What's in markets this week? extended risk-off?!

Value-adjustment in extended phase?

Lots said and less said the better on the sharp rally in global equity markets since mid October additional liquidity injection by major Central Banks at Zero or negative interest rate. DJIA rallied up from 15850 through 17350 into 18000; so was NIFTY from 7725 through 8175 into 8625, in 2-steps re-rating! While the 1st step (DJIA from 15850 to 17350 and NIFTY from 7725 to 8175) is seen to be in order, the 2nd step rally (DJIA from 17350 to 18000 and NIFTY from 8175 to 8625) is excessive from mad liquidity chase without fundamentals support. It is obvious that such sharp re-rating (in valuation) without strong fundamentals back-up is tough to sustain. What goes up this way, has to come down sharply with greater pace! This is what precisely has happened now, with the unwind of 2nd step (DJIA from 18000 to 17350 and NIFTY from 8625 into 8175) in week's time! Investors were cautioned to exit the chase from cheap-to-acquire level (DJIA at 15850 and NIFTY at 7700-7750) at hot-to-hold valuation (DJIA at 18000-18100 and NIFTY at 8585-8635) for reversal (to unwind stretch valuation) into intermediate support zone (DJIA at 17350-17500 and NIFTY at 8150-8200). It is done now. What next? The million dollar question is should investors prepare to absorb excessive reversal (DJIA below 17350 and NIFTY below 8180) or stay aside for more? The answer can be either-way as cues are mixed to take a firm stance either to stay in favour or against! When in doubt, it is prudent to be with the bearish momentum with stop loss - buy entry to reinstate investment!

DJIA weekly close below 17350-17500 is weak; possibility of extension below 17175 into 16900-17000 is high. The strategy is to be with the chase with stop-loss buy at 17500. On the way down, good to enter one-third (of earlier exit) at 16900-17000 with enough appetite to add more around 16650 and 16300, while trailing stop-loss buy down to stay fully invested for baby-steps recovery.

NIFTY will be under severe pressure from IIP shocker (although immediate rate cut could dilute the downside pressure) and risk on FII mood-swing when both equity and Rupee come under pressure. Any weakness below 8150/8160-8185/8200 in extended holiday market will be painful for complete unwind of 7725 to 8625 rally since mid-October to first week of December; it is pity that gains from 2 months will be knocked out in 2 weeks! As said, there is no great comfort to reinstate at 8160-8185 given the mixed cues. It is good to be with the extended reversal mode with stop-loss buy now revised down at 8285 and watch price-actions at 7920-8070 for 50% entry, retaining balance for 7700-7750 or at the then lowered trail stop buy level. All taken, bulls are down and out at the speed of 5% reversal, while bears are seen to take control of the street to execute the next 5% reversal before leaving the floor to the bulls!

Risk-off support to Gilts despite stretched valuation

There is nothing against Gilts/Bonds, while things in favour are from liquidity over-hang, NIRP/ZIRP/low interest rate regime, shift of investor appetite from high-valued equity to Bonds/Gold, interest rate expectation (extended carry-play on expectation of 12 months pause before FED rate-hike, and rate-cut from RBI ahead of next policy) despite stretched valuation. As expected US 10Y found solid support at 2.35-2.40% for pass-through of 2.15% ahead of strong resistance at 1.90%; India 10Y bond extends gains below 7.85-8.0%. In the process India-US 10Y bond spread moved up from 2.60 to 2.75%. What next? The million dollar question is the period of sustainability at current lower yields when cues may reverse quickly in the new year? The earlier reversal in US 10Y bond was sharp from 1.90% to 2.60-2.65% on minor scare from possible rate-hike by mid 2015; need to keep this in mind. India 10Y bond yield will be adjusted to this risk retaining bond spread at 5.60-5.85% to retain FII appetite on India bonds and to ring-fence Rupee exchange rate from sudden FII pull-out, repeat action of June-July 2013.

Given the current dynamics across asset classes, prefer US 10Y bond stability at 1.90-2.15%, not ruling out swift push-back into 2.35-2.40%. India 10Y bond yield at current has factored in most of positive cues including 50 bps rate cut before end of FY15; what it has not covered is the downside risks in CPI inflation print from lower to higher end of 4-6% focus zone, unfavourable demand-supply equilibrium on credit pick-up, Rupee/FX adverse impact on MM/Bond yield and risk of FII unwind. Prefer 10Y 8.40% 2024 bond in tight stability at 7.75-7.85% at 5.70-5.85% bond spread traction with US 10Y at 1.90-2.15%. Need to stay cautious on "long" book, hedging against the risk of post rate-cut sell-off!

Consolidation of USD against majors, while Rupee give up relative gains

Lots discussed about the dollar and Rupee. All taken, Rupee has lost (or diluted) its advantage over the dollar. Rupee moved into over-valued zone without adjusting to DXY rally from 84.50 to 89.50 and weakness in Euro from 1.40 to 1.2250 and JPY from 105 to 122, since mid-October (with marginal adjustment in Rupee from 60.20 to 62.50). This advantage is thanks to huge FII supplies. Will FIIs continue to pump-in more when NIFTY at risk of extended weakness into 7700-7750 and lack of comfort on 10Y bond stability at 7.75-7.85%? If FIIs choose to exit, can RBI defence be strong with pipe-line lumpy month/year end $ demand? There is no comfort to stay affirmative to these questions!

Trading focus on DXY is retained at 87.50/87.75-89.75/90; EUR at 1.2250/1.2350-1.25/1.26 and JPY at 115-120, with a note of $ retaining its short/medium term bullish momentum and now into near-term consolidation phase. Into year end, needless to say to stay light and fleet-footed playing end-to-end with tight stop on break-out.

Rupee near term focus is now at 61.95/62.20-62.85/63.10 with extension limit at 61.70-63.35. There will be good flows at either-end to prevent break-out either-way. Looked for end 2014 spot USD/INR target at 62.10-62.35 which is now shifted to a wide range at 62.35-62.85. Good to play end-to-end and not the time to stay over-weight on Rupee.

Moses Harding