Indian stock markets having gone up 93.4% from its March 2009 lows has attained dizzy heights. This article tries to seek an answer to a question on how much more upside the current rally has and if it?s advisable for investors to consider exposure even at these levels.
As mentioned in the beginning about the 93.4% surge in the markets since 9th March 2009. However, if we break up this rally into equal parts then the following is observed:
•The Nifty went up 80.9% from March 9, 2009 to June 10, 2009 (3 month period). On June 10, the Nifty closed at 4655.25 as against a low of 2573.15 in March.
•The Nifty has gone up 6.9% from June 10, 2009 to September 18, 2009 (3-month period).
On September 18, the Nifty closed at 4976.05 (new highs for the year) as against levels of 4655.25 in June. So, in the last three months, the Nifty has practically gone nowhere. The markets have been largely range bound with a slight positive bias (which is indicated by the marginal rise in the Nifty post June 2009).
In my humble opinion, markets are headed for the correction in the next 2-3 months. My opinion is based on some fundamental and technical factors which I would discuss below.
Price earnings ratio for the Nifty: The historical and current PE for the Nifty gives some insight into how undervalued or overvalued the markets are currently. Below is the PE valuation graph for the Nifty from March 9, 2009 to September 18, 2009.
As shown in the graph above, the Nifty PE has gone up from 12.2 in March 2009 to 22.4 currently. These are expensive valuations considering the fact that the world is now just getting hopeful about coming out of the worst financial crisis and one of the worst economic crisis.
Also, the following needs to be considered: In the last nine years, the Nifty PE has never gone above 28.5. The Nifty commanded this PE during times of extreme optimism and during the peak of liquidity cycles. Thus, the current PE of 23 again looks expensive relative to historical data.
The markets are also giving the same indications and have hardly made any significant moves in the last three months. So at times, one needs to listen to what the markets say, and currently the mood of the markets is not very bullish.
Movement of the dollar index:
Recently, when some of the major global markets (including India) touched new highs for 2009, the dollar touched new lows for 2009. Thus, it is very important to look at the dollar index for any trend reversal.
The dollar index has gone down from a high of 85.9 in March 2009 to a new low for the year (76.2) on September 17, 2009. What I wish to emphasise is that the sentiment on the dollar is very bearish right now. The number of traders betting on the dollar going down is well over 90%. Generally, when trends get so bearish, there is a sharp counter trend which gets established and even a slight up move in the index would lead to traders covering their shorts (which would lead to further rally).
Thus, in my opinion, the dollar is quite oversold in the near term and might make a temporary reversal in the next 2-3 months. This would be negative for equities and commodities and hence these asset classes might trend down over the next 2-3 months.
Nifty trading 23% above its 200 day EMA:
The Indian markets are currently trading 23% above its 200 day EMA of 4055.69. This is very important in the context of valuation of the markets. It must be noted that if the markets are trading above their 200 day EMA then it is a bullish indicator. However, whenever markets have gone way above their EMA?s, there has been a trend reversal.
I consider the trading of the Nifty 23% above its EMA important and a sign of an impending reversal based on the historical Nifty and EMA trend.
When the markets peaked out on 9th January 2008, the Nifty was trading 27.8% above its 200 day EMA. Similarly, when the markets corrected significantly in May 2006, the Nifty was trading 27.2% above its 200 day EMA. So whenever the markets trade more then 25-28% of their 200 day EMA?s a sharp correction follows.
The following is another interesting piece of data: In October 2008, when markets made new lows, the Nifty was trading 26.8% below its 200 day EMA. Currently, the trend has reversed and the markets are 23% above its 200 day EMA, which probably gives a little bit of head room for a rise till 5,200. But given that risk reward ratio is skewed towards risk any bets on the long side may prove futile.
Conclusion:
As per the charts and valuation discussed above, the Indian markets surely are in overbought zone in the near term. My expectation is that the markets will correct significantly over the next 2-3 months. Any correction can be a good opportunity to consider exposure to quality stocks. It is always difficult to predict market movements and time the markets. But if an investor buys quality stocks and has the patience to hold on to his positions for long term then big gains can be expected. The best part of the India growth story is still to come and the same would apply to the Indian stock markets.
The writer is a derivatives analyst
