Index Outlook: Correction around the corner?

Indian stocks displayed great resilience over the last two months. Even as rich valuations, lacklustre earnings growth and weak readings on the economy made analysts repeatedly issue warnings, stock prices held on to higher levels.

The consensus is now veering towards a view that the slow-down in earnings caused by demonetisation and GST are now behind, and growth will pick-up in the coming quarters. While that is possible, it is impossible to ignore the fact that many stocks have moved too high without supporting growth in earnings. Moreover, the surging demand for high-growth stocks has resulted in frothy valuations for most fundamentally sound companies.

But as we have written before, there is no weakness on the charts yet. It is quite possible that the indices move a little further from here before a reversal happens. Even if there is a sharp decline in prices, the stronger companies’ stocks could rebound soon, thus making profit-booking a little tricky at this juncture. The best course for investors would, therefore, be to hold on to their portfolio and do nothing for a month or two.

December is typically a good month for stocks. But if there is an upset for the BJP in Gujarat elections, it could set the stage for a fall. If December passes peacefully, there could be some ugly surprise in store in January, as fund managers return from their Christmas breaks. The rally in US market is definitely unsustainable and a crash there could set off a global melt-down.

Investors need to keep an eye on the dollar that is one of the important determinants of the fortunes of global markets. The greenback lost almost 12 per cent between January and September 2017, leading to sharp appreciation in emerging market currencies including the rupee. If the dollar resumes its downward trajectory in 2018, due to stable global growth and a stronger euro zone, that will be conducive for rupee.

A stronger rupee helps boost foreign portfolio flows that can support markets going ahead. Flows in to equity market have been almost double the flows received in 2016, with YTD flows of ₹53,046 crore. But it is clear that flows can turn erratic at a short notice. While there was inflow of ₹19,728 crore in November, December has witnessed outflow of around ₹4,089 crore.

As the Federal Reserve and the ECB start monetary tightening, fund flows in to equity market could reduce. The meetings of these central banks this week will therefore be of great interest.

Not much has changed for the Nifty since Diwali. It hit a high of 10,490 in November, after which there has been a gentle slide.

Short-term trend: The short-term trend in the Nifty is downward. But the key short-term support is at 10,000. Investors with a short-term view can buy in declines as long as this support holds. Breach of this level can take the index down to 9,700. The Nifty can try and move to 10,407 or 10,490 in the coming sessions.

If there is another explosive result from the Gujarat elections, Nifty could move on to 10,687 or 10,800 in December. A strong close below 9,500 is needed to signal a reversal in the short-term trend.

Medium-term trend: There is no change in our medium-term view. We had given the target of the final leg of the move from the December 2016 low at 10,216, 10,544 and 10,921. The second target has been almost achieved. We will, however, wait for a close below 9,700 to confirm the end of the move from December 2016. Else a move towards the next target of 10,921 can unfold. We retain the next target for Nifty at 11,360. Key medium term support is at 9,300.

The Sensex too hit a high of 33,865 in November after which it has been sliding lower. Immediate short-term supports for the index are at 32,500 and 32,150. Short-term investors can buy in declines as long as the index manages to hold above 32,150. Next downward target is 31,100.

If the rally progresses this month, the Sensex will try to achieve the peaks of 33,770 and 33,865. A strong break-out above 33,865 will bring the next medium term target of 35,000 in to play.

There has been a marked dichotomy in the performance of global indices in the last quarter of 2017. US indices such as the Dow Jones Industrial Average, S&P 500 and NASDAQ continued to rage on hitting new record highs. Indices of other developed economies such as Germany’s DAX, UK’s FTSE, Switzerland’s Swiss Markets Index and Straits Times Index also held on to their gains.

But indices of emerging economies such as Taiwan, Mexico, Philippines and South Korea have witnessed corrective moves since November.

CBOE volatility index has once more slipped below 10, implying that the sentiment among traders has become positive again. This index has mostly traded between 10 and 13 this calendar, barring the rise in April and August. But the VIX has not crossed 20, through 2017 implying that the US investors have had a good year of stable returns from equities.

Commodity prices have also been largely range-bound in 2017. While the CRB index declined mid-year, it has since then recovered, along with recovery in crude oil prices.