they'll fail.

It's too early to tell which environment we're in yet.

Some of those names on our list include Dabur India, which continues to bump up against resistance near 455.

And ICICI Bank, which is trying to clear 360 once again.

The Bottom Line: This is not an all clear, go out and buy everything hand over fist signal like we got in November. This is a more structural improvement that will take to time to develop. What it tells us is that we now have the foundation for this market to build a long-term bottom upon.

Castles aren't built in a day, so remember that cash is still a position and we can be patient and wait for our pitch. And if you do want to put cash to work, we'd be using smaller position sizing until we get more evidence that this move to the upside has legs.

If this truly is a long-term bottom in this market, we will have plenty of time and opportunity to take advantage of the trend without having to catch the exact bottom. Don't let anyone try to tell you otherwise.

If you still have some mean reversion trades on and they're working, great keep them on. As for shorts, most of our ideas are back above their risk management levels, but even if they fall back below their entry levels we wouldn't be looking to short them.

If we touch a hot stove enough times and get burned, we know to not do that again. The market is telling us that short positions are that hot stove right now, so let's err on the neutral/long side until proven otherwise.

The chartbooks will be updated over the next 24-36 hours, so we'll highlight some actionable themes and individual stocks of interest then since this post mainly provided context on the current market environment and not trade ideas.

As always, thanks for reading and let us know if you have any questions.

Allstarcharts Team