Buying Fear and Selling Greed in India

“The first eighth and the last eighth are the world’s costliest eighths.”

I don’t know where I read this, but it stuck me as one of those profound statements whose wisdom separates the best from the rest. It’s interesting when you see a money manager rising head and shoulders above the crowd and say, no, a firm no, to that ‘one’ last drink of profits. Effects are heady intoxication and painful hangover.

There are a few interesting threads coming out of it, each one giving an aspect of the crowd psychology, socioeconomics and stocks (with a strong India focus).

Thread 1: Market is the tail wagging the dog

Common sense and common psychology thinks, believes and feels a soaring economy leads to a soaring market. But a basic analysis of the 70’s bear market [DJIA], ’87 crash most notably, and ’29 crash continues to hold water to the very opposite. It’s this:

A soaring market leads to a bountiful economy, and, which automatically follows, stocks will bottom out before the economy. Already India has downgraded its economy growth from estimated 8.7% to 7.5% for 2008-09. More specifically, bourses will bottom out approximately two quarters before economy. People have already started talking about this mess to clear up by mid-2009 to late-2009. Nouriel Roubini, the man who predicted with such clarity (and of course got scoffed), has predicted that the damage will accelerate and this credit crunch will spread to other parts of the economy. After all, too much credit is like amphetamine. Feels like heaven, but leaves a wreck.

I don’t know where the bottom is, if you ask me. I don’t know when the ‘bottom’ will come. Maybe today, maybe tomorrow and frankly, I don’t care, as long as I am on the right side of the trend. The crux of the matter is, stocks will enter a flat region, of sideways movement and consolidate for some time.

India, being primarily a country with relatively less foreign trade, compared to its Asian peers, my strong hunch is Indian markets will enter a flat phase sometime soon. How soon? Again no answer. (If you think, I am being circumspect, I can’t help it. I don’t gaze into a crystal ball!)

Thread 2: Past developments, present tense

In Indian markets, during the last one year, we have seen this crisis unfold in three major spurts. One was the outbreak. January was when NIFTY, the 50 company benchmark of NSE, India fell by around in one day 7.8%. At the end of the month, NIFTY was down by around 16.1%. This was Phase 1.

Then came Phase 2 in June. It was a market which fell by another 17%. Of note is the nearly flat ‘season’ between the two falls. [Figure 1]

Figure 1: Nifty falls over the past 11 months.

The big one came right in October and that was big. 27% in one month! And it tested historical new lows. Almost a 3 year low! But one extremely interesting thing is, how much did the retail sector sell off, and how much did professionals sell off?

For the starters, we had around $4 billion sell-off in January and it tanked circa 16%. So, now that it has tanked in October by around 27%, can we expect an FII sell-off of at least one or two billion more than Jan sell-off, i.e. ~$6bil? At least, a couple of hundred millions more than the Jan benchmark? The truth is something else.

October saw around half of what FIIs sold in Jan. Shocking isn’t it? The graph below talks it in plain black and white (err… blue and red).

Figure 2: FII activity over the past 11 months.

So what transpired behind the scenes? If such a massive sell-off didn’t come from the wholesale sector, then what pushed the NIFTY so low? After all, the retail sector is the only thing remaining in the puzzle.

When you see the chart in Figure 1 and the consolidation between the last two phases, you can quietly understand that retail lost faith, lost its confidence and got spooked by the ongoing happenings. AIG went bankrupt at that time. But technically all the data were lined up for a good sentimental rally. Inflation screeched to a halt, oil kept on falling, commodities relaxed their bullish grip. Yet, when FII gave a nudge, retail got shoved.

It panicked and sold off. And here’s why, this is a major level to be seen by technical guys. I have a strong belief that it’s when crowd gets impatient, spooked out, gets tested and shaken off, only then trends change. How much of a blind belief it is and how much of truth is there, I can’t vouch.

The irony of the situation today is that everybody wants things cheap but doesn’t want to get caught with a falling one. Natural, but this is the crux of trading, yet it presents with itself a Catch-22 position. You seek to nail bottoms/tops, which just makes isure you get caught in the wrong direction. So, if intelligent trading has to be accounted for, this paradox has to be circumvented by riding trends. And you identify these trends by buying fear and selling greed.

Thread 3: Undervalued Profits or overvalued pain?

Buying now has to be interspersed with a strong hindsight and focus on charts. I am already seeing a few scrips developing mouthwatering patterns in NIFTY. And given the fact that they are heavily beaten by the public, I am sure it’s quite a steal for bargain hunters.

Take a look at ICICI Bank (IBN) for instance [Figure 3]. The charts [in Rs.] show some very brilliant divergences on the weekly patterns. Comprehensively trading below EMA [25] and EMA [11]. Although my signals have not started screaming ‘buy’ yet, I am watching! And I am watching very closely.

Figure 3: ICICI Bank [weekly] on NIFTY. Green line showns EMA [25], red line shows EMA [11], second pane shows MACD and third pane shows slow stochastics.

This is not the only script I am watching closely. A few scrips like INFY, Reliance Steel (RS) and M&M come into my watch-list.

Are all, developing such patterns. No. But I am sure they will some time or the other.

Another interesting observation is, each investment cycle has its own heroes, flavors and tastes. While the 90s rally in Dow clearly had tech stocks as the preferred flavor, this time it was real estate and banking which touched highs. A new investment cycle will be born in a few months from now. So what will be its new flavors?

Smell the coffee, closely.

Disclosure: The author may or may not have exposure to all those scrips mentioned here. This is not investment advice and take professional help before investing.

Comments

[Natalie Le:]

Bombay Stock Exchange and National Stock Exchange was closed on Thursday after the attacks, which killed 101 people and brought the security forces into two luxury hotels in south Mumbai.

Aaron Lee Smith, MD of Superfund Financial mentions a rally coming soon but downside risks are there and eventually stocks are a dangerous place to be in.

www.youtube.com/watch?...

2008 Dec 03 03:06 AM