Last Monday we discussed our thesis for a bounce in Indian stocks and by Friday we were talking about how to manage those trades so that we could avoid letting winners turn into losers.
Now that we’ve gotten a decent bounce, many are asking what the next directional move in the market is going to be. In this post we’ll outline why we think that Financials and Smallcaps are the areas to watch for clues.
First let’s start with a look at the Nifty 50. It looks like a lot of the other large-cap and broad-based indexes, sitting at or near a flat or slightly declining 200-day moving average with momentum in a bearish range. They’ve bounced at support and now we need to see prices stabilize at higher levels or if they start to roll over again. What’s clear is that a lot of technical damage was done over the last few months, so we a swift recovery to new all-time highs is likely the lower-probability outcome.
Click on chart to enlarge view.
For now it appears a neutral / bearish stance remains best, but further sideways consolidation would be extremely constructive behavior.
So let’s get into the two themes we’re watching.
In early September we highlighted the weakness in Financials as a major headwind for the broader market, but instead of relative weakness we’re now seeing some relative strength from this sector. Not only did the Financial Services Index hold its March lows, but it also made a higher low as the Nifty 500 made a lower low in late October. This sector represents nearly a third of the market, so if we’re going to see further downside it’s likely in an environment where Financials are making new lows.
Our September post also highlighted some of the weakness in the sector’s largest component, HDFC Bank, that ultimately helped drive a failed breakout in the index itself. HDFC Bank continues to lagg, but its impact is being offset by strength in other large components like ICICI Bank and Axis Bank. If this relative strength in Financials is going to continue, HDFC Bank needs to get back above its January highs.
As I mentioned, there are a few areas of strength in the sector like ICICI Bank, which is attempting a breakout to new all-time highs. A breakout like this would certainly be a bullish data point to add to the mix.
It’s also worth noting that many of the Financial stocks that have been hit hard are experiencing some mean reversion. If they begin to stabilize and build bases at higher levels, that would be extremely constructive to the sector and broader market. However, if they begin to roll over again that would continue to be a headwind for stocks as a whole.
Smallcap under-performance was an issue under the surface since January, but only began to matter once we saw the leading large-cap sectors get hit.
This ratio helps measure risk appetite in the market, so the higher low we saw in late October as the Nifty 500 made new lows was a constructive sign for the market overall. Continued out-performance, or at least in-line performance from small-caps would suggest an improving environment for equities as a whole.
Here is a look at that ratio flipped, with the Nifty 100 in the numerator and the Nifty Free Float Smallcap 100. What we see is a failed breakout as momentum diverged, suggesting that as long as its below 1.772 it’s likely that small-caps out-perform or in-line with large-caps.
While the major indexes are mixed at best, there’s still plenty of opportunity under the surface. Many of our premium long ideas from last week are working well and there continues to be new long and short opportunities emerging across sectors each week.
For example, Divi’s Laboratories broke out of a massive base to new all-time highs after holding up well during the broader market’s correction.
Another example is Intellect Design Arena Ltd., which is pressing up against all-time highs as it attempts a breakout from a nearly 3-year base.
Bata India Ltd. was another leader that broke support briefly during the market’s pullback, quickly reclaimed it, and is now squeezing back toward all-time highs.
On the short side, names like Tata Global Beverage saw no relief and are rolling over as the market bounces. These are the names we want to avoiding on the long side, or shorting if we want that type of exposure.
Same thing goes for Bharat heavy Electricals Limited which is consolidating near the lows of its 3-year base. A break below 60 and we could easily see the stock cut in half if its next long-term price objective is met.
The Federal Bank Ltd. is one we’ve played on the long side after a failed breakdown and bullish divergence confirmed in early October. Prices have met our upside objective near former resistance and are now rolling over.
This is an ideal candidate for the type of trade we outlined in our post about what we look for in fading strength. If prices are below the downtrend line at 86, prices look vulnerable to retest and potentially break through support at 74.
The Bottom Line: It may seem like we often reiterate a lot of the same themes and concepts on the blog, but that’s because it continues to work. Many of the major indexes are in a bit of “no-man’s” land at current levels, so we’re watching Financials and Smallcaps for clues about the next major directional move for stocks as a whole.
In the meantime there continues to be long and short opportunities offering elevated reward/risk in individual names across varying sectors and industries. If you primarily trade the indexes, remember that cash is a position too.
We’ll continue to monitor the weight the evidence as we get more data and will keep you updated as we always do.
Thanks for reading and let us know your thoughts!