“Give me six hours to chop down a tree and I will spend the first four sharpening the axe.” – Abraham Lincoln
The Indian stock market had a dream run in 2017, as it went past multiple hurdles to scale new highs time and again. After languishing sideways in 2015 and 2016, a strong year like 2017 was somewhat expected. However, the magnitude of returns took everyone by surprise. Sensex’ 28% return in 2017 was ranked the 15th best year in the 38 years of its existence.
As all good things come to an end, the Indian market’s phenomenal rise was cut short by a strong wave of foreign institutional selling in February. FIIs sold a whopping Rs. 18,619 crore last month, making it the fourth largest amount since the January 2008 sell-off.
Aggressive selling by FIIs put the Indian market in a spot of bother lately. Most investors are now concerned whether or not 2018 would prove a good year for the markets.
If there is one thing that is certain about stock markets, then it is their unpredictable nature. With this note, we aim to showcase how predicting market movements can cost you a bomb.
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Prediction Rarely Pays Off in Market
There are hundreds of variables used by investors to justify why the market is going up or why it is falling. But, at the end of the day, it is the overall earnings growth that pushes the market higher over the long-term. In the short-term, however, markets get impacted by the general investor sentiment, which largely depends on liquidity flows from market participants.
The prime example of a liquidity-driven market is during mid-1999, when the fourth conflict between India and Pakistan took place. At the outset, people would assume that markets would have crashed during the Kargil War. And there’s nothing wrong with that line of thought. An armed conflict can push an economy backwards big time, and for a developing country like India, it can have large repercussions. However, the Indian stock market surprised investors, as the Sensex gained about 38% in less than three months (May-July 1999).
Now, let’s forward to a more recent event. The surgical strikes carried out along the LoC sent investors into a panic mode as they ran for cover on September 29, 2016. Multiple articles suggested that such events do not impact the market and even recommended buying stocks on every dip. Most cited the example of how the Indian market climbed all walls of worries during the Kargil War and gave solid returns. Moreover, market bulls made their case stronger by asserting that institutional investors bought truckloads of stocks on September 29, 2016.
Now, imagine if you had gone by this and looked for evidences that made your case stronger (institutional buying)? You would have bought stocks on every dip. In the coming months, your representation and confirmation biases would have hurt you badly. How? India’s leading indices sold-off about 10% in the next three months, as they struggled for an uptrend in the aftermath of Donald Trump’s presidential victory and Modi government’s demonetisation drive.
How to Prepare?
“Personal opinions, feelings, hopes and beliefs about the stock market are usually wrong and often dangerous. Facts and markets, on the other hand, are seldom wrong. The law of supply and demand works better than all the opinions of all the analysts on Wall Street or off.” – William O’Neil, MarketSmith Founder
As an investor, the biggest lesson from the Kargil War and surgical strike events is that the market obeys just one law – the law of supply and demand.
And that’s the reason why we keep a close track of the price-volume action of key indices. The day when the Indian government declared surgical strikes across the LoC, the Sensex breached its 50-day line and the distribution day count increased to five.
Looking at a high distribution day count and the Sensex breaching its 50-day line, we moved the Indian market into Under Pressure on September 29, 2016. And we all know how the market got into further trouble with the double whammy of demonetisation and Trump’s victory in the following months.
On the other hand, the Sensex saw minimal distribution during the Kargil War and maintained its uptrend without much trouble. The index did not breach its 50-day line even once during May-July 1999.
Distribution days are almost always signs that institutions are exiting the market. With big funds controlling the bulk of trading volume, and hence the overall market’s direction, you cannot expect stocks to rise without the big guns on your side.
Is There a Way to Prepare for Market Bottoms?
While distribution days help you in pulling out of a weakening market much early, follow-through days can help you back into the market at just the right time.
The start of a major uptrend is difficult to identify if you are relying on headlines and news. By the time reporters figure out what’s going on in the stock market, the best part is over. A follow-through day is a mechanism for confirming a new uptrend. The benefit of focusing on this, rather than going by news reports, is that it is more reliable.
While the Indian economy was reeling through a major cash crunch in the aftermath of demonetisation, the Sensex gave a strong follow-through day on December 27, 2016. This marked the beginning of new uptrend that lasted for about 13 months.
The current Indian market outlook of a Rally Attempt continues to test the patience of many investors. Leading indices have been trading range-bound for the last few weeks, with the 50-day line serving as stiff resistance and the 200-day line acting as a strong support level for the market.
For now, investors should continue to wait for a follow-through day before they get aggressive in the market. The recent correction has provided a great opportunity to investors. This is a period when leaders of the next uptrend will consolidate in new base patterns. Keep an eye on stocks with leading earnings and price strength ratings that are acting strong in the current market. These stocks would usually have their Relative Strength line at or near new highs.
Build Your Watch List using Filter India Stocks
To build a list of some strong names that have done well in the current weak environment, make use of MarketSmith India’s Filter India Stocks feature.
For instance, we did a quick check on stocks that are looking well-placed in the current market environment by applying few filters. We avoided stocks with poor earnings, low liquidity, poor ROE, and high overhead supply (difference between 52-week high and current price). We got about 60 names that are worth a look.
While the markets continue to struggle for direction, it is a wonderful opportunity to prepare and not waste our time in predicting what’s going to happen next. The hard work will surely pay off when investor sentiment revives and the market begins its new uptrend.
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