A Highly Volatile November

I have been wondering what to write over the last few days and also trying to get a grip on the markets as to whether the correction that I was expecting and has unfolded has ended where it did at around 19000 level of the Sensex and 5690 for the Nifty or do we have further to go. At this point of time my base case view is that we should have another downleg as most of the factors that were to contribute to a bigger sell off still exist.

The current month started off in a positive manner by upholding the bullish trend that started as a range breakout in the month of September 2010. We saw the markets move up strongly for the first few trading sessions of the month before the much anticipated correction started and the markets fell by nearly 10% from its peak before seeing a small rebound at the end of the month. The end of the month also saw positive and forecast beating GDP numbers being announced for the 2^nd quarter at 8.9%. The figure was slightly surprising given that the IIP data for two months of the quarter was near 5%. Given the high weightage of agriculture in the third quarter the December quarter GDP number should also be quite strong. However going forward growth could be affected due to the tight liquidity and rising interest rates.

The current month saw the markets being hit by various events, both anticipated and unanticipated. Negative domestic factors like the breakout of the Telecom issues related to the 2G spectrum, poor IIP number for the month of September and the bribery scandal that rocked the financial sector at the end of the month had a major impact on the market scenario. Despite the significantly positive listing of Coal India, in which both retail and institutional investors made good money, the above negative factors incrementally affected the markets

Global factors at play in the current month were largely related to the Eurozone, where the crisis in the troubled countries refused to subside and seem to be growing with time. We saw bond yields of countries like Greece, Ireland, Portugal, Spain etc. shoot up significantly, surpassing their May 2010 highs as well. The relatively better-off countries like Italy also saw the yields move up and the CDS spreads, too, moved to an all-time high. The end of the month saw the Irish package being announced; however, it did not have much effect on the credit markets which seem to be anticipating things to become worse before they become better. The Eurozone troubles are far from over and will continue to create volatility with a negative bias for the markets.

The other source of negative news flow was from China, where the Central bank and government have finally woken up to the risks of inflation after a huge credit binge and have started tightening liquidity very fast. With inflation moving far beyond the comfort zone, the tightening cycle in China should continue for some time and this should also have an impact on controlling commodity prices. The Shanghai Composite declined by nearly 15% from its peak of 3184 which was hit in the middle of November 2010.

Also, contrary to general expectations, US Dollar started to strengthen post the announcement of Quantitative Easing II. The USD Index moved up from a level of 76 to 81 in the last two weeks of November. Although this has not had much effect on global funds flow as on date, a short term reversal of USD carry trade cannot be ruled out if the USD strength continues for some time.

The most intriguing thing about the current month was the way the European markets held on despite a correction in the emerging market equities (Europe being the troubled zone). A correction in the European equities looks imminent, going forward.

I have been cautious on the markets over the last couple of months and at this point in time continue to believe that in the near term, the downside risks seem to be higher than the upside potential. We continue to see the markets correcting further to a Nifty level of 5400-5500 and a Sensex level of around 18000 and look towards those levels as good entry points for increasing exposure into the markets. A large part of the froth in the mid-cap side of the markets has been removed with the correction over the last few days where we have seen specific stocks correct by 30-50%. This corrective move in the broader markets is now creating excellent buying opportunities which we will seek to capture over the next 4-5 weeks.

However, as I have reiterated earlier, I do not believe that there is any change in the longer term outlook for the markets where we see the Sensex moving up to a level of 25,000 by the end of 2011. As mid-caps get sold in the correction, the return potential from this segment of the market could be even greater.