The astronomical rise of stock markets all over the world continues with gay abandon, dominated by the “Dollar Carry Trade” as the dollar continuously loses value and given the virtually zero short term rates in the US combined with the extremely low levels of dollar borrowing costs reflected by the Dollar Libor where rates have declined to a level of 0.47% for three month dollar LIBOR today which is just 10% of the peak rates seen around 10 months back.
Funds flow into equity funds has reached a frenzy with nearly USD 10 billion coming in over the last week of July. The comments of central bankers globally saying that they are not going to pull out liquidity any time soon and are going to keep short term rates at extremely low levels are boosting the confidence of both equity and commodity speculators. Central bankers in their desperation to keep hopes of economic revival afloat are fuelling significant inflationary expectations which is the bane of stock markets (ALWAYS).
Without much pickup of end user demand except in China the rally in most commodities where prices have now touched 9 month highs will eventually have two impacts, specially in Western economies –
Firstly it will impact consumption directly as the price of crude oil picks up and cuts into the disposable incomes. Similarly other commodity prices moving up will lead to manufacturing inflation slowly coming back.
Secondly it will eventually make key central bankers again talk about the threat of inflation and i think that the first of such comments will most certainly lead to a reassessment of risk and an equity and commodity market selloff.
I have been expecting a correction for some time, a correction of the magnitude that i visualised did happen post the Union Budget. Although in value terms it did correct almost to the extent of 15-20% from the top that i had expected it did not satisfy the time criteria of a 4-6 week correction that i had visualized. After a nearly 21 week rally a timewise correction is also likely to take place some time over the next few weeks.
Overall the results season passed off quite decently with sectors like Auto, Cement and Technology outperforming expectations. Sectors like Banking and Capital Goods underperformed expectations and some other sectors like Telecom, FMCG etc. had neutral results.
The economy continues to pick up well with the index of 6 core industries growing by nearly 6.5% for June and the initial numbers for Auto and Cement sales for July coming out very positive.
The two key criteria that shows the quantum of complacency that has set in the markets are –
Extremely oversold dollar – The US dollar looks to be extremely oversold and looks to correct upward over the next few weeks. The short term rally of the US dollar will generally be accompanied by a market sell off. The US Dollar Index is now oversold not only on a daily basis but also on a weekly basis.
Extremely oversold VIX – The volatility index as measured by the VIX index looks extremely oversold with VIX declining to a level of 23-24 from its peak of around 90 in October -November 2008. The levels of 23-24 should be a good support range for the VIX from where we should see a sharp bump up.
Given the fact the momentum is taking the markets up very sharply in the short run the correction also should be pretty sharp. Lot of people keep on telling me that as an all time bull how come i am so skeptical when i believe that the eventual target of this bull move is around 35000 for the BSE Sensex and 12000 for the NIFTY. To this my answer is that even in bull markets like we saw in the years 2003-2007 there are sharp and nerve shattering corrections like those of May 2004/May 2006/Feb 2007 etc. which provide excellent buying opportunities for the long run. I believe after the rally of the markets over the last four months where large cap indices have doubled in value and mid cap indices have more than doubled in value, it does not matter now if one lags behind the markets or sacrifices some returns in the short run to maximize performance in the long run.
I was one of the first ones to turn extremely negative on the markets in the month of October/November 2007, however i could not ride my convictions due to extraneous pressures. Today i believe that it is again time to ride out ones convictions while capturing short term opportunities in the markets.
Its time to remember Newtons third law of Gravity
“Every action has an equal and opposite reaction”