Market View: Debt Trap

I will be changing the format of posts slightly - and instead of putting up the views, will rather put some facts and information. And based on them, would try to get the scenarios done. This would help put things into a better perspective, and also throw up likely if-else scenarios. Quite often, when the view goes wrong, I'm caught clueless about 'what to do now'. 


The easiest way of starting this framework would be to state the simplest fact about the markets today - everyone is borrowing. Companies are raising equity as well as bonds (and all the fancy things that fall in between). Countries are raising debt from other countries, as well as their own citizens. Very soon, we would have a world with very high leverage, and very high debt servicing costs. Developed world is borrowing to maintain its consumption levels, whereas the developing countries are borrowing to spend on infrastructure and create capacity. 


So, what will happen from here?


1. Banks would be the out-performers: More borrowings means more business. A world with a higher debt to GDP ratio also implies very high activity levels for the banks. Credit growth would be humongous, and margins would expand as well. 


2. Companies with large free cash flows would do well: All the tech and IT companies with zero to little debt on the books would be best placed to ride over the situation. However, they would have to do with lower returns on their portfolio as long as rates are kept low. Telecom would have fallen under this category, but for the 3G auctions (and subsequent debt on the books of each of the operators). 


3. All the companies with large capital requirements and long term projects would suffer: Capital goods and real estate being the top 2 sectors. At some point, interest servicing would rise to very high levels, and any fall in business activity would squeeze them. They might do well if global economy recovers, but if there is any slowdown, they would bleed badly. 


4. ...


P.S. - Now I can slightly appreciate the consumerism in US and other developed economies. Irrespective of what the interest rate parity and fisher theorem says, people need an incentive to save money (for future consumption). And an interest rate of 1% or 2% on bank deposits is hardly any incentive to save. More so, when I can borrow also at very cheap levels. If the rates were 6% to 8%, one might give it a thought. But at 1%, no way.

Gamma Bleed

World markets are going crazy, and traders all over are bleeding gamma. Volatility has dropped below long term historical levels in a lot of markets, and naturally, traders are sitting long Gamma/Vega.

Nifty seems to scaling new peaks everyday, and is currently trading at 5600+ levels – looking all set to conquer 6000 by the end of this year. The all time peak now appears well within the grasp of the market, and one last moment of euphoria could take us there. Coal India IPO in October would be the final decider – if it goes through, we would be in for a new peak, or else, we may come down from here.

The trade here seems to be going long a strangle – buying 5400 Put and 5800 Call for November/December expiry. Will check the prices in more details tomorrow on this, but if its within 150 INR, then seems like a good trade.

Trading View: August 13

Markets haven't really been moving as per my views in the past few weeks - they have been exceptionally strong. FIIs continue to pump money into the Indian markets, making it the most stable markets even on global-down days. Downside volatility has almost disappeared from Nifty, and markets just seem to be inching up. 


There are plenty of red flags, but for the moment its more like 'ignorance is bliss' once again. The results haven't really been exceptional - with only banks and autos surprising on the upside. Rest all have been a drag on the markets at best. Telecom is almost wiped out completely out of the rally, and so is Real Estate. IT and Metals, which led to the first leg of the rally from 5000 to 5300 levels seems to have gone quiet taking recessionary global cues. Now, for the next leg up, we need pure domestic sectors, and this is where banks and autos fit the bill. Indian banks are primarily a domestic story, with negligible global operations and exposure. And so is the auto sector - with most of the supply being absorbed by local demand. Only Hyundai exports a decent chunk of its production, but thats not listed in India anyways. Other domestic stories are FMCG, and Infrastructure. If we do have a next leg up, I would be betting on Infrastructure more than anything else. 

I'm not particularly bullish over the short term, though over the longer horizon I do believe that as a whole the India story is intact, at least for the next 3-4 years. We do have a case of over-heating and excessive inflation, but these are not big issues to worry about. 

Market View: August 9

This post assumes the reader has seen 'Inception'. In case you haven't, sorry for all the comparisons with the movie. Just to give you a rem/primer on the movie, its a new version of the Matrix trilogy - with more emphasis on the construction of matrix than on action and Trinity. 

We are all dreaming. In fact, we have been dreaming for the past couple of years. The reality was bad, very bad for the human race to digest. The Americans and Europeans who had spent their lives living off their credit card debt were suddenly to be told that it was not the right way of existence. It would have led to widespread depression (not the economic variety), and panic. So, to save the world, Uncle Ben Nolan weaved this dream - that all was well again. 

He injected massive amounts of penicillin in the system, and everyone went to dream. Whether we are in the first level of dreams or further down is anyone's guess. The only certainty is that no one would be able to get us out of it - neither crash landing, and nor any kicks on the back. The dream is much better than the real world - everything appears rosy, markets seem to be making a new high every day, gold is up, real estate prices are back to their peak levels and so are the markets. There are small-cap growth stories floating all around - and there are plenty of multi-baggers waiting to be discovered. Each new guy you meet has a secret of stocks that would become 4x in no time. 

This is not the real world, and we all have been dreaming. In the real world, more than 10% of people are out of jobs. There is a massive oversupply in the real estate markets, and there are no buyers. Government debt has exceeded all their previous highs, and yet show no sign of abatement. Companies are issuing fresh equity/debt at a breath-taking pace, each one trying to go ahead of others. 

Someone would need to start pulling the brakes. Or risk a crash. 

Market View: July 28

After being a bull for quite some time, I'm turning more and more bearish on the markets. Going back to my childhood, I used to feel very happy whenever I got a raise in my pocket money. However, in the end it never mattered, and I was left with same/no savings at the end of the month. The expenses always used to catch with the free money/increment. I guess the same is about to happen with the stimulus spendings - a lot of it has gone down the drain. In the end, people would be left no richer than they were without it - and thats not a happy state as they weren't very rich to start with. 


We are coming close to end of 2010 - the time predicted for the Quantitative Easing to end. Almost three years have passed since the crisis started, and we are no where close to closing down the taps. The stimulus would continue for another year or so, and this isn't a very happy sign. Never mind the asset prices and the booming markets, its all in the dreams. Only, instead of Christopher Nolan its been designed by Ben Bernanke (and its awful). 


Nifty has outperformed the global indices, and has scaled to a new 30 month high. Markets look all set to break new grounds, and may even tough the earlier highs. A lot of FII money withdrawn from the Euro area has entered our markets (with more than USD 2 Billion flow in July). However, do not thing this is a long term shift, but just a temporary parking space. And thats what makes it much more dangerous - we are moving towards the Asian crisis scenario. There aren't too many markets with good GDP growth, and hence it may end up over-heating the handful of markets which are growing now. 


In India, the result season has been very good so far, with most of the top names not reporting any great positive surprises. Add to it RBI's firefighting with inflation, and we do have a possibility of good correction in the markets from here. I wouldn't be surprised if August and September turn out to be bad months for the Indian equities. 


I'm currently short on the markets, and would continue to roll my positions until 5600 is broken on Nifty. Earnings haven't supported to the recent upmove, and markets may find it increasingly difficult to justify their premium to the region. DIIs have been sellers for quite some time now, and FII may very soon find India too overbought. Or worst of all, some one may kick Uncle Ben out of his dreams, and he would put an end to this whole messy maze. 

Europe: The Clouds of Worry

The last time I talked about the markets, it was somewhere close to March, with the budget session grabbing the limelight. The current darling of the market seems to be Europe, and its deficit problems. Greece, Spain and Portugal, all seems to be in big trouble - and they may spell doom for the common currency. US may be breathing the sigh of relief, for two reasons - (a) Its banks are no longer under the spotlight, and relentless attacks from bears all over the world, and (b) USD would continue to be the De-facto reserve currency for the next decade at the least. 


So we have US almost out of trouble from here - substantiated by economic data as well as the market sentiments there. Asia was never under direct trouble (except perhaps fears of bubble in China). Which leaves us with the Europe and all its worries. Markets worldwide are crashing everyday on some news from the region - be it the fresh debt issue cut-offs, or the actions from the Central Bank of Spain. However, in the larger scheme of things, does rest of Europe matter? Take out Germany, France and UK, we are left with a lot of small debt-ridden countries. As long as no one is seriously doubting the debt servicing ability of the big 3, I do not see Europe being too important. They were never the growth drivers in the world economy, and there is no reason why they would hamper it either. It would cause some panic, and spike up the volatility levels, but in all, it won't be catastrophic. People on the street still do not fear for their jobs the way they did in 2008, and this indicator works way better than all the volatility indices of the world to measure the panic levels. 


I'm not saying that it would lead to nothing. There would be serious re-rating of the whole of the world. By no matrices, European nations deserve a better rating than the Asian ones. US and UK may not be as safe as they were 10 years back. It would be a slow and painful process, and every few months, some Euro-block country would be down-graded. However, it should not spook the markets, these nations are over-rated and it would get corrected soon. Very soon, some of the Asian economies might get upgraded - as early as next year.


In a nutshell, I remain bullish on the local markets. Even though the charts tell otherwise, and the world thinks otherwise. I think after the clouds clear over the European skies (pun intended), it would be smooth flying all around. 




Food for Thought: Germany bans short-selling, and markets tank. Spain merges four of its banks and markets tank. Rumors of face-off between North Korea and South Korea, and markets tank. We live in a world where people trust one yellow metal more than anything else. All in a hope that when the world ends, there would be two guys left - me and the jeweler who would buy the metal from me. 

Technical Analysis 105: Important Tools - II

Earlier posts of Technical Analysis:

• Technical Analysis 101
• Technical Analysis 102
• Technical Analysis 103: Trends and Channels
• Technical Analysis 104: Important Tools – I

There are numerous other tools which are used in Technical Analysis – (a) Oscillators, (b) Stochastics, (c) RSI, (d) Moving Average Convergence Divergence, and (e) Bollinger Bands, just to name a few. However, I do not think I would be able to follow so many of the tools, and have identified two additional tools which I believe I could track:

1. Relative Strength Indicator (RSI): Very simply put, it measures the relative strength of the overall market, and has readings between 0 and 100. Usually, it is computed as

RSI = 100 - {100 / (1 + RS)},
where RS = Average of N period’s up moves / Average of N period’s down moves

RSI would be more than 50 if the average up moves are greater than the down moves, and would reach 100 (theoretically) when all days are up-days. Usually N is taken as 13 or 14. An RSI value above 70 is considered signs of an over-bought market, and RSI value below 30 indicates oversold markets. However, one should also look at the price charts in addition. If the prices are forming a double top, whereas the RSI isn’t, then it may be a bearish signal. Similarly, in situation when RSI is making a double top, and prices aren’t,we might see an up-move in prices.

2. Bollinger Bands: These are bands placed 1.5 to 2 standard deviations up and below a simple moving average line. For example, if we are looking at a 20 DMA line, then its Bollinger band would be 2 sigma up and below the 20 DMA line. Usually, the prices would remain within the band, however, the breakout is a strong bullish/bearish signal. If a breakout happens on the upside, its a bullish sign. And only when it returns back to the band, its a sign of reversal.

Technical Analysis 104: Important Tools - I

Earlier posts of Technical Analysis:

• Technical Analysis 101
• Technical Analysis 102
• Technical Analysis 103: Trends and Channels

In this post, and the next one, I would discuss about some of most commonly used tools (indicators) in Technical Analysis:

1. Moving Averages: Perhaps the most important points on any price charts are the moving averages – and they can used both for short term as well as long term analysis. Usually, there are multiple ways of calculating the MA, but most commonly used is the Simple Moving Average, and hence I would be using this one.
The important moving averages which should always be kept in mind for the important securities are:

1. 5 DMA
2. 10 DMA
3. 20 DMA
4. 50 DMA
5. 100 DMA
6. 200 DMA

These are important levels on the charts, and act as strong support and resistance levels. In addition to the home markets, they should also be followed for the regional as well global markets. I would be following the levels on Nifty, Sensex (home markets), Hang Seng, Shanghai composite, Kospi, Nikkei (regional markets), S&P, Dow, DAX, and FTSE (global markets) – on a daily basis.

2. Relative Strength: In a trend, there are sectors which perform well, and there are sectors which are laggards. Its always profitable to identify the sectors (and within the sector, the stocks) which have the strongest relative strength, as well as those with the weakest relative strength. This coupled with the general market trend could result into good stock picking early in the cycles.
I would be following the sectors of the home market, and track their performance vis-a-vis Nifty on a weekly basis, and report on Friday.

3. Volume and Open Interest: There is great information hidden in the market volume, as well as open interest data. Very few people in the market are able to make sense of these, and due to added complexity due to options data, it becomes quite complicated to make any sense. However, would try to capture the data and their sense on a weekly basis – how have markets moved, volume during the week, and how has open interest changed. Would start with Nifty on this, and as I become more comfortable, might add a couple of other indices or stocks.

Technical Analysis 103: Trends and Channels

Earlier Posts on Technical Analysis:

• Technical Analysis 101
• Technical Analysis 102

One of the principles on which technical analysis is based is that prices move in trends, and continue to do so for some time.

Trendlines: A trendline is simply a straight line connecting two or more points on a price graph. An uptrend line connects a series of bottoms, and a downtrend line connects a series of tops.

• The more the number of points that form the line, the more important it is.
• The longer the trendline holds (time period), the more significant it becomes.
• The angle of the trendline is also very crucial, the lower the angle, the stronger is the trend (a very steep trend is very unlikely to persist).

Trendlines are broken when three criteria are met:

• Extent of penetration: The trendline must be broken by atleast 2%-3% to be sure of a clear break, more valid for longer term lines. For short term trends, the extent of break would be lower to confirm the break-out.
• Time Filter: The prices shouldn’t go back to trendline immediately after penetration, and should confirm the penetration by staying in the range for 2-3 days. Usually, intra-day breaks are discounted to confirm a break-out.
• Volumes: If the penetration is followed by heavy volumes, then the breakout is much more credible, as against one with low volumes. 

Channels: Like trendlines, prices also tend to move in channels, with parallel support and resistance lines. There are traders who trade for price actions within the channel, buying near the support line, and selling near the resistance line, with stop-loss on other side of the lines. Some signals from channels:

• If prices after being in a channel, fail to reach the top line or bottom line, then it might signal a break on the other side. For example, if prices fail to reach the top line repeatedly, then it might signal that prices would break the lower support line.

Support and Resistance: Support and Resistance are very important levels, and prices often bounce back from these levels. A support is the level where there is good demand for the stocks, and resistance are levels where there is a good supply of the stock.

• If the prices touch a level repeatedly, then the level becomes more and more important – a long term support/resistance is much more important level, then short term levels.
• After the level is broken, support becomes resistance and vice versa. And more the time stock has spent near the level (consolidation), more important is the level.

Retracements: Another important tool is retracements levels – after a trend reversal, the prices tend to retrace by a certain proportion before continuing the earlier trend. Often, prices will retrace from a minimum of 33% to a maximum of 67% of its previous move, before continuing in its earlier trend direction. 50% retracement is also a very important level, and is observed quite frequently. However, if the prices retrace by more than 67%, then the trend may be broken for good.

Cement Sector 101

Cement sector is one of the promising sectors in any growing economy, and it’s the same in India as well. However, most of the analysts believe there would an over-capacity in the sector in the coming years, and hence are quite bearish on it.
Overall capacity is 180 Million Ton, and another 90 MT is in the pipeline (to be added over the next 5 years)
Important Factor:

• Overall Capacity: This is again a purely volumes game, and the players are ranked as per capacity. There is as such no pricing power with any of the players, and is a relatively commodity business (except may be some premium or white cement segment).

• Geography: There are two broad regions – North and South, and both have slightly different dynamics. Currently, all the infrastructure push is in the northern region, and hence the prices here are at a premium. Given the bulky nature of cement, usually its quite difficult and cost-ineffective to transport the same within regions.

• Growth Rates: The industry growth rate is directly linked with the GDP growth rate, and more specifically, very closely with the Infrastructure growth. Currently, the cement demand growth is close to 12%.

• Operating Efficiency: The industry operates at a high utilization rate of 85%, though going forward due to high capacity addition in 2010, this is expected to come down to 80%.

• Coal Prices: Usually, coals are an important input to the process, and constitute a good amount of the total cost of materials. Roughly, a 1% rise in coal prices would lead to 35 bps fall in earnings.

• Freight Cost: Cost of transportation is also an important cost as cement is a bulky good. And that indirectly would depend upon the oil prices.

 
Some of the big companies in the sector are as follows:
 

• ACC: Currently trading at a market price of 900, the stock might be a good buy at lower levels (700). The EPS is estimated at INR 75-80 in 2009, though there may slight reduction in 2010 and 2011. High presence in the Northern markets, with a total capacity at 26 MT. It is the largest player in the Indian markets, and has a large presence in Eastern as well as Northern markets.

• Ambuja Cement: Current market price of 100, and target price of 85. EPS is INR 7-8, whereas the capacity is ~24 MT. It’s a big player in north and western region, and usually is one of most richly valued stock in the sector.

• Ultratech Cement: It’s the 2^nd largest cement company in India, and is being controlled by Aditya Birla group. Overall capacity of 23 MT, with presence in southern and western markets. Again, target buying level would be INR 800.

• Grasim: This is also one of the largest companies in the sector, with an overall capacity of 25 MT. However, this is not a pure-play cement company, and has textile exposure as well. Again, this too is controlled by Aditya Birla group (along with UTCEM), and there are plans of merger between Grasim Cement and Ultratech.

• India Cement: Has a good presence in south india, and buy target at INR 100. Current capacity is 14 MT, however, its present mostly in the southern region where there is substantial capacity addition plans. Also, they are the owners of the Chennai Super Kings, and a small part of their valuation comes from the IPL revenues as well (around INR 20-25 per share).