Nifty Looks to Undergo a Correction - GV

To many, the Nifty looks poised to correct. The hourly charts shows:

• A rising channel, which indicates a breakout to the downside.
• Bearish divergencies on RSI & MACD.

On the economic front, we see a falling IIP and steady inflation and RBI trying to drain out cash and possibly a rise in the cost of funds.

The daily chart too shows:
• A rising channel.
• The index painfully close to the upper band.
• Negative divergences in both RSI and MACD.

From a near term perspective these are not very worrisome. Technical analysis (TA) always gives two 'effects' to a single 'cause' - surely one of them is bound to materialise. If negative divergences suggest weakening of trend, there is another school of thought that says “in to a strong trend, negative divergences could be suggesting continuation of the trend”. Even in this case, the trend has been continuing for a while now despite so-called bearish divergences, sky rocketing inflation, anticipated RBI moves, etc.

The Indian stock markets have four quarters at play: retail, FIIs, DIIs, and the fourth unseen quarter – a much maligned group responsible for all our ills; a group never seen but only talked about but which is strong enough to do something unlikely on a given day. What worries me about the medium term health of the market is the signs I get from deep within the markets, which point to the activities of this fourth quarter.

If the Nifty could rally intraday on the back of a sharp fall in US (thus, poor sentiments) on the 12th, then there must be the fourth quarter playing; especially since on the day, FIIs net-bought a mere Rs 218 crore while DIIs net-sold a huge Rs 656 crore.

I have a market breadth study that reads as below:

Market Breadth as a rule slopes down. For example, my 'proprietory' adjusted breadth gave a reading of +0.37 on December 13, 2001 when the index was in 1100's, and now reads a minus 67 - yes, minus 67.3551 - with the index in 5400’s.

When the Nifty was in the trending phases the indicator gave very early and clear signals and most of the time it hit the bull's eye. But in consolidation phases, it does not say much except showing a slow - a painfully slow - message of accumulation or distribution.

However, reading this can be very tricky, made so by the natural downward bias of the indicator. Essentially one had to go by the slope of the indicator over a reasonably long period. So I created a histogram for easy reading of divergences.

From Nov-09 - Mar-10 there was a positive divergence suggesting accumulation. From Jan-10 to 'now' there is a negative divergence.

The above chart tells me that the larger market has been "undergoing shifting of stocks" that rallied during this period, which is nothing new. Except in a foolishly bullish market not all sectors rally - they only take turns; however, the number of such 'rallying-phase stocks' have been dwindling. Compare this with the period from Jun-July last year to Jan 2010. The indicator stayed sort of horizontal. The histogram / indicator for the period till June-July 2009 to be ignored as that was the last phase of the secular rally. Now we are considering a phase that has been mildly rallying or sort of consolidating. In this phase, the breadth has been increasingly weakening suggesting "possible distribution" sectorwise.

The depths of ocean a depths of the markets are only for the cunning and the gullible - the balance 2 quarters of the circle leaving the FIIs - the D&F variety. Thus, the Nifty has to fall some time - after all the price travels only in waves. And it has fallen before also and so it will in future as well. What is worrying this time around is that if the 4th quarter had been distributing then the fall could be more pronounced and the recovery may not be swift as before - 'V' shaped things may not happen - after all the 4th quarter would require some time to take position again. In other words, the fall not only could be deeper but recovery could also be slow after the inevitable volatile periods.

To be exact, my worry is not that it might correct or the timing of it but as and when it does, it could be a deep one and recovery could be slow.

Caveat: Prior to hitting 6000+, in mid 2007 onwards, my MB indicator was sharply sloping downwards - possibly caused more by heavy tranches of selling rather than gradual and consistant weakening of breadth (as could be the case now) because there was no negative divergence in the histogram then. In other words the indicator gave one wrong sell signal while the Nifty was still climbing and continued to do so but never showed any negative (wrong) divergence. The indicator did catch up with the index but that was a clear 700 points later. If I remember correctly, the DIIs were selling prior to May 2007 as the FIIs were getting deeper into their frenzied buying while commencing that rise of 5000 to 6000 on the index. And later on, the DIIs simply could not take the heat of 'not being in the party' and joined late and were to regret it deeply in early 2008. For all I know, something like that can always happen.