Can liquidity driven rally on equity assets hold on to stretch valuation in the absence of support from fundamentals?
Despite weak macroeconomic fundamentals, G7 risk-on equity assets have built significant valuation since 2009. Central Banks are in ultra-dovish monetary policy stance since then, pumping huge liquidity at near zero interest rates and now with bloated Balance Sheet. The regime of zero (or negative) return on idle funds parked with Banks is with intent to build economic capacity through leveraged consumption. Despite FED ending QE in 2014, others in Euro zone, Japan and China are still in extended supportive mode. Unfortunate part is that all these measures have not led to economic growth, but only led to liquidity flows into risk-on assets for short term "carry trade" play. In the absence of fundamental support, liquidity driven rally has to end at some point, at hot-to-hold valuation. DJIA multi-year rally from below 6500 is already losing steam over 18000. During this period, NIFTY rallied from below 2500 to over 9000 before reversal. The reasons for inability to pick up global growth momentum despite 5-7 years of overdose monetary support is mystery - "something is seriously wrong somewhere".
The Indian scenario is more complex despite optimism since mid 2014. The macroeconomic fundamentals look definitely better, but not with significant economic capacity expansion. The GDP growth got lifted up from below 5% to over 7% on the book through review of base year calculation. The significant improvement on the CAD, inflation and fiscal deficit is largely due to sharp decline in Crude. The external appetite for India is more to do with others being worse, and attracted by elevated interest rates & sharp decline in Rupee exchange rate. The comfort is from opening up of huge opportunities, while the risk is from execution efficiency. While India is still seen as "best among the bad" (along with China), it is not good enough to sustain stretch valuation in the absence of backing by strong fundamentals.
What Next? MARKET PULSE set 2015 focus on DJIA at 14850/15350-17850/18350 covering the above-said dynamics in play against 2014 close of 17823. As per script, overshoot beyond the hot-to-hold resistance point 18350 was short-lived with punch at 18351 (in May) before sharp unwind to low of 15370 (in August) followed by recovery into 17977 (on 3rd November). Now, the pace of correction from below 18000 into set target at 16850-17000 is worry with weekly close below 17250-17350. The cues ahead are complex with conflict between the FOMC and IMF on FED preparedness for December rate-hike. The economic data from G7/G20 (excluding the US) provide little comfort on growth, consumption and employment. It's not good risk to stay invested in risk-on equity assets taking comfort from liquidity support from G7 (excluding US). All taken, the short term outlook is not in favour, thus setting up risk of extended correction into 16600, seen as make-or-break point which is also mid-point of set 2015 strategic focus range of 14850/15350-17850/18350. For now, it is good stay focused at 16500/16650-18000/18150 with short term cap at 18250-18350. Given the liquidity support and possibility of rate-steady FED in 1st week December FOMC meeting, risk-on buy would emerge at 16500-16650.
NIFTY comfort is largely from significant unwind in valuation since March 2015 high of 9119 to 7730 (by over 15%) and not far away from (September) 2015 low of 7539 which is just 2.5% short pulling in short-squeeze bids and value-buy appetite. MARKET PULSE 2015 strategy was not to chase NIFTY into 9000-9150 and to accumulate at 7500-7650. While 2015 high is seen very safe, uncertainty is from the hold at 2015 low at 7539. The unfortunate part is that 50 bps rate cut support rally from 7691 to 8336 (between 29/10 to 26/10) is set to unwind completely by stretch into 7539-7691 in the immediate term. The short term resistance (for rest of 2015) is away at 8115-8150 and 8315-8350 not ruling out 2015 close below 2014 close of 8282. The immediate minor support at 7685-7710 with make-or-break support zone of 7500-7535, which is likely to hold. MARKET PULSE has already squeezed the Q4/2015 (post 29th September rate cut) range focus at 7500/7535-8315/8350 and with break below mid-point 7925, the bias was for test/break of 7750-7785 which is done now with low of 7730 before weekly close at 7769. For the week, short-squeeze correction will be shallow at 7850-7885 with firm resistance zone/cap at 7915-7950. The downside pressure at 7685-7710 is likely to give way for stretch into 7500-7550 before consolidation at 7535-7935; break below 7500 will be very bearish. Stop for weekly big-picture focus is at 7500 and 7950.
Bank NIFTY went sharply down to 16587 from 2015 high of 20907 (by over 20%) against 2014 close of 18736. The sharp unwind post 1.25% rate cut in 2015 says it all on the woes from NPA and Capital squeeze on Banks P&L and Balance Sheet. The 2015 focus was set at 15000/15850-20650/21000 and have seen end-to-end with stability around 16850 now. Can the 2015 low punch at 15762 stay safe? There is high probability of staying firm post the recent measures to find structural resolutions relating to Capital (through enhanced FDI limit) and steps to reduce the huge NPA burden largely from infrastructure and price sensitive commodity sectors. The earnings risk is from hardening bond yields (leading to huge opportunity and real losses on the Banks investment book), squeeze in the intermediation margin and increased competition in the lucrative product segments of low cost CASA, high yield small ticket loans and Transaction Banking fees. All taken, Bank Nifty is likely to outperform NIFTY for rest of 2015 in bullish consolidation mode at 15850-18250 with intermediate resistance zone at 17050-17450. For the week, it is good to retain focus at 16500/16650-17350/17500 in sideways mode with 51% bias for unsustainable stretch into 15850-16000.
Limited clarity on the trend in Gilt yields
The huge volatility in US 10Y yield has impacted most markets; Euro zone woes drove US 10Y yield down from over 3% to 1.65% in 2014 before stability at 1.85/2.0-2.35/2.50% in 2015 (low at 1.91% and high at 2.50%), and now in risk-neutral mode at 2.25-2.35%. What Next? FED holds the trigger for breakout of 2.20-2.35% pre FOMC focus range. FED rate-hike would trigger move into 2.35-2.50%, while rate-pause get the focus back into 2.05-2.20%. The most critical will be the policy guidance tone between neutral to hawkish. At this stage (against IMF red flag on rate hike while G7 in extended dovish stance), set 51% probability of mid-December FED rate hike; eitherway, volatility will be extreme in thin Christmas holidays market conditions. For the week, good to retain focus at 2.20-2.35% with marginal bias for spike into higher end of 2.35-2.50%.
India 10Y bond has now completed the expected FY16 rally from 7.90-7.93% to 7.47-7.50% ahead of time at end H1/FY16, and now in end-to-end sideways mode at intermediate zone of 7.65-7.75%. What Next? RBI next round of rate cut is seen distant away, having already unwound impact of 25 bps rate cut, seen as more than necessary of the 50 bps cut delivered on 29th September. The probability of CPI stability at 5-5.5% in rest of FY16 is higher than ease into 4.5-5.0% which puts RBI in extended rate-pause mode. During this time, it is higher probability of FED delivery of 50 bps rate hike before end of FY16. Combination of RBI and FED monetary policy stance, India 10Y bond range focus is now set at 7.60-7.85% with India-US yield spread squeeze to 5.20-5.35% cutting FPI appetite significantly till USD/INR exchange rate correction into upper-half of 65-70. For the week, it is good to retain focus at 7.60/7.62-7.73/7.75%. The strategic play is to unwind "long" (entered at 7.73-7.75%) book at 7.60-7.62%. Banks also will be seen cutting duration here on core SLR book for reinstate at 7.75-7.85%.
USD retain bullish undertone despite swift rally into 2015 high
DXY intra-2015 moves have been volatile within set strategic focus at 90/92.50-98.50/100 against 2014 close of 90.27. The back-and-forth moves are wild at 90.24 to 100.39 to 92.62 and now at 98-99.50. USD continues to retain its strong hold on major (and EM) currencies, both from macroeconomic and interest rate advantage. Will DXY punch a new 2015 high over 100.39? Between Yes and No, the bias is in favour of punch of new high if FED is seen ok for bullish extension beyond 100. For the week, it is good to retain focus at 97.85-100.35 with extended correction not beyond 96.50-96.85 while retaining bullish momentum for break of 100.35 to test FED nerves whether to intervene or be with the flow.
EUR/USD is the worst hit in 2015 down by over 13.5% in Q1/2015 to low of 1.0450 from 2014 close around 1.21. The recovery from here was equally swift to August high of 1.1711 and now under pressure at 1.07-1.0850. What Next? Post the Q1/2015 crash, MARKET PULSE strategic big-picture focus was set at 1.05/1.0650-1.15/1.1650; since then overshoot into 1.0456 and 1.1711 couldn't last beyond intra-day. Now 1.05-1.0650, seen as short-squeeze (and long-build) zone is at striking distance is at risk against the DXY bullish momentum beyond 100.35? It depends on FED guidance more than the token rate hike act; neutral guidance with 25 bps hike will lead to print of new unsustainable high, while a hawkish guidance can shift the range focus to 98.50-103.50 (driving Euro below 1.05 to striking distance of parity).
Rupee resilience to USD strength is at risk
Rupee has been resilient to USD strength down only by 5% against DXY up by 10% from 2014 close, thanks combination of CAD decline from 5-7% to 1-2% of GDP, robust NRI/FDI flows and huge FPI appetite for India debt & equity assets. But for aggressive RBI $ purchases at 63.35-63.50 & 64.70-64.85 and huge offers at 66.35-66.85, Rupee would have been extremely volatile at 60-70. Can all these dynamics sustain to retain Rupee resilience against the USD strength? The risk is from FPI flows; while elevated Bond yields is relief, consolidation of equity market is essential to cut FPI exit mode. While FPIs move away, USD/INR will build traction with DXY strength and stay diluted with DXY push-back. For now, USD/INR near/short term base seen firm at 65.50-65.85 with bias into 66.50-66.85; consolidation outlook here is valid while DXY at 96.85-100.35 and extended gain beyond 100.35 will build downside risk on the Rupee into 66.85-67.20. The hedging strategy is to cover near/short term imports at 65.95-66.10 (end December 2015 $ at 66.50-66.65) and long term imports at 65.50-65.65 (12M $ at 69.85-70) while exporters stay away for 12M $ at 71-71.25 (spot at 66.85-67.10). Beyond 67.20, focus will shift into August 2013 low of 68.85. Rupee complete unwind of post 29th September strength from 66.35-66.50 to 64.70-64.85 may not be to RBI's dislike. All combined, Rupee retains its nervous undertone from global headwinds and domestic complexities.
EUR/INR post the unsustainable swing between 65.65 and 78.15 (tracking EUR/USD between 1.0450 and 1.17) is seen to be settled at 70.35/70.60-72.15/72.40 within near term big-picture at 70-72.50 while USD/INR at 65.50-66.85 and EUR/USD at 1.05-1.10.
Commodities under pressure with most cues against
Commodity assets have lost advantage from combination of demand-supply and growth-inflation dynamics not being in favour with shift of traction to USD price movements. The abundant liquidity at near zero interest rate has not helped.
Brent Crude recovery from 40-42.50 strategic support zone lost steam at 53.50-55, and now building pressure for more downside risks. MARKET PULSE strategy was to stay focused at 40-55 with bias for bullish extension into 55-70. But given the growth pressure and supplies pile up, near term risk remains for closer look at December 2008 low of 36.20, which will bring more fear than cheer to even Crude importers. For now, may need to review strategic focus from 40/42.50-53.50/55 to 35/36.50-48.50/50 with near 100% probability of relief recovery into 53.50-55 from 37-42, seen as good hedge for oil importers.
Gold under pressure again at 1070-1085 having lost over 8% from 2014 close of 1183.50 and by over 17% from intra-2015 high of 1306. Gold has lost its safe-haven status from low inflation and Central Bank sales for cash liquidity. MARKET PULSE was on the down-hill chase through 2015 for 1070-1085 and favoured deep correction from here into 1185-1200 before sharply down. The fall from 1185-1200 (high at 1190.60) since mid October to 1070-1085 is at break-neck speed. Now, the outlook is negative while below 1100-1110 for 950-1000. For now, let us keep close watch at 1070/1080-1100/1110 with bias for downside break into 1000.
Have a great week ahead; Good luck!
Moses Harding
Good article. Thanks.
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