A Tale of Two Markets

It has been quite a rollercoaster ride for equity investors in the past few months. US investors have seen gains of more than 9% in SP500 turn into year-to-date losses of more than 3%. Indian investors have seen losses of more than 9% in CNX Nifty turn into year-to-date gains of more than 2%.The question is what’s next.

Some weeks back it appeared that the US markets were in the process of forming an intermediate-term bottom. On June 8^th, the SP500 tested the low it had made on May 25^th. That test came on lower volume and fewer 52 week lows, a positive divergence that in many instances has resulted in tradable bottoms. It also marked an “initial rally attempt”. An initial rally attempt begins when a major market average closes higher after a decline that happened either earlier in the day or during the previous session. What we need after an initial rally attempt is a follow through day (FTD) to ascertain that the market has indeed put in a bottom. The concept of follow through day was introduced by William O’Neil in his book, “How to Make Money in Stocks”. In the book, O’ Neil defines a follow through day as one where one of the major market indices registers a booming gain on heavier volume than the day before. All major market bottoms flash FTD’s though not all FTD’s result in market bottoms. Most successful FTD’s that mark durable bottoms occur four to seven days after the “initial rally attempt”.

The US markets flashed a follow through day (FTD) on June 15^th. However, this recent follow through day was not confirmed in terms of new breakouts in institutional quality stocks. Some stocks that did break out following the intermediate term low quickly reversed course. This is never an encouraging sign for a fledgling rally. And then last week we saw a series of distribution days in the major indices. Some weeks back in an article titled, “The Anatomy of a Market Top”, I had explained the concept of distribution days. In that piece I had written how 3-5 distribution days over some days can sound the death knell for a market rally. By Friday, the major US indices had already registered two distribution days. What however makes me extremely bearish is the notable increase in short side setups/candidates. A lot of institutional quality stocks like Microsoft (MSFT), Adobe (ADBE), Cisco (CSCO) and Blackberry maker Research in Motion (RIMM) etc have seen heavy selling in recent weeks and are now breaking down on long term charts. This selling reeks of extreme risk aversion. That along with the rally in safe haven assets like gold and treasuries is conveying some significant downside in the US markets in the coming weeks.

The picture for Indian stocks on the other hand appears quite positive. Indian stocks have been outperforming their global peers for some weeks now. The chart below depicts how Indian stocks have been doing compared to the SP500 since May. A rising line on the chart indicates outperformance by Indian stocks as measured by the S&P CNX Nifty Index.

 

I expect this outperformance to continue on the back of expanding new highs, breakouts in frontline stocks, positive breath and broad sector participation we have seen recently. Color me bullish on Indian stocks.