Stocks may get a short-term fillip from S&P 500 rally

By George Albert

The correlation between the Indian and US equity markets shows that the Indian markets could rally as the S&P 500 index nears a correction point after the recent selloff.

It is said that Indian and global equity markets follow the US markets closely. There has been a high degree of linkage between the US and global equity markets in the past, which has resulted in several cliches.

One of them is, “when the US sneezes, the world catches a cold.” So is it not presumptuous to say that when the US smiles, the world laughs. The next few days could provide the answer as the recent selloff in the markets is taking the S&P 500 into an area where the demand for stocks was shown to exceed supply in the past.

Short term rally: The demand area on the S&P 500 futures contract is between 1236 and 1247. The futures contract of the S&P 500 index closed at 1263 last Friday. The futures contract closely follows the index and is traded, making it a better chart to analyse. A drop into the demand level in the next few days could lead to a rise in the index, or at least pause the selloff.

If the S&P does rise from the area of demand, one can definitely expect a rally in the Indian and global markets.

However, it’s important to remember that the Indian equity markets have technically entered bear territory, in which rallies can be sharp but short-lived. There are multiple thresholds a market must cross to be termed bearish and the Indian markets have crossed several.

The US markets, on the other hand, crossed a few after last week’s close. But markets never move in a straight line and technical indicators show that US markets could rally in a few days, impacting Indian markets positively.

The first technical indicator is price. The S&P 500 had rallied strongly from the 1236-1247 area and we feel that a return to that area can lead to another rise in prices. The other indicator is the commodity channel index (CCI), which shows if the market is overbought or oversold.

Ideally, when the markets are falling, the CCI should point down. However, the CCI is moving up in the S&P 500 even as the market sells off. This shows that the downtrend is weakening.

These indicators tell us that the S&P 500 has a high potential of rallying from the 1236- 1247 demand area and take the Indian markets up with it.

Fundamentally speaking, one of the key drivers for the current rally - the easy money policy - is coming to an end. India has been raising interest rates for some time and the quantitative easing in the US will end in June. This has exerted a downward pressure on the markets.

There have also been other indicators - unemployment, GDP, etc - in the US signalling a slowdown, which is driving the markets down further.

Markets discount the future and we believe that most of the negativity has been priced in. However, the negative price momentum and news overhang is expected to push a lot of retail investors to sell in panic, which will drive the S&P 500 to its area of demand.

At this point of demand we could see buyers come in to go long and professional short-sellers buying to cover, which usually results in a sharp rally. It’s very possible that the markets may just slow down and consolidate at the demand level, before continuing lower.

So, at the very least, it’s time to stop selling or shorting the markets right now. One could take profits on some short positions near the demand level and aggressive traders cantake some long positions.

Long term outlook: It’s perilous to ignore the inter-connections between the Indian and US equity markets. The Indian markets began falling before the US, but then paused as the S&P 500 continued to rise. Even after the pause, though, the trend was down, pushing prices slowly into bear territory. Long-term technical investors use the four stages of the market to identify the trend. Markets usually move in four stages - bottom, rally, top and selloff.

For the markets to turn bearish, it must move sideways at the top after a rally, then fall below the lowest point in the sideways movement. Next, the price must be below the 30-week simple moving average and, finally, the moving average must slope down.

A moving average shows the past average price over a specified period. The Sensex, Nifty and several Indian sectors have met all the above criteria. Last Friday, the S&P 500 fell below the 30-week simple moving average. It also fell below the lowest point of the sideways movement.

However, the moving average is still pointing up, due to which it’s still early to call the US market bearish.

In conclusion, it can be said that since the Indian markets have been relatively stronger (as they did not fall as sharply as the US) in the past two weeks, a rally in the S&P 500 from the demand level of 1236 to 1247 can produce a sharper rally in Indian stocks.

George Albert is based in Chicago and edits www.capturetrends.com