Neighbourhood Worries May Spook the Bulls

Last week I wrote bulls may run into rough weather based on the data that I shared.

The markets moved as per my expectations on Monday and Tuesday. Wednesday and Thursday were bullish days due to the sops announced for the telecom, auto, and banking sectors.

I would have loved to go wrong in my earlier prognosis and witnessed a rally in the markets. But Friday’s session was noteworthy in more ways than one.

Let me explain by starting with China.

China’s Lehman Moment

Data about the Chinese economy is not exactly behind an ‘Iron curtain’, but a lot of the news (especially bad news) isn’t forthcoming.

I have been trading since 1986, and I enjoy an edge of experience gained by trading through previous economic crises.

In all those cases, the playbook, checklist, and central bank actions are almost always identical, as is the case in Chinese financial markets right now.

About five months ago, Huarong (a Chinese asset management company) started experiencing ‘delays’ in repaying its debts.

Its corporate bond price crashed. The Chinese government assured international investors that all was well. The markets moved on.

A few weeks later, Evergrande (now officially the largest indebted real estate company in the world) is experiencing ‘difficulties’ in repaying its loans.

Its bonds were suspending from trading from 16 September. Bondholders are unlikely to get all their money back. Retail savers and homebuyers are coming out on the streets to express their displeasure.

But it doesn’t end there.

SoHo China, another mega-corporation with a gargantuan loan book, is ‘delaying’ repayments.

The Chinese tried to sell the company to Blackstone. The deal failed. The stock fell 40% in double-quick time.

Investors in all three companies may get a fraction of their original investment back. That includes international investors. Evergrande’s outstanding debt is now way above $300 billion. Its debt is climbing as numbers are released in a piecemeal fashion.

Very simply, this is China’s ‘Lehman moment’.

What about India?

There’s a risk of these neighbourhood worries percolating down to our market. The reason is simple. It happened in the South-East Asian currency crisis of 1997 as well.

Think of a bond investor as a money lender. He witnesses one of his borrowers’ default on his commitment. Then another and another.

What does the moneylender do? He demands repayment from everyone out of sheer insecurity.

Let us not forget the cumulative debt amount of these three companies is now nearing Bear Stearns and Merrill Lynch figures of the 2008 global financial crisis. That is if the Chinese government has even revealed the entire picture. Investors fear the reality could be even more frightening.

Fear is not logical. It’s contagious and multiplies as it spreads. This is the primary risk I foresee in the near future. The long term Indian bull market story remains intact. But staying alive to see good times is important.

Let us look at what happened in the market last week to guesstimate what lies ahead of us.

Government’s Boost to the Market

Last week, the Bank Nifty outpaced the Nifty 50 since the finance minister announced a bad bank. Banking investors were happy for the relief from the rising non-performing assets (NPAs).

More good news was the possibility of Indian sovereign bonds being included in global bond indices. This would mean sizable inflows into India that could be bigger than PSU divestment and GST put together.

It also means banks need not have to fund the government single-handedly through the bond markets and will now have surplus cash to lend. Watch this space for more.

The dollar rose, and that pushed bullion lower. As China gets weaker, the dollar will get stronger due to a flight to safety.

A rising dollar is negative for India. A weaker rupee makes all imports more expensive. Rising oil and gas prices are inflationary and that impacted sentiment on Friday as well.

Let’s take a look at the market internals.

What Does the Market’s Data Say?

The market-wide position limits (MWPL), which measures the level of commitment of traders, continued to rise. This indicates hope based buying.

The confidence showed by bulls is welcome. If the news from China gets worrisome, it means that many more frightened bulls will seek exits from their long positions.

This is called a crowded exit. There is no certainty of that happening yet. But we have no control over the news emerging from China.

Take a look at the volumes chart below. These are individual stocks and index futures volumes. They are cumulative figures of the Sept + Oct + Nov series.

One thing is immediately obvious in this chart. The index futures turnover hit a period high, and stock futures turnover hit its highest after 26 August 2021.

What bothers me is the fact that Friday was a reversal day in our markets. Indices hit a high and simply crumbled under the weight of selling. The fact that the selling was this heavy should be a cause for concern.

This leads me to believe that our focus should be on capital preservation rather than aggressive fresh buying.

Let us look at the Nifty daily chart.

The first two sessions of the week were subdued along expected lines, as I mentioned at the beginning of this piece.

The next two sessions were bullish on news of sops provided by the government. The final session saw the markets turn on a dime.

Unfortunately for the bulls, this red (bearish) candle happens to be the most prominent candle of the week. That is the number of points (rupees) covered intraday. As we saw from the volumes chart earlier, the turnover spiked sharply too.

While it’s definitely a cause for concern for the bulls, things can change if the Nifty trades consistently above this candle’s high at 17,793.

That will indicate that the bulls are back in the driver’s seat and our markets are unfazed by the Chinese markets.

On the flip side, the low of this candle at 17,537 is a litmus test for the bulls. They must not allow the Nifty to close below this threshold, or else fresh downsides may open up. So, all in all, I would keep a wary eye on China.

Your call to action – Trade light and enforce stop losses on your longs extra diligently. Focus on capital preservation as a priority. Profits can follow later.

Have a profitable week!

Vijay L Bhambwani is the Head of Research - Behavioural Technical Analysis, Equitymaster.

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