We’ve been outlining our thesis for a choppy environment in stocks both in India and globally for several weeks now and evidence continues to build that the market agrees with us.
With weakness in the broader market, sectors and individual stocks that have not participated remain at risk to lead to the downside.
Today we’re looking at the Auto sector, which looks vulnerable to a swift 10% move to the downside if support at its multi-month lows breaks.
Let’s start with a daily chart of the Nifty Auto Index, which is currently pressing 4.5-month lows and weighing heavily on support at 7,750. After prices found support at their 2016 lows last summer, prices began to mean revert with other weaker areas of the market.
After capitalizing on those gains we suggested that if prices could stabilize above 7,750 then their bearish to bullish trend reversal would remain intact and prices could work their way higher.
Click on chart to enlarge view.
Today, that’s not what we’re seeing. Rather than an expansion of participation to the upside among its individual components, we’re seeing more of them give back their gains and continue lower with every passing week. From our perspective, that 7,750 level remains key. If we break that then there’s potential downside towards 6,900…and we think it could get there very quickly.
The Nifty Auto vs Nifty 500 relative chart has already begun to roll over and is back into oversold territory, suggesting sellers have once again taken control and that the path of least resistance is lower. Relative underperformance is often a precursor of weakness on an absolute basis to come, and we think that’s the case here.
If the Nifty Auto Index is going to resolve itself lower and continue to underperform the broader market, then stocks like Apollo Tyres and Hero Motocorp Ltd. that have not participated in the August-November rally are likely to lead to the downside.
From a tactical perspective, as long as Apollo Tyres is below 158.50, then the risk is to the downside with a target at its 2016 lows of 127.
Hero Motocorp Ltd. is testing multi-year support again. The more times a level is tested, the more likely it is to break and the fact that prices could not gain any traction at this large of a support level as momentum diverged positively is a testament to the stock’s relative weakness.
A break below 2,200 would signal the continuation of its multi-year downtrend and target 1,375-1,425 on the downside over the coming quarters and year. More importantly, our risk is well-defined and reward/risk skewed in our favor on the short side.
Looking at the Nifty Auto Index and its individual components, the higher-probability outcome appears to be a downside resolution to its November-February consolidation. As longer-term market bulls this is not the outcome we wanted to see out of an important sector like Autos, but the market does not care what we think. If prices are below 7,750 in Nifty Auto then there’s a lot of downside potential and opportunity cost on the long side.
The bottom line is that we want to either avoid the sector altogether or play the short side through the index or weaker components like Apollo Tyres and Hero Motocorp Ltd where our risk is well-defined and reward/risk very skewed in our favor.
In the event that prices dig in here and we’re wrong, then we’ll take our papercut and move on. For now though, the weight of the evidence suggests looking for more downside.
Thanks for reading and let us know if you have any questions!