Thursday, May 21, 2009

Changing Trends - Changing Fast?

Dear Readers,
I had been maintaining that markets in most part of world are in uptrend and then came May 6 and I posted my WARNING on seeing some interesting developments on charts. The levels for S&P 500 and Nifty Futures (929 and 3730 respectively) I posted that day remained not even touched and unbroken. But, then came Monday, 18 May. There was this BIG DRAMA in Indian Equities markets and a new chapter in history was written - First time ever in Indian history of equities there was a circuit up! The ostensible reason was "central election results in favor of a stable govt". That day what happened took almost everybody by real surprise. All pundits were expecting anything but a clear mandate to Manmohan Singh and Soniya Gandhi led UPA. What was real surprise was that Indian National Congress party had more seats than expected, giving it the power required to do what they want, rather than so many small allies having constant pressure on day to day work of govt. While there was no real fundamental change in economy on that day, the very expectations of stable next five years (read hope or greed) led to that kind of historic day in Indian Markets. If something of that magnitude happens then no chartist can have real explanation...

This unnecessary drama in Indian Markets has washed out all signs of "oversold" conditions on even long term charts and now we see Indian Indexes almost 50% recovered from last year's fall. Remember, the historical upper circuit on Monday could be a dangerous sign - how many times did you see such big moves on the upside during bull market? as my friend Abhijit says - Bull Markets have circuit downs and Bear Markets have big up moves. The historical circuit up only worsens the situation and whatever positive outlook I had in Indian Markets has been washed for the time being. This can be a preface to a long scary story.

On the other hand S&P 500 once again tried to conquer my 929 level last week but it failed again. I have so far been proved right about it and I strongly hope that my advice of "top formation" did help my readers, so far. It also bounced from 870 odd level which my important support and if it managaes to break down below that, then this bear rally will be history.

Now let me take this opportunity to bust the myth of greener pasture that Indian "investors" have. They have jumped to the conclusion that this election result has paved way for Manmohan Singh to kick start economic recovery and worst is definitely over as there are no left parties to threaten development. The above conclusion is not my imagination but a result of conversation with some clients of our brokerage as they started calling me on Sunday the 17th and asking for how they can buy on Monday morning so that they are not left out. I told them there was virtually no possibility of buying on Monday as the Euphoria was expected to hit upper limits. Also, I told them even if they can, they should not. My reason was simple - euphoria don't last long enough to make you any good profit. Those who had gambled on Friday and had open positions did benefit tremendously but you can't praise gambling even if it made you rich.

Coming to the reality, there has changed NOTHING that justifies a possibility of strong growth returning in at least next two years. This crisis in global economy can not be "cured" by an economist Prime Misnister of India alone. If it were a usual cyclic downturn then govt could do few things to manage but this time its truly global with systemic meltdown! The entire economy of world is in danger of being torn apart due to massive leverage and the deleveraging process has only started! This chart from shows what is the state of Global Trade!

India, however strong, can not post those 9% GDP growth figures in such circumstances.

Then comes the govt plans of massive infrastructure expenditure (fiscal stimulus). Somehow people forget that real money is required for any project even if it is funded by govt and govts anywhere in the world except US can not run deficits beyond certain limits. US exception owes to the reserve currency status of Dollar but even they can not run massive debts forever, at least when the system of "US buying Asian products, paying them dollars and Asians buying US debt with those dollars" is collapsing. China, which is the biggest buyer of US debt is "concerned" and already showing signs of pulling out from this "burden" (buying gold and signing agreement with Brazil on future trade in their currencies instead of US Dollar). Germay, Japan and UK, the big economies are down 14, 15 and 8 % this quarter! How can one imagine India returning to past growth rates ? I will be pleasantly surprised if India can grow even by 6% in next two years at least. And this scenario does not make any case for investing in Indian Equities at such high PE ratios.

Markets try to be rational but the fact is they are not. They are run by emotions more than true fundamentals as people usually think. They try to discount future but exaggerate some times and prove wrong other times. That is the reason we look at charts for trading rather than looking at fundamentals but what this week has done is a good distortion of charts to the extent that we will need at least one more week of stabilization in price pattern so that charts restart functioning properly.

Let us hope the masses do not remain out of sense for long...

Saturday, May 16, 2009

Weekend Musings - Will Obama Magic Work?

Dear Readers,
Today I am posting here my thoughts on various "efforts" by govt , esp. Obama, the US President, in response to fighting ongoing Global Depression (some say its only a recession).

The Obama hope came into existence long back when he was campaigning for presidency of US. People (mostly Democrats and their supporters) believed Obama can be the only person who can help them out of this mess of economic downturn and his popularity was always increasing with every campaign round. Let me first outline what was and is being seen as "problem" -
  • Decreasing jobs nationwide
  • Decreasing housing prices
  • Decreasing stock prices and 401(K) value
  • Decreasing loan availability (credit crisis)
  • Increasing Loan Defaults, particularly in housing
  • and many more other things...
Whatever many people think, I just can not agree on these things being problem in the first place. This is simply a reversion to mean after big excesses in credit and asset prices for almost anything. After a breathtaking increase in leverage it was only "normal" to see the kind of deleveraging that is continuing today and will continue for good amount of time in future. Noble Prize winning economist Joseph Schumpeter termed it "Creative Destruction" in which old businesses and economic tradition get destroyed in order to create opportunity for new and relevant ones. If you watch closely, today exactly the same thing is happening - destruction of inefficient and unsustainable businesses in order to pave way for newer ones which would help reallocate capital efficiently.

People abhor nature taking its course and "correcting" the excesses so they turn to the govt - to do "something" that stops the necessary correction. They want something for nothing and pin their hopes on presidents, congress, feds etc etc. This is why Obama became the "man who can do this" as Americans wanted to continue with the excesses they had been doing - buying things NOT Required with money they DID NOT HAVE (all credit!). On seeing their pseudo prosperity disappearing, they shouted - SAVE US OBAMA!

Now let us put the reasoning aside and think on the core issue of this post - Will Obama Do "Something"? As we count various actions and expressed will of Obama, it seems he is really "doing a lot of things" - big stimulus with massive deficit, tax increase, protectionism - all the evils at once. Let us forget what is right or wrong, let us better concentrate on "Will Obama's Efforts Pay Off"?

Considering the circumstances and time when Obama took office, we can say he is either extremely unlucky or extremely lucky depending on what line we think. Some say he came at a time when everything was in total mess and so he was unlucky given the situation at hand. Others say he is lucky to enter office at such bad time because he has a chance to "correct" this mess and prove himself. I say he had the great opportunity of being lucky but his actions will prove otherwise. So, how could he possibly "be lucky"? My answer is simple - If he had done nothing! If he had let nature take its course and punish those who speculated on wrong things at wrong time, let the Creative Destruction do its work so that world would have brighter future. If he had stayed away and let the free market do its work, we could have really hit the bottom by now. It would be massive correction but it would be swift and would not get worse than it would owing to all this mess being created by govt.

"But we have already hit THE BOTTOM"! say many mainstream pundits today. They are producing so many evidences - unemployment number, GDP data, housing prices etc which according to them is not "that bad" and so recovery is underway meaning bottom is firmly in place. Even masses believe in these same pundits who had been saying "there is no reason to worry" before this crisis unfolded. One friend from BlogCatalog, a hardcore democrat and Obama fan was so furious when I raised this thing (Will Obama be Effective) and accused me of being a Republican! I never knew republicans were free-market minded people, they may have been just saying those words but their policies don't speak it. Bush left office with massive intervention in the form of short-selling rules to bailouts to stimulus packages - all signs of at least not free market!

Let me come to the data first. The "not so bad" data that is being interpreted as "bottom sign" is misleading. The unemployment number or GDP data are revised many times and if we look at recent past we see a trend of negative revision. Unless this trend is not reversed and revisions do not start in positive, there is no case for recovery. This data is actually irrelevant. The best we can use that data is by looking at "revision trend" and so far its negative.

Now the question is what "steps" Obama has taken or is planning to fundamentally "reform" the economy? Let us analyze one by one:

  1. Tax Increase: One of the biggest tool in Obama's hands is increasing tax on profiting businesses so that the budget deficit can be narrowed. This line of thinking is basically flawed - if you tax too much, total tax return is going to suffer in the medium to longer run and in a bad situation of economy when businesses find it hard to generate sustainable profits, it is going to be disastrous. Contrary to popular thinking, its not biggest firms that employ most people, in fact, small businesses are at the core of employment to the masses and today they are the ones who suffer most on credit crunch. You can't do worse than raise taxes on these businesses when they are already reeling under pressure. Increased taxes means increased costs and increased costs means more cost cutting measures and laying off employees that are "not that important" is one way of effective cost cutting. So what is going to be actual effect of this "tax change" thing? Sure its going to deteriorate situation further. Govt whenever tries to play the role of "distributor" of money, it fails.
  2. Closing "loopholes" in US Tax Code to close foreign "Tax Havens": US firms have been benefiting and saving good amount of tax by using tax havens in foreign countries (Cayman Islands is more in news) and this is undoubtedly unfair. I do not support this practice as free market theory can not overlook such "out of box" ways to avoid tax. However, the timing of Obama's decision is not good. Today when US businesses are already under pressure for profit and margins, this crackdown will break their back. Consider a firm ABC using this method to save taxes which result in higher profits. If ABC finds it suddenly that it can no more do it, then its already falling profits / increasing losses will be worse as it would need to pay more to produce same thing it was producing yesterday. What will ABC do? what options does it have other than "cutting costs the other way" - firing more people? So, this action is not the demand of time at least and is going to do more harm in the short to medium term.
  3. Climate Change policy: Obama's intention on Global Warming and Climate Change is plausible and this is one reason I admire him. He has a plan to curb greenhouse emissions by enforcing "cap and trade". Undoubtedly this is a welcome thing as the biggest danger for life on earth is increasing emission of greenhouse gases. However, once again, the problem is in the circumstances. Obama is bold enough to take this action NOW but this could mean rendering US companies not competitive to that of non-conforming countries like China and India and other developing world. Because its hard time in terms of economic growth, the chances of a global enforcement of such rules is almost non-existent and this brings the bad luck for US firms. Coal-burning firms in China and other developing countries will not stop it for the sake of "responsibility" and US firms will find it better to shift business toward such countries. This may also prove to be detrimental to US recovery. The better option would be a global understanding on the issue but that looks almost impossible. I have a better solution and that is once again - "DO NOTHING". Yes, if Obama stays away from all these "reforms" then Depression will take care of this greenhouse gas emissions issue. Slowing consumption is the best answer and gradually by the time recovery starts, there will be a permanent shift toward "rational consumption" which will be the best thing for earth and its climate.
  4. Fiscal Stimulus: Obama has outlined a big fiscal stimulus plan of spending on infrastructure. He says it will create around 3.5 million jobs and will lift economy out of contraction. While I am strongly against fiscal or monetary stimulus of any kind, there are more supporters of this scheme than opposing ones. The line on wall seems good enough to lure us into thinking that such a program will save us from economic downturn but the fact is opposite. Govt turns out to be very bad when it runs businesses and running big infra projects is no exception. Moreover, these kind of measures stop the natural remedy of "reallocating" capital to better businesses through private firms. Then there is an added issue. Even if this program creates 3.5 million jobs, how many of them will accommodate those from retailing, financials, autos etc where there is bigger job loss? Can a Wall Street person help laying out a bridge or highway? This creates a BIG question mark on the efficiency of this program as job provider. However, even if this program does work out to be a good job provider, where will the money come from? the printing press? as there may not be enough lenders left. This brings to my next point - Monetary Stimulus.
  5. Monetary Stimulus: Although this is a project by "Helicoptor Bernake" and Obama has limited role in it, the FED is off limits in combating this ongoing crisis and in its last meeting the result was "monetary easing" - a euphemism for "printing money" without any backing. This is effectively being done to stop deflation and start inflating dollar supply so that asset prices can be "reflated". The biggest danger for a central bank is deflation and they do their best to stop it. Today when US is already under big debt and running big deficit, the question is what happens if they really are successful? that is, if they manage to ignite the spark of inflation. So far deflation looks very strong and the rising dollar against euro and falling asset prices are evident of this fact. But if and when they are successful in turning things around, it will be immediately out of control and chances of "that 70's show" of stagflation will be highest. Any recovery has to be stopped because FED will need to "do something" to stop the inflation menace then. What an exam for FED!
Apart from these five above mentioned things, there may be smaller "actions" by Obama to stop this downfall but looking at current situation and analyzing the facts I just can not see how these will work. To make things worse, there are so many other things to look at.

One of the biggest problems in US is Social Security obligations. The US govt published two important reports on budgetry trends this week - both implying that US is on an unsustainable path that will almost certainly result in massively higher taxes. By 2016 US will have to fund Social Security out of general revenues, as the surplus will be gone. And there are no trust funds. They are a myth. It as if I wrote myself a check for $2 trillion and then declared I was worth $2 trillion. The money is just not there. Social Security makes Bernie Madoff look like a small-time crook!

And, then comes Medicare, which is in even worse condition. Bruce Bartletts has this to say - taxes will have to go up by 81% if we are to pay the obligations as they now stand. Sustainable? LOL. That's the abbreviation we use in internet chat for Laughing Out Loud. Now that is unsustainable. It won't happen. And as the saying goes, if something is unsustainable, at some point it will stop. No getting around it. Long before we get there, change you will not like will be forced on the US.

Then, there comes the classic problem of PROTECTIONISM. Head of a govt thinks he can make his country safe if he can close "outer" shell. He can do this in one way - protectionism. He hikes tariff on imported cheap items, devalues currency and urges his citizens to buy products made by local firms. Truly Anti-Globalization. While this looks impeccable at superficial view, the fact is such measures deteriorate free global trade and undermine global growth which in turn directly affects that protectionist country very badly. The very reason behind globalization and free trade efforts were to counter this force. But, in times like these political call of the day is to be protectionists. Masses like it and masses vote. Please read this for how is the latest trend of protectionism.

Can Obama resist the forces of protectionism? I don't think he can. Very soon we are going to read news of US hikes on various imports as well as crackdown on outsourcing.

Although there are a lot more issues I can throw light upon, I think it is already enough for the debate. I am a big admirer of Obama for his pro-science and pro-climate attitude, but the circumstances may not be willing to support him for long. The best thing he can do now is postpone this crisis to beyond next elections. The opportunity he had to let nature run its course of correction is already over.

My BEST WISHES to the man-in-charge.

Sunday, May 10, 2009

Markets (S&P 500 and Nifty) Analysis

Dear Readers,
I posted about markets showing a topping signal on May 6 and my concern is still there. If you paid attention to my levels you must remember that since then both S&P 500 future and Nifty Future could not manage to break those big resistance levels -
  • S&P 500 Future: 6 May high - 918; 7 May high 928; 8 May high - 927.50 !
  • Nifty Future: 6 May high - 3729!
  • For both index futures price level could be as accurate as it can be - just one point below my resistance levels!
Now, for this week, here are my observations based on Daily, Hourly and Weekly Charts :
  • S&P 500 F Support: 887, 871, 860. If it goes below 971 and trades there for few sessions then my fear of topping markets will confirm further.
  • Nifty Future Support: 3560, 3500, 3450. If it breaks 3500 on closing basis then 3450 may become weak support. We need to watch that level very carefully.
  • Resistance for both these are at the same levels as in my last post, i.e., 929 for S&P 500 and 3730 for Nifty Future. If these resistance levels are broken with supporting volume, then we can see further rally in coming days.
  • Of the two markets, Indian Markets look stronger. However, I have not seen such an overbought market since this Bear Market started in January 2008.
Happy Trading...

Wednesday, May 6, 2009

WARNING: Markets in US and INDIA may be topping

Dear Readers,

In my last post about S&P 500 Future I had put resistance at 917 and 929 as important. Today, when I looked at Daily and Weekly Charts of S&P 500 Future I got a topping signal for this Bear Market Rally and so I am posting this as a caution to long traders. If it falls now and goes below 870 odd, then we may see bears pouncing with full force.

Although Indian Markets look better in terms of the strength on upside, Nifty Future may not survive much further upside from here before giving a healthy correction. My advice is not to jump on and start buying. Instead, if it manages to get past 3730, which I think is going to be BIG resistance, with good volumes, only then one should start buying on retracement. If it retraces right from here, then keep a close eye on 3440, which should be buyers' stop loss and if breaches it would be better to go short on retracement.

Sunday, May 3, 2009

The DOW and GOLD - Correlation?

Dear Readers,
Today I am posting here an interesting case - the relation between DOW Jones Industrial Average Index (DJIA) and GOLD. Historically, one ounce of gold is enough to buy one set of DOW components, at least when there is a bottom. Today, if we care enough to see, one needs NINE ounces of GOLD to buy DOW Index! This proves that DOW has not hit the bottom yet and there is a long way to go. First, let me put this picture (courtesy Agora Financial):

The above graph shows what has been historical correlation between DOW Index and GOLD. Now, assuming history repeats itself (or as my friend Abhijit says - History may not repeat itself but may do enough to make you feel nostalgic), I have following points to consider:
  • Dow goes to 3000 and Gold moves up to $3000. Then One Ounce of GOLD for ONE DOW can be done.
  • Dow Goes to 1000 and Gold moves up to ONLY $2000. Then two ounces of GOLD for ONE DOW.
  • Dow Goes below (well below) 1000 and GOLD stays where it is today. This will fulfil Deflation expectations and also prove Robert Prechter of EWI fame correct. EWI (Elliott Wave Internatonal) predicts DOW at 400!
  • Dow stabilizes here and GOLD shoots up to 8000+. This will be dream come true for those who see HYPERINFLATION in near future.
  • Dow moves up as it is doing these days and GOLD stays near this level (sub $1000). This menas majority of economists of today who say BOTTOM IS HERE, prove right (VERY UNLIKELY).
If you ask my opinion, I don't think DOW is the right choice to look at as it is neither a weighted index, nor it is inclusive (it has only 30 big companies and that too change arbitrarily). It would be better if someone could produce GOLD Vs S&P 500 Index.

Friday, May 1, 2009

Depression, Climate Change, Swine Flu and Markets

Dear Readers,
These are interesting times and people have the tendency to develop new theories in such times some of them derived from history and some from recent past. One thing that remains most influencing on the majority of population is short term memory, people are most affected by the events and patterns that happened in recent past. Today I am posting here my views on the bad situation of economy (which I say is Global Depression ) and a potential pandemic - Swine Flu.

Global Depression
When I use the word "depression" I get immediate negative reaction and disapproval from most of the people. They say this is not a depression as there are no food lines, no social unrest, no major shift in people's habits etc. like that was during The Great Depression of 1930s. They say its only a "deep recession" and only a matter of time before we "get out" of this downtrend and see those good old days again.

But, I insist. This is a Depression. There are no food lines, no social unrest...... of the kind of 1930s but still this is Depression and that too a Global Depression. Why? Well, you need to know few things before comparing today with 1930s time.

The situation today is quite different and the base (from where it started) is very different in both situations. Today there are more people with more wealth to withstand the early part of this Depression. Comparing to 1930s, there are many more households that fall in upper middle class category and they have enough money to stand in food lines easily (I wish no one has to do that). In fact, there may be no food lines at all even when this Depression is in full force and deepest point! However, what do you say about the unemployed having "Unemployment Benefits" by govt? Isn't that similar to food lines?
The dynamics are different today and so comparing the two times exactly is not fair. Instead, we should think on the line that people are changing habits very quickly. Their perception of life is no more the same it used to be before 2008. They are suspicious of "investments" in assets ranging from stocks to houses to even art! They are not spending like there is no tomorrow, even if they have money.
And, this is only first year of this Depression. In 1930s, there were several occasions when there were strong and powerful rallies in markets that made people believe "worst is over" and they were disappointed every time for at least three years!
Why do I think this is going to be worse? Let me put the actual situation in simple words - people in US and other developed world spent too much on things they did not need with the money the did not have resulting in excess inflation in asset prices of stocks, houses etc. Credit was available to anyone who was willing to take risk and spend no matter what his / her capacity to pay back was. Too much of credit and too much of spending could not sustain and finally when it hit the wall, the leverage factor which was multiplying profits changed direction. Now, we are still at the beginning of this massive unwinding of the excesses that were created in the boom time and all the govt can do is merely postpone the recovery that would happen if it were left to the market itself to correct. That's why I call those bailout plans "Crisis Postponement Plan". Please read these posts here and here for my detailed views on this.

In the first paragraph I told about people's short term memory and its effect on their thinking. Today so many people are optimistic because they still remember the recent past (recent recessions and how things improved) and don't want to believe that things are very different this time. They still think that govt can "correct things". By this I don't mean there will never be a recovery, what I mean is this time there is a lot to happen before we start rising again. We are just in the first phase of a big Depression and there are a lot of things waiting down the road.

Climate Change
Global Warming is definitely making its presence felt as there are evidences of big changes in Arctic ice sheet, rainfall patterns, mountain glaciers and temperature patterns across the globe. Freshwater sources are depleting fast, revers are drying up or flooding - going to extremes faster than usual. However, still majority of people are in no mood to accept these facts. They deny it. The deniers are also affected by short term memory which makes them think that these "small" changes are not going to do big damage and so they don't need to care at all.

We as a species have been growing too fast for some time in terms of our number of heads. The total population of world was 1.65 Billion in 1900 and today there are 6.77 Billion of us!!! We added SIX BILLION MORE of us in a century! or to say in other words, we MULTIPLIED FIVE TIMES in 108 years!!! More people means requirement of more resources. Mother earth has plenty of resources - almost everything from fresh water to natural resources of all kind to sustain even this growth BUT then we have the DEVELOPED WORLD. Thanks to their outrageous lifestyle of over consuming and wasting which has put huge pressure on resources. The culture of "long drive for pleasure", wasting food, wasting water (private swimming pools, lawn sprinklers and what you have) was the main driving force behind the prosperity of past 50 years but this over consumption was unsustainable both economically as well as environmentally and SO WE ARRIVED AT PEAK OF BOTH.

Mother nature has big heart but she is equally brutal when we take everything for granted. The bad thing is she does not care who suffers. So is this Depression a manifestation of nature's balancing act? May be. The only way people could cut back on excess consumption could be this economic collapse otherwise nobody would want to stop throttling his SUV and burn fossil fuels for no requirement. Showing off is human nature and people just don't behave themselves. They have to receive a message and they take it the harder way. The rule of pain or gain could have worked as well but that would have taken longer time and the damages by then would be irreversible. So, there is good reason to believe that this Depression is at least coincidentally a balancing act by mother nature in response to human activity.

Swine Flu
Mainstream media has started reporting the outbreak of swine flu as "next big worry after recession". Some say its going to wipe out "the recovery in economy". First, there is no recovery at all. If you say -6.1 than -6.3 is real recovery then you are daydreaming. Second, this flu is not that big a trouble as the worst case scenario, as reported by computer simulation by scientists, is a mere 1700 deaths worldwide and that is when it is handled the worst way. So if you are fearing that this flu may be a real pandemic, you are worrying too much.

History shows that big economic downturns and big epidemics go hand in hand but this flu doesn't look like a big one, at least so far. There may be epidemics but swine flu is more a danger to poor pigs who will get culled, than humans. However, we never know what methods mother nature may have in store to contain growing menace by the so called intelligent species.

Stock markets the world over are perhaps underway a big bear market rally. Most indices are up 25% or more for last six weeks or so. Opinions are divided. Some say its a new bull markets while others like me say its more a bear market rally. Markets have the tendency to retrace to 50% on an average and as high as even 62% some times and still remain in the primary trend which means we may see this rally to continue further and still we be in secular bear market. Fundamentally also there are no signs of a meaningful recovery (a pause is not recovery and so don't believe the "-6.1 than -6.3 means recovery" guys). There is a long way to go before we hit bottom in the downturn and this Depression will give many more such big bear market rallies before we hit ultimate bottom.

For traders I don't recommend following fundamentals and instead chart patterns represent better outlook and should be looked at for clues. The chart patterns for US markets are not suggesting any change in primary bear market. However, I am not so sure about Indian markets as the chart patterns on Nifty and Sensex suggest a disturbance in primary bear market. But, this does not mean there has started a new bull market. Even if the primary bear market is over, there may be a sideways trend for some good time which will eventually equal a timewise bear market. Its too early to say anything for sure and we need few confirmations before we seriously consider that Indian Markets have bottomed out.

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