Contrarian view: The charts still favour the Nifty bears

Over the last few years, Prime Minister Manmohan Singh has shaken the faith of many who believed that barking dogs seldom bite. People who were expecting action from the quiet prime minister were repeatedly disappointed.

That changed with the new impetus for incremental reform from Dr Singh. What is more encouraging is that he stood his ground in the face of political pressure. All this brings us to the topic that we are most interested in: the effect of the new initiatives on the stock market.

The market reacted enthusiastically to what has been said so far, but the buying rush has taken the Nifty to a strong area of resistance. Resistance levels are where the supply of stocks far exceeds demand, leading to a fall in price.

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But while technicals are telling one story, fundamentals of more reform are giving another signal. Fundamental analysts will say that the if the reforms are implemented the market will go to new all-time highs. That, in the case of the NIfty, would be over 6,350 and the index closed at 5,691 on Friday. But there is a big “if.” The implementation of the reforms needs a lot of political support, which the Singh-led government might not have, leading to early polls. That creates a lot of uncertainty, which the market hates. So while it’s understandable why fundamental investors are rejoicing, we’d look at the technicals before taking an investment decision.

In our last column, we said that the Nifty had reached a resistance zone and is likely to correct. It did correct briefly before rallying again on Friday to enter the second resistance zone as shown on the chart. (See the Nifty chart above). The level between 5,694 and 5,738 is a level from where the index had crashed strongly. Right now, given the market euphoria, it looks unlikely that the market will fall. But often in the past markets have turned around and crashed right when things looked great, like in November 2010, the month the NIfty began its decline.

[caption id=“attachment_464624” align=“alignleft” width=“380”]  The market seems to understand the long-term benefits of incremental reforms and is already discounting it.[/caption]

It is very possible that the markets could head higher, but we’d again not be buying on Monday with the index at a resistance zone. If the market clears the 5,738 level, the next resistance would be in the 5,900 area, followed by 6,170 and then the last frontier of resistance around the 6,350 level.

The technicals are right now stacked against the bulls and a lot depends on how the fundamentals play out. If the government is successful in rolling out the promised reforms, we could see the market continuing its rally. A failure will surely see the stocks tank as a lot depends on the money that the reforms bring into the country. The Indian government is running huge deficits and it’s bound to get worse with the European Central Bank and Federal Reserve deciding to pump in money.

One of the big drivers of the deficit in India is the oil subsidy and the Singh government is trying to reduce it. The continued printing of dollars is likely to push up the price of oil, which not only increases the subsidy burden but also widens India’s current account deficit. We can be sure that Singh, a former central banker, realises what is at stake. So unless the subsidies are reduced the burden on the budget is sure to increase.

By increasing the cost of diesel the government hopes to reduce consumption, which will slow down crude import growth and help the current account deficit. But by opening up the markets, the government aims to bring in more foreign money both in the terms of direct investments and hot money. This will help with the foreign exchange situation and also the weak rupee. In fact, after Singh’s public appearance on Friday, the rupee rallied by Re 1 against the greenback, which was quite an impressive jump. A rising rupee also helps the current account deficit and the costs of imports drop.

The market seems to understand the long-term benefits of incremental reforms and is already discounting it. But if Singh disappoints, we will see another crash. Then people will look at Singh and say what they say in America: “This dog don’t hunt.”

George Albert is Editor, www.capturetrends.com