A Tale Of Two Charts – 16/07/2018
Over the last several months, one of the more perplexing issues for most traders has been the dichotomy between Nifty moves and stock moves. Both seem to have headed in opposite directions. The Nifty is seen challenging its highs while our stock portfolios are plumbing the depths! This is a vexing situation, making everyone feel that it is only his or her portfolio that is faring so badly! But the fact of the matter is that it is the story in every house!
The other vexing issue is about the market not falling. The macros are nothing majorly positive to mount a challenge on the all-time highs. There is enough noise in the fore as well as background to make people plenty nervous. FIIs have been selling, money flow into DIIs has reduced, earnings improvements are not catching up, Modi campaign for 2019 doesn’t look so formidable, etc. etc. In spite of all these – and perhaps many more- the market refuses to fall by more than a couple of hundred points. Every reaction begins to look like this is the one, but then it just fizzles out in a few sessions.
What can be at the back of such perplexing moves? A look at a couple of charts will quickly reveal the story. Here is the first one.
This chart shows my proprietary BIAS Indicator, which I use to measure to check the creation of trading positions in the market. It uses a mix of volumes, open interest and delivery percentages. Plotted against the Nifty, it reveals some interesting reads. From 2015 till June18, you can see three strong dips in the indicator. The first one was during the major market bottom in Feb 2016. The second one occurred post the Demonetisation announcement in Oct-Nov 2016 and the third one has occurred now, in the six months of 2018. Note the extent of each of these and you will find that the present fall is steeper and deeper. What this means is that position liquidation is high and greater than the previous big liquidations.
The next point to note on this chart is that the Nifty has been moving higher all thru 2017 but the Bias indicator never picked up during this advance! It is obvious that even as the index hit all-time highs, the bulk of the market, particularly Futures, did not meet up with buying. But the very fact that the index kept moving higher, hitting new highs by end of the year, meant that index heavy stocks were moving up. We all know that this continues to be the situation. Even in July 2018, the Nifty is being pushed higher by a clutch of 7-10 stocks. The Bias indicator continued fall to new lows is a clear indication that the rest of the market showed scant build up.
What this means is that the market, even at 10900 levels, is DEVOID OF LEVERAGED LONG POSITIONS. It has never had much leverage built up all thru the last year and half! That explains almost completely why none of the reactions in the market ever lasted more than a few days. Whatever little positions were there were liquidated in a swift rush to sell and the market went light. Lack of index losses along with an overall expectation that Indian economy was set to recover prevented the big guns from selling out. The inflow into domestic funds was sufficient to balance out the selling by FIIs.
So, the first mystery gets somewhat cleared. Very little positions were being built up and hence there was no stock overhang- and particularly not of the leveraged variety- to take the market down more than a few days and a few hundred points. Even as of now, there is hardly any leveraged long build up visible in the market.
But we all suffered badly as the small and mid-cap stocks plummeted. With most of our portfolios composed of these stocks, the pain was quite acute for most players. It continues into this day. This creates the second mystery. If the earnings outlook is set to get better and fund flow is still pretty much alive, why are stocks still falling? Is there an end to this? A look at the following chart throws up a possible answer.
Also watch the video on the same BIAS indicator by Dr.C.K.Narayan based on the above findings.
Click here https://youtu.be/Ysp40igK-bA
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This chart shows the relative performance of Mid and Small cap vs. Sensex. On the left is the last year or so while on the right you can see a 3-year history of the same. Note that the more recent data shows a gross under performance by the small and mid-cap indices, with both plummeting lower while the Sensex remains tempered and headed up. This has been our recent experience. The picture on the right shows that the extent of outperformance of the mid and small cap stocks since 2016 (where they all bottomed) has been of such an extent that even after a sharp decline this year, they are still at a premium to the Sensex. (In fact the chart updated into July shows that the two indices have now caught up with the Sensex returns!).
The important point here is that with the decline, the steep out performance of the small and mid-cap section of the market (largely patronised by Retail) is erased! It is noted from the past that whenever this kind of convergence happens, the market is near an important turning point. The sentiment is now quite despondent and almost no one is speaking about investing into the market! Six months ago, we could not parley enough money into the market! Such is the flick of sentiment!
One could ascribe part of this fall to the realignment action of mutual funds as dictated by Sebi. More importantly, I believe that in the latter half of 2017, a huge amount of leverage was taken up in purchase of small and mid-cap stocks (unlike the usual large cap or futures) and over the past six months it is this leverage that is getting unwound. Operators had become quite active in the last year and many of them are stuck now and unwind of those positions too is in progress.
Be that as it may, with the out performance now erased, mutual funds will no longer have a reason to sell out their mid and small cap stocks. Retail has this habit of turning fatalistic when declines continue for sustained periods, inflicting severe damages on stock prices and portfolio values. They simply withdraw from the fray, drying up the supply, progressively. This is currently happening now.
Now, let’s take the two charts together and draw some fresh conclusions. We have the following:
1. Hardly any leveraged longs in the futures.
2. Over performance of small and midcap over Sensex completely erased by now.
3. Market is at an important turning point.
These indicate that there is unlikely to be much supply even if the market were to decline on any macro related issues. There simply isn’t sufficient ammo among the players to keep the trend going to the downside. So, we are probably quite unlikely to see deep cuts to the index. Now, that can be a comforting thought.
The only way the market can continue lower is if significantly poor fundamental news flow were to emerge. This can be local (earnings, politics etc.) or global (tariff war, currency wars etc.). But it will have to be big. The ordinary factors will keep the market moving the way it is. This is possible but not something that can be forecasted. So we will simply have to deal with it were it to happen.
Over the years, it has been seen that whenever ‘risk-on’ sentiment is dominant, it is the small and mid-cap stocks that do very well. This was the phase from 2014 thru 2017. During times of local and global uncertainties, the large cap action takes over and dominates. We saw this in 2012-14 and we are seeing it again now in 2018. Trump tariffs, Oil rally, Dollar strength, Modi wave waning etc. have all created a sense of uncertainty about the surroundings to lead to a ‘risk off’ sentiment prevailing. It is therefore nothing out of the ordinary to see the large caps doing well right now.
Using standard deviation as a measure, I find that the out performance of small and mid-cap indices over the Sensex had reached a reading beyond 2 SD- surely a point of reversal. The correction over the last 6 months is owing to this and now there is a progress towards mean. But the mean is still some distance away and this would mean that small and mid-cap stocks may not sit up and fly just yet!
Reaching a low, reduced-supply point, does not automatically mean a reversal to a rise. It only means that we may not fall much further. It means that large cap out performance may continue for some more time. It means that turnaround in certain select small and mid-caps may occur but it is not going to be the kind of all-out affair that it was for the past 2-3 years.
But we can take solace from the fact that the market is unlikely to fall much. This should quell the fears of many. With valuations at more reasonable levels now, we can look forward to the June and September 2018 quarterly earnings to throw up new candidates or revive existing ones for us to invest into. It means that the large caps will continue to do well where their fundamentals provide a reason to do so.
Finally, it means that the speedier part of the market may take time to return. But the current times are certainly not one to turn despondent or withdraw from the market. Indeed, this may be a good time to parley some fresh money into the market for some attractive returns that can be harnessed thru some judicious stock picking.