Long term technicals – Turning extremely positive

As I wrote in a previous note although my fundamental bet is that the next year could be difficult in terms of the percentage return expectations from the markets given the fact that specifically the Indian markets today are trading at around 15x consensus 2011E earnings. However technically the picture is turning much more bullish.

I tracked the markets in an expanding triangle formation right through the bull market of the year 2003-2007. The formation held on perfectly till October 2007 when a breakout happened on the upside out of the expanding triangle which led to the blow off move above the upper trend line of the triangle formation. Subsequently as the markets cracked they came back into the triangle formation in Jan/March 2008 and finally broke down below the lower trend line of the triangle formation in October 2008. Once the formation got broken the markets cracked big way.

Over the last few weeks the markets have again come back into this expanding triangle formation and now seem to have settled down into the formation again. I believe the markets should now move up to the upper end of the expanding triangle hit the upper end of the triangle by the fourth quarter 2010/1st quarter 2011 at BSE Sensex levels of 23000-25000 and for the NIFTY into levels of 6800-7100. Under the circumstances, technically speaking I believe that there is unlikely to be any major correction in the markets (corrections in the 20% range) till these levels are reached. As such the markets look extremely bullish over the next 15 months.

So what will justify this move fundamentally? I believe that improvement in the economy and the markets will be much faster than expectations. Already consensus earnings estimates which were for a 5% decline for the current financial year have come upto a 9% growth and are likely to be upgraded further subsequent to the third quarter results. Current estimates for FY 2011 earnings growth is in the region of 20-25%. My guess is that this will ultimately trend up towards the 30% range.

Economic growth numbers are also coming out better than expectations and the second quarter GDP growth has come out at 7.9% vis vis expectations of just around 6%. This sets the stage for a 7-7.2% full year GDP growth. The next year itself should see growth picking up to 9% as against expectations of 7% currently. But for negative agricultural growth contribution this year the GDP growth would have been 8%. Next year (hopefully with normal monsoons) the agricultural growth with the low base of the current year should see the growth in the region of 6% plus.

MSCI EMF Index

I have analyzed this chart both on the basis of trend line breakout on the weekly charts where a breakout is in process currently. As the breakout fructifies we should see the markets move up with strong momentum. Currently the Index stands at a level of 983 and a move towards the 1000 level should confirm this breakout.

The second, more interesting analysis is that of the monthly log chart of this index where it has been moving in a nearly 30 year trend channel. Given the sensitivity of logarithmic charts due to the multiplier impact the next level of the upper end will depend on when the upper end gets hit. If we are to assume that the move will take the same time as the last move of 2003-07, the upper end could be hit sometime in the year 2013 at levels of 2300-2400. Things seem clearly on track for a sustained long term up move.

In conclusion the charts are showing that the uptrend is likely to be very strong. What this implies fundamentally is a V shaped recovery, aggressive earning growth and moderate inflation. As the markets started falling in 2008 the fundamental reasons were not immediately apparent and the markets collectively saw the slowdown coming much before it got reflected in economic / earning growth numbers.

It seems likely that the next half decade at east seems to be that of emerging markets and now it is our time to see a repeat of the Big Japanese boom of 1970s and 80s and that of Western economies of late 1980s and 1990s. I see valuations moving higher and to levels that are above historical ranges. The reasons for the same would be clearly the fact that emerging markets will lead the world economic growth in this phase and the leader of the move will always get a higher valuation. I would not be surprise if at some stage valuations for the market move up to the mid 20s to early 30s in terms of Price to Earning ratios.

“The safe way to double your money is to fold it once over and put it in your pocket”

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