The broad market indexes – the Nifty and the Sensex - are not doing much of anything as they cling to the resistance zone. So we thought we'd step back and take a long term look at the auto sector, which is very bullish right now.
Readers of this column who look forward to an analysis of the Nifty need not worry; we will take a look at the index later in the article.
There are some strong sectors in market now such as fast-moving consumer goods (FMCG), healthcare, etc. But for today let's take a look at the auto sector and some companies in the sector.
We regard the auto sector to be relatively much stronger than the broad market as the sector has made new all-time highs but the Sensex and Nifty have not. (Click here for the Auto sector index chart) So why is relative strength so important? It essentially indicates that in a rally the auto sector can go much higher than the broad market. It also shows that the sector may not be a good shorting target.
Most importantly it signals that the auto sector would be a good buy when the broad market falls to support. Support areas are where the demand for stocks exceeds supply, leading to a rally in price. Most traders would buy the Nifty when it hits support, but buying the auto sector that's stronger than the Nifty, increases the possibility of not being stopped out and also getting a better bang for the investment.
So the basic rule in operation here is buy the strong sector or stock when a weaker broad market hits support. Alternatively, short a weaker sector or stock when a relatively stronger broad market hits resistance. For instance, one can short the realty sector or realty companies, which is weaker than the Nifty, when the index hits resistance.
A look at the BSE Auto Index shows that the sector is correcting after a rally. In November 2012, the index broke out of its previous high to enter the uncharted sky. There is no previous resistance in price when a stock or index goes to new highs, forcing investors to rely on other tools. One of the most favoured tools is the Fibonacci extension, which projects price targets.
Most trading platforms have the Fibonacci tool and it displays by default the key price targets which include 0.236 (23.6 percent rally), 0.382 (38.2 percent rally) and so forth, as shown on the chart. Notice that the auto index fell when it hit the 0.236 Fibonacci level. A decent selloff will present a buying opportunity. The blue lines show the zones that present decent buying levels.
Now let's take a look at some of the auto companies to identify the stronger and weaker ones in the sector.
Ashok Leyland: This company is clearly weaker than the sector as a whole, as the sector has made new highs, but the stock is making lower highs showing a bearish trend. (Click here for Ashok Leyland chart). A look at the down-sloping trendlines shows that the stock is not in an uptrend at this time. This is one stock we'd not buy when the Nifty hits support. It could be a stock to short in case the index hits resistance, but since the sector is in a uptrend we'd ideally ignore this one for the short side. It is best to pick up a weak stock in a weak sector to stock, which will have better odds for falling than a weak stock like Ashok Leyland that is part of a strong sector.
Bajaj Auto: Bajaj is clearly stronger than the auto sector index. If you look at auto sector index, you'll notice that index moved in a horizontal channel before rallying out, but Bajaj Auto moved in an uptrending channel before breaking out. We feel that the stock will correct and fall back into the uptrend channel, providing an opportunity for bulls to take a position. (Click here for Bajaj Chart)
The fact that the stock is stronger than the index signals that it will be a good buy after a correction and surely better than Ashok Leyland. A break outside its normal channel shows that price is extended and ripe for a correction. Bulls must be patient and wait for prices to correct before buying. The 1,800 level looks like a decent support level.
Hero Motocorp: Not at all a good buy. The stock has been moving in a range, while the auto sector index has been rising. Within the sector it's better than Ashok Leyland, which has been falling, but worse than Bajaj Auto, which has been rising. If you are infatuated with Hero you can range-trade it, by selling at the top of the range and buying at the bottom of the range. The top and bottom levels are shown by blue horizontal lines on the chart. (Click here for for the Hero chart
Mahindra and Mahindra: This is a good stock moving in tandem with the auto sector index. (Click here for for Mahindra chart) Notice that the stock moved in a horizontal range and then broke higher, just like the index. The horizontal range is shown by the blue horizontal lines.
This stock can be traded with the index. If the index hits support one can buy M&M. The stock itself has support levels around 825, 750 and 690, which are good levels to buy.
Maruti: Nothing hot when compared to M&M and Bajaj. The stock has not been able to make new highs unlike the other two companies and the auto sector index. So this is not a good buy, comparatively speaking. Also price is at the resistance zone, as shown by the blue horizontal line, which indicates that there is a higher chance of the stock falling. Even if the stock clears its current resistance level, the price is close to an all-time high, which can be very difficult to break through. So we'd leave this stock alone.(Click here for for Maruti chart)
Tata Motors: Tata Motors, unfortunately for bulls, is not in the buy column. In fact, it hit resistance this week and sold off a bit. The resistance zone, which is the stock's all-time high, is shown by the blue horizontal lines. (Click here for for Tata Motors chart) The stock has not made a new high like M&M or Bajaj or the auto sector index. We'd put his in the buy column only if price breaks out to a new high.
Auto sector conclusion: Bajaj Auto and M&M are good buys once price corrects to a support level. For now we'd leave the other companies alone. Shorting one of the weaker auto stocks may not be a good strategy when the sector itself is bullish. But if you are desperate to short an auto stock you can look at Maruti, Hero Honda and Ashok Leyland, when the sector index or Nifty reached resistance. Like we said earlier, a better short would be a weak stock in a weak sector.
Nifty review: The Nifty is still hanging on at its resistance zone (Click here for for Nifty chart) and all of what we said in last week's column about the broadening formation, the resistance level, the copper market and the Nifty uptrend line still holds true. There is an additional factor favouring the bears, which is that the Nifty gap-down of Friday. This shows that the sellers may be gaining an upper hand. A gap down happens when price closes at one level and opens lower the next day due to extreme oversupply. A gap down after a strong rally in price, as it happened with the Nifty, can indicate a reversal.
The dollar index, however, pierced its uptrend line that we mentioned last week, but closed above it on Friday. Despite the intra-week slump in the US dollar, Nifty was not able to break higher, which showed weakness in the equity index. As we have mentioned earlier the US dollar is inversely related to the equity markets.
George Albert is Editor, www.capturetrends.com