Index Outlook: A Happy Diwali for Indian investors

Dalal Street has much to feel pleased about this Diwali. The Sensex and the Nifty have moved up around 23 per cent in the last 12 months and many smaller stocks have given multi-fold returns.

But don’t expect too many fireworks in the Muhurat session this year. With the indices perched close to their lifetime peaks and threatening to slide further, investors are likely to be circumspect.

The action this week is likely to be muted with indices moving in a small range as the market is open on only three full sessions. Many might want to cut back their trading activity to spend time with their family.

Concerns on the ability of the Euro Zone to ward off a recession caused deep cuts in European and US stocks.

While stocks did recover some ground towards the end of the week, the complacency of investors in the developed markets appears to be shaken.

This is reflected in the CBOE volatility index hitting the high of 31 during the week.

This level was last visited in December 2011. The VIX that is calculated based on the premium of S&P 500 options, shows the level of fear among the traders.

That this index did not cross 23 since January 2013 implies that the level of investor confidence has been high since the beginning of last calendar year.

The CNN fear and greed index is also tilting towards extreme fear reflecting this change in the sentiment.

The Sensex too sold off to dip below 26,000 on Thursday. But improvement in global sentiment and hopes of a strong showing by the ruling party in the assembly polls helped the index rally.

There are other factors playing in favour of Indian stocks. Fall in crude prices will help the country’s current account deficit that is again beginning to bloat with growing gold imports.

Nymex crude futures dipped below $80 last week. But there is strong support in the zone between $75 and $80 for crude. It is quite likely that the crude futures halt their decline in this region.

If this level is breached, next support is around $65. Since many are of the opinion that oil producers will find it unviable to produce below $80, we should be able to find the floor of oil prices soon.

FPIs were net sellers through last week. Their net sales for October stand at $613 million. Sharp spike in derivative volumes on the NSE too implies that traders were quite active in the previous week.

The Sensex hit the intra-week low of 25,911 before rebounding on Friday. Oscillators in the daily chart are quite weak though they are appearing oversold at this juncture.

The Sensex has closed firmly below the 50-day moving average. This denotes weakness. The possibility of an evening star pattern on the monthly chart also does not bode well for the medium and long-term outlook.

The week ahead: The short-term trend in the Sensex is weak. But the index is holding around the key short-term support at 26,000. This level needs to be breached before the index can decline to 25,329 or 24,892.

But since most global markets reversed higher on Friday, there can be a rally in the early part of the week that takes the Sensex higher to 26,451 or 26,810.

The inability to move above the first resistance will be the cue for short-term traders to go short.

Medium-term trend: We retain the positive medium-term outlook for the Sensex. Unless there is a strong breach of the 26,000 level, the outlook will not be threatened.

Medium-term supports for the index are at 25,000 and 24,500. As long as a correction halts above these levels, there is a possibility of the index spending some time (few months) moving in the band between 24,500 and 27,500 before it moves higher again.

Medium-term outlook will turn negative only on a close below 24,500.

Nifty is establishing a sequence of lower peaks and troughs since the end of September. This is a negative formation and can precede another leg down. That the index is firmly below the 50-day moving is also a negative for the index.

The week ahead: But the factor favouring Nifty in the short term is the fact that it is not too much below the short-term support at 7,790.

It is possible that the index attempts to recover next week to move higher to 7,900 or 8,016.

Traders need to watch out for the resistance at 7,900 since the 50-day moving average is also positioned there.

Reversal from there will be the cue for traders to initiate fresh short positions with stop loss at 8,025.

Downward targets are 7,594 and 7,540. Target above 8,000 is 8,160.

Most global indices recorded sharp declines in the middle of the week. But subsequent recovery was sharp. This leads to the hope that at least one leg of the correction could have been completed last week.

The extent of the recovery now will indicate if the decline will have legs or if the uptrend will resume from these levels.

The intra-week bounce from 15,855 in the Dow has helped it reverse from key medium-term support. If it holds above 15,700 in the coming week, it will mean that the Dow is on the road to recovery.

Conversely, a decline below 15,700 will take the index to 14,720 levels.