Market decoding: Poor economic outlook prompted sell-off in equities, says Rahul Ghose

Last couple of days have been tumultuous for the markets with a deep cut on the major indices Nifty & Sensex. Nifty fell by almost 1000 points in 3 days & benchmark Sensex dropped by 3000 points which translates into a cut of 3-4%. Post exit polls event, it can easily be said that this was one of the sharpest cuts in the indices in recent times. However, the last time this happened, markets took the news in its stride, shrugged it off and went on to make newer highs making it business as usual. The question is, can the markets shrug off the multiple macro headwinds this time as well & keep on rallying? Well, the odds look limited. Let’s understand why

The previous event of election was a local event impacting majorly the Indian market. The fact that the ruling party could still form the government albeit with a lesser majority meant there was less room for more negative surprises. However, this time there are a few important differentiators.one, the triggers impacting the market are not local, but more global in nature. Second, the valuations of many mid & small cap stocks have reached unrealistic levels making them difficult to sustain. Thirdly, whenever there are geo political uncertainties, they seldom die a sudden death. Remember, the Russia Ukarine war is still far from over 2.5 years later. Similalrly, the tensions between Iran & Isarel will keep propping their ugly head from time to time keeping an overhang on the markets for some time to come.

Let’s understand the macro events that led to a catastrophic fall on indices world over one by one -

1. Yen Carry Trade & Cascading Impact

The yen carry trade, a strategy where investors borrow in yen at low-interest rates to invest in higher-yielding assets, has seen a reversal. As the Bank of Japan signals potential tightening of its ultra-loose monetary policy, investors are unwinding these trades, leading to a stronger yen. This unwinding has caused ripple effects across global markets, as investors pull out from riskier assets, contributing to the market correction.

2. Nikkei Dropping Almost 20%

Japan’s Nikkei 225 index has plummeted nearly 20% from its all-time high, triggering concerns about the health of the global economy. This significant drop reflects investor anxiety over Japan's economic prospects, exacerbated by the potential end of the yen carry trade. The Nikkei’s decline has further dampened investor sentiment worldwide, contributing to the broader market sell-off.

3. Goldman Sachs Raises US Recession Probability

Goldman Sachs has raised the probability of a recession in the US, citing persistent inflationary pressures and the Federal Reserve's aggressive monetary tightening. This forecast has spooked investors, leading to increased volatility in the markets. The fear of an impending recession has caused a shift towards safer assets, resulting in a sell-off in equities.

4. Israel & Iran War

Geopolitical tensions between Israel and Iran have escalated into open conflict, raising concerns about stability in the Middle East. This war has heightened uncertainty and risk aversion among investors. The potential for disruption in oil supplies has also led to volatility in energy markets, further contributing to the market correction.

5. Poor Economic Data from the US

Recent economic data from the US has been disappointing, with indicators suggesting a slowdown in growth. Concerns about the US economy sliding into recession have been amplified by weak consumer spending, declining manufacturing activity, and a sluggish labor market. This poor economic outlook has fueled fears among investors, prompting a sell-off in equities.

6. Warren Buffett Sitting on a Huge Pile of Cash

Warren Buffett, often seen as a bellwether for market sentiment, is currently holding a substantial amount of cash. This conservative stance is interpreted by many as a signal that Buffett is anticipating further market downturns. His cautious approach has added to investor unease, contributing to the overall market correction.

7. High Valuations of Indian Markets

The Indian stock markets, particularly large and mid-cap segments, have been trading at high valuations. These elevated levels have made the markets susceptible to corrections. As global factors exert pressure, investors are reassessing the sustainability of these valuations, leading to a sell-off in Indian equities.

Now that we have understood the fundamental factors, lets understand the markets from a Technical perspective. Markets are more driven by sentiments & what better tool to use than charts to understand those sentiments.

Technically Nifty 50 has entered into an overbought territory on weekly, monthly & quarterly time frame with the upside capped at 25500 in the medium term. This coupled with higher valuations signal a significant correction in the short-term. On the weekly time frame chart, Index has had a pro-gap down in an overbought market. Pro-gap in an overbought market is generally a sign that the markets would find it difficult to make a fresh high immediately, & the gap will act as a strong resistance.

On the daily time frame, there is a negative divergence between price & RSI with prices making a lower low, suggesting a strong possibility of correction. In the short-term 23500-23300 happens to be a strong support zone. If this is breached, index has a strong possibility of sliding further to 22000 levels. A move towards 22000 would mean a drop of 10% form the top & that can could be a reasonably good time to start shopping on the upside

Since the month has just begun, we can’t conclude much from the monthly time frame charts. However, monthly time frame chart should be on every investor’s radar. Prices are already overbought on monthly & overstretched at the top end of the Bollinger band. If we have a strong bear candle close inside the upper band, we could have confirmation of much lower levels of around 22000 range mentioned earlier.

In conclusion, the recent market correction is the result of a complex interplay of global economic, geopolitical, and market-specific factors. From the reversal of the yen carry trade and the decline in the Nikkei to heightened recession fears and geopolitical tensions, each element has contributed to the current market landscape. Technical picture too is pointing towards a strong possibility of correction further deepening, suggesting a wait & watch approach.

Investors should navigate these turbulent times with caution, as the search for stability continues amidst uncertainty.