[Chart Of The Week] Small Stocks, Big Failure

JC Parets
September 23, 2020

Since late August we've been discussing the slow, but steady growth in the number of bearish data points pertaining to Indian Equities.

This week we got another one, with a failed breakout in the Nifty Small-Cap Index. Let's take a look at what has happened, what it means, and how we're approaching it.

Here's the Nifty Small-Cap 100 Index chart we shared with members in our Sunday evening post discussing three charts for the week ahead. What we noted was that it was the only major nifty index to make new marginal highs last week, while the Nifty 50, Nifty, Nifty Next 50, and Mid-Cap 100 all made lower highs.

And now we're seeing prices of the Small-Cap Index confirm a bearish momentum divergence, a failed breakout above that 5,910 level, with prices settling back into a range between 5,050 and 5,910.

Click on chart to enlarge view. 

Notice that prices are near a flat 200-day moving average too, which would suggest a lack of trend and a very choppy tape is in store for us in the weeks and months ahead. This would support the more cautious view taken three weeks ago and another reason for us to remain very selective in the trades we're taking.

Here's that same picture in the Nifty 50. The index failed to break above resistance near 11,750 and is now settling back into the middle of its range between the recent highs and major support at 10,000.

And Internationally we continue to see breadth deteriorate, with major indexes like the Euro Stoxx 50 breaking to multi-month lows after failing to break to new highs over the last few months.

And in terms of the most important sector in the world, Financials, their performance across various countries/regions weakens. The last man standing is Canada, but with India, the US, and Europe breaking to new lows the weight of the evidence remains in favor of the bears here.

And with Financials being a third of the Indian major indices, this is a major headwind for stocks going forward.

And another change of character over the last month is that we're finally seeing downside follow-through in the weakest stocks, like Gail Ltd. (or ITC Ltd.). Two months ago we were seeing consolidations resolve higher, not lower. That has changed.

And in addition to the major indexes, we've got more stocks failing to sustain their breakouts. Again, a change of character.

Meanwhile, there are stocks that continue to show absolute momentum and relative strength, with well-defined risk. Dr. Reddy's Labs was a great example of that. Finding strong stocks in strong sectors on the long side continues to work. There may be failed breakouts here and there given the increased volatility in the overall market...but that's to be expected and can be adjusted for in position sizing, entry strategy, etc.

And then finally let's hit on the US Dollar Index from an intermarket perspective. The strength in the US Dollar continues to weigh on cyclical assets in the US and around the globe. The Dollar Index going up towards 96 will remain a headwind for Stocks, Commodities, etc. and has stopped us out of the bullish Metals thesis we outlined a few weeks back. From an intermarket perspective, this puts a damper on a lot of themes.

To Conclude: The caution flags we were highlighting three weeks ago are being followed up by downside action and more caution flags from the market. In other words, the weight of the evidence has shifted from very bullish, to bullish, and now to neutral. That doesn't mean the Bull Market is over, it just means that over the short/intermediate-term we should expect continued volatility and choppiness as the market works itself out.

So what is our strategy for this environment? Well, in addition to what we discussed three weeks ago like raising cash, hedging, etc., we want to focus our analysis less on the major indexes and more on individual stocks. When the market isn't trending, it pays to focus on individual securities that are...in both directions.

Remember, when the market is trending down, it's a headwind for all stocks. When it's trending up, it's a tailwind for all stocks. When it's not trending at all, most stocks will fluctuate with it...but there are always some that will trend.

Focus on the ones that are trending and ignore the rest.

In the next day or two we'll be releasing some new long and short ideas for the current environment and a lot more analysis in early October as we approach a new quarter and adjust our research universe to reflect the changes in the Nifty Indices that take place twice per year.

In the meantime, please let us know if you have any questions.

Allstarcharts Team

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