Why you should avoid financial stocks in this bear market ?

Nifty took support around 7500 and has bounced back to 9000 levels. One sector which clearly shows leadership is pharma. You can read my post here. 

As Warren Buffet mentions, there are 2 main rules one should follow in stock market:

Rule 1: Never lose money
Rule 2: Never forget Rule #1

So I think it is also very important to identify the sector which we should stay away from. Why ? Because thats where maximum pain would be and even with the recovery chances of making money in near term are less.That sector is Financials.

Financials had weightage of ~37% in Nifty which shows huge ownership. They were the leaders of bull market and have shown meteoric rise for more than 10 years. And now with a major fall, its likely that there will be a sector rotation i.e. money will move out of this secotr into other sector. There is an old adage that "Leader of previous bull market rarely come back". This is because due to sudden collapse in prices, there are many investors who are left holding these stocks just to get out at break even prices. During each rally, there are such sellers who get out creating pressure on prices. Also there are bottom fishers who play for a bounce and at each bounce they create additional selling pressure due to profit booking. 

Currently the maximum pain that will be felt due to lockdown is in financials as there will be large number of defaults that are looming.

Now most of these stocks are exhibiting what we can call a bearish pennant or a bearish flag pattern. You can read about it here.

Lets try to understand the psychology about why this pattern is formed and the resultant move. Read below post from the link I've mentioned.

Psychology behind bearish pennant formation

Thus this is a reason why leader of previous bull market rarely forms a new trend.

Now lets look at charts of some of these stocks where you will clearly understand the weakness and how almost all of them are exhibiting bearish pennant formation signalling significant downside ahead. Key is to look at the slope of the lower trendline. This indicates whether there has been any bounce with Nifty rallying 20% from lows. Lower the slope, weaker the stock is. 

Bank Nifty

Major reason why Nifty today is at 9000 and not 10000 is because of Bank Nifty. It has fallen the hardest and as can be seen in the chart is not even retracing 38% of the entire fall. Thats a major sign of weakness.

Bajaj Finance

Bajaj Finance was the leader of the pack and has fallen from 4800 to 2100 ! During last 1 month's upmove in Nifty, it has hovered around this level and has touched the lower base 6 times. Each time is rebounded except today viz. 21st Apr and it closed around days low ! 1900-2100 is a major support for Bajaj Finance and with its break it will be a major fall ahead for the stock.

Kotak Bank

Same story here, breaking down from a rising wedge.

IndusInd Bank

RBL Bank

IndusInd and RBL Bank have been weakest of the lot. They have corrected significantly in wave 1 itself. 

Many of the funds and PMS have been hiding behind financials which helped them achieve strong performance. And with that hiding place crumbling, it will lead to more redemption pressure on these funds thereby leading to more selling of these financials thus creating a spiral. Interesting times ahead.

Will Pharma lead the next bull run ?

From stock market participants, currently there are 2 million dollar questions:

1. Where will the market bottom ?
2. Which sector will be leader of next bull run ?

I have already covered the first one in my earlier blog post. You can read the same here.

Now lets try to find out the leader of next bull market. What are few traits which one can look at while identifying a leader ?

1. Sector should be under owned
2. Price action should display leadership

Lot many try to focus on fundamentals which at bottom will always be negative. Always remember: "Price follows first, reasons follow later"

Looking at these traits, one sector which seems poised for a bull run is Pharma sector.

Let us try to analyze the reasons one by one:

CNX Pharma index: This is the sector index for Pharma. Look at the weekly chart. This sector was in a bull run since 2009 and topped out in 2015. Since then it has been in a bear market for 5 years and has seen multiple rallies only to make a new low each time. This is a typical Lower High Lower Low pattern exhibited in a bear market. What does it do ? Each time folks see a rally, they try to get expecting resumption of a bull market only to be disappointed each time. What happens when such an event plays out over 5 years period ? People get fed up. This leads to under ownership of the sector. You would hardly see new funds being launched by AMC's which also signify that there is serious lack of interest. Nifty pharma weightage in Nifty is 2% compared to 36% for Financials !! This all points out to under ownership of the sector.

CNX Pharma

Look at how the price has been correcting below this sloping trendline. A close above this line will also lead to break in Lower high Lower low pattern thus indicating end of bear market. Currently entire world is focusing on de-risking from China and Indian pharma would be a major beneficiary of this move.

Now whenever a sector which has seen a bear market for 5 years starts rising, one thing we see is the old leader get selling pressure a higher levels. Why ? There are many so called long term investors who are stuck at higher levels and are holding these stocks waiting for a day they can get out once their investment breaks even (they hate getting out at a loss without realizing that they have faced huge losses on account of opportunity cost) . Due to this there is a strong possibility of new leader emerging in this sector and old leader under-performing. How do I know ? Well the price actions is saying so.

How do you identify leadership ? Best way in my opinion is to look at stocks which don't significantly correct in bear market and lead the charge during bounce back.

Few leader below looking at price action. (comments are present on chart)

Torrent Pharma

Biocon

Divis

IPCA Labs

Granules

Now lets look at some of the old leader and you can see why chances of these giving multibagger returns are less. Of the lot I find Dr Reddys to be the strongest which has clearly bottomed out. The other are yet to establish a clear trend

Dr Reddy's

Sun Pharma

Cadila

Cipla

I think the key to make money here is to look at how these stocks react when the market corrects again and when there is a rebound. For those who don't want to be stock specific, buying a pharma fund or a basket of above stocks is also a good idea.

Disclosure: I am not a SEBI registered investment advisor. The content in this blog are academic in nature, please consult your investment advisor before taking any investment decision; I may have position in stocks discussed on the blog

Where will Nifty form a bottom ?

There is no doubt that we are in a bear market. What have we learnt from it ? "The only thing that we learn from history is that we never learn from history."

I hope you read my previous blogpost as to why 10,000 - 10,200 was a very important level on Nifty & with it being broken, one should have moved significantly to cash. This level was 200 weekly moving average which has been broken only once in last 17 years which was in 2008. So without any doubt we are into something like 2008 or far worse than that.Market has been literally butchered. Portfolio's are down 40-50% for many investors. And this is after a severe bear market in small caps for last 2 years

Psychologically there are 3 phases of a bear market:

Phase 1: During 1st bounce, we feel that worst is over and we can do bargain hunting 
Phase 2: Bloody hell. This is worse than I could have thought of !
Phase 3: I'm getting out of this market.

Phase 3 is where a bottom is formed !
Psychology plays a very important role in bear markets since as you deploy your capital, you may see your portfolio down by 20% the very next day !

Now the million dollar question is: where will the market bottom ?

As it is rightly said that, 'Tops and bottoms are made in hindsight'. So does this mean we would never know where the bottom would be ? Thats simply incorrect. We can certainly find patterns which have worked in past. Why ? Because even though history may not repeat itself, but it does rhyme. 

I have laid down few findings from previous bear markets (India as well as globally). 

Multiple bear market rallies
Bear markets generally never bottom in a single go. Nifty in 2008 saw 7 major rebounds. So don't go in all at the first temporary bottom. Market usually bounces back to get in more suckers to buy the rally & kills them with a brutal drop which follows. This is also the A-B-C pattern which I have mentioned in my previous blogpost. 
Bull market tops are made in minutes while bear market bottoms take days to form

Multiple rallies in a bear market

Nifty 8-12 p/e for bottoming out
Nifty in past has bottomed out between 8-12 p/e. With current EPS of around 525, that level comes to around 4200-6300

Technical patterns to signal that bottom is near

Fall in VIX: 
VIX is the volatility index or commonly known as fear index. Higher the VIX, higher the volatility. This is the sole reason we are seeing daily moves of more than 5% on the index. VIX always shoots up during bear markets & cools off during bull markets. So this is the first major signal of a bottom being nearby

Volatility Index

Reduction in trading range: Average daily trading range increases a lot during bear markets. Why ? Its because of VIX! Higher the VIX, higher the trading range, as VIX starts cooling off, watch out for reduction in trading range. Currently Nifty has an average trading range of 500 points. This trading range normalizes as bottom is being formed

These 2 are initial signals which you can look out for a confirmation of bottoming process.

Bottom confirmation using charts

Looking back at the bottoms which have been formed in history after a major bear market, below are few repetitive patterns identified. This is something which I've assimilated by reading various books & articles on internet pertaining to bear market. One should strictly use daily charts for this

• Wait for a long tail candle where the market closes above days low. This low is a new low in the bear market. The close is generally significantly above days low & is a rally attempt by the market. Lets call it day 1 low
• In the following days, market doesn't break the low made on day 1. It might test this bottom thereby making a double bottom, but doesn't break it
• Coming to the most important part. There will be a follow through day wherein market rises 2% or more. This follow through day should ideally happen after 3 days or more from Day 1 (this though is not a stringent condition, just signifies that the markets are respecting the bottom formed for a week or so)
• The follow through day bottom is an important level. Post the initial rally (wave 1) after the follow through day, market may come back to test this low (wave 2). Market may go below this low but closes above the low level & rallies back with another follow through day giving a confirmation of a bottom in place
• This follow through day may be a false attempt and market may go on to make new lows which signifies that the bottom is not in place

Have a look at charts below which exhibit these patterns for all major bottoms formed in past few decades. 

Dow Jones - 1987 bottom

Dow Jones - 2003 bottom

Dow Jones - 2009 bottom

Nifty - 1997 bottom

Nifty - 2003 bottom

Nifty - 2009 bottom

After looking at charts, do revisit the conditions which i've listed above. Bear market bottoms don't happen without a follow through day !

Fibonacci retracement

Though its futile to predict the accurate levels, we can try to identify some range. If we see 2008 bear market, Nifty retraced 78% of previous bull market rise. This range on Nifty will be between 4700 - 6400. In my earlier post I'd covered why 6300 is an important level on Nifty. Do check that here

Nifty - Fibonacci retracement 

So to summarize, one can look at bottom being formed anywhere between 4700 - 6400. (using Fibonacci retracement & historic p/e ratio).
But how will you get a confirmation that the bottom is in place ? Boss, you just read it sometime back ! 

Be on lookout for VIX cooling off & a 'Follow Through Day'

The 2020 'Corona virus' stock market crash !

2020 will certainly go down in market history as one of the most volatile years from stock market perspective. Never did anyone dream of a 30% drop in frontline index like Dow Jones in a matter of 2-3 weeks. To get a perspective of the severity of decline, have a look at the below chart which shows all the declines > 20% which Dow Jones has had.
Dark pink is 2020 fall which has been the steepest. Algorithmic trading is causing havoc & things get sold off in matter of seconds.

Dow Jones draw down > 20%

In my previous blogpost I had mentioned that get used to see days of 4-5% index moves.. reason has been increased volatility. But one thing that I never thought is for Nifty to break 10,000 so easily. This was 200 weekly moving average which has been broken only once since 2003. viz. in 2008. It went off like a flash !!

Lesson learnt: When it's a bear market, supports hardly matter. 

The volatility was so high and can be seen from below daily moves in S&P 500.

9th Mar -7.6%
10th Mar +4.9%
11th Mar -4.9%
12th Mar -9.5%
13th Mar +9.3%

Friday, 13th March was an unprecedented day in Indian markets. After being 9% down on 12th Mar, Nifty opened gap down and hit lower circuit of 10% at 8555. Trading was halted for 45 mins. This has happened only thrice. 2003, 2008 and now 2020. So all those who saw it live, congrats, you have witnessed history being created in front of your eyes. It was panic selling with many stocks large caps as well down 10-20% with very low volumes. e.g. Kotak Bank down 20% with only 50 cr turnover.

After trading opened, index recovered and closed around 9950 levels. Imagine a 16% swing on Nifty in a day !

Why is this happening ?

Corona virus will have a profound impact on world economy. There are shutdowns and it will give a big jolt to the consumption. Imagine malls, multiplex, restaurants are closed. Tourism has come to a halt (not even a slowdown). Worldwide markets are factoring this and falling like house of cards. There is asset liquidation worldwide which hasn't happened since 2008 ! That is one reason, market didn't bother about 10,000 level on Nifty.

Equities, Gold Silver, Bitcoin, Oil, Treasury 10Y.. everything is correcting like world is coming to and end. See the chart below. Market simply ignored the stimulus given by FED of USD 1.5 trillion. 

Asset wide liquidation

Corona virus has been spreading like crazy if not contained initially. See the chart below.

Exponential growth of Corona virus

Now biggest challenge is that US and European countries are not taking lessons from China and are not shutting down immediately. e.g. When Italy took a decision to shut down, infection had already spread a lot and it spreads exponentially if not contained.

Will we have a V shaped recovery when Corona goes away ?

There is another school of thought that says that this is temporary. I really hope it is temporary because like everyone, I'm also worried about my near and dear ones. But the argument that there will be a V shaped recovery looks bleak. Imagine what effect the shutdowns will have on businesses. Sectors like Aviation, Tourism will be the ones to get hit first. There will be bankruptcies. Yes, you heard it right. There will be. Operating leverage works in reverse direction as well.

See this article with the first airline on track to go down. Norwegian Airlines
Quote from the article. The airline’s CEO, Jacob Schram, did not disclose the amount that is being sought from Norway, but has said that the airline requires help “within weeks, not months.”

Also once the momentum of consumption is slowed down, it does take time to get it back in track. Remember Bird flu ? Even after it had vanished, it took time for folks to get back to consuming poultry products. Why ? It's because of fear. Even if the rate of infection comes down a lot, still we won't see people roaming on streets freely. There will always be an element of fear in their minds to go into crowded areas. Also these bankruptcies will cause job losses, so there will be a spiraling impact on the consumption.

As a market participant what should be the course of action. ?

Needless to say, we are already in a bear market. Now looking in hindsight, probably some sign were visible that we were at the top. But unfortunately these look like regular things when bull market is ongoing. Many including me are surprised at the speed of the fall. But if I look back at the charts of 2008, it looks pretty similar. 

Nifty 2008 fall: (using weekly charts)
7th Jan 2008 - 6337 to 21 Jan - 4420. A fall of 30% in straight line.It then bounced back to 5560 on 1st Feb. A 25% rally from base ( 60% retracement of earlier fall)

Now many chartists including me will come up as to why 8885 was the perfect support for Nifty. But that's all in hindsight. When Nifty was falling like pack of cards, no one had an idea as to where this will stop !

Now bear markets generally move in a downward A-B-C pattern. The current fall (4000 points on Nifty) we saw is wave A. Wave B will be the retracement of the fall and generally retraces 50-60% of the fall.. i.e. it should rise 2000-2500 from bottom of 8555 which gives us levels of 10,500-11,000 on Nifty. Post that we should come back to test bottom of 8555 and then if that breaks there will be further downside. How fast this will happen is anybody's guess. Bear market generally retrace atleast 50%-60% of the overall advance. So if we see from 2200 (bottom of 2009) till 12500 (top of 2020), we have seen an advance of roughly 10,000 points. So correction of 50-60% means we could see index levels of 6300 odd which coincidentally was also the top of 2007, 2011, 2013 & 2014. Below chart has the figures mentioned above.
In current downfall, Nifty has taken support at 38.2% Fibonacci retracement. The level around 6300 which I mentioned is 61.2% fib retracement level. Hope so we don't see it !

Fibonacci supports - Nifty

Another reason why the recent bottom of 8555 is important is captured in below chart.It is 100 moving average on monthly charts where Nifty also took support in 2008.

100 monthly average - Nifty

What is the next course of action ?
As mentioned in my previous blogpost, one thing you should have done in the current fall is to move your portfolio into stronger stocks which bounce back with each rally that the market witnesses. The current rally can be used to move to cash to a level you are comfortable with. Avoid putting in additional capital at the moment & understand that cash is also a position.Return of capital is more important than return on capital !!

When will above scenario change ?
If SPX crosses 3100 on upside & stays there for a week or so, this entire scenario will get negated and we can go on to hit new highs.

Overall we should get ready very high volatility & avoid constantly watching your portfolio on each down fall.

One thing is for sure, with so many couples working from home, there will be increase in divorce rates or there will be a baby boom around Dec 2020 !!

Disclosure: I am not a SEBI registered investment advisor. The content in this blog are academic in nature, please consult your investment advisor before taking any investment decision; I may have position in stocks discussed on the blog

What to do when stock markets crash ?

When Amazon announces 'Big Billion Day' sale we get super excited, start looking for offers and short list products which we want to buy.Stock market is a different ball game. Here people lose sleep whenever there is steep fall (Big Billion sale !!). That's because our money is invested and we see it going down in value. People feel the pain of loss twice as strongly as they feel pleasure at an equal gain. Human brain starts equating it to loss in purchasing power. e.g. If portfolio value is down by 2 lakh people think they missed out on an International holiday !
Now best thing we should do when market starts falling is to think rationally. But hey, it's human brain and it gets swayed by emotions or what we call in investing paralance as 'Behavioral bias' Corrections and bear markets are part of life of an equity investor. There isn't much you can do to avoid it. If you look at markets for last 30-40 years, we experience 10-20% decline atleast once every 12-18 months and 50% type falls happen once every 8-10 years. So if you want take advantage of these 10-20% type corrections, you need to establish a systematic process. This process driven approach helps removal of investing biases which otherwise resist you from investing rationally. Understand structure of market By structure I mean how the market has been performing over a period of 1/2/3/5 years. Why is this important ? Because if it is a bull market that is couple of years old and has started after a severe bear market, then chances of another bear market are very low. This currently is a US led bull market which has begun since 2009. So it is a 11 year old bull market. Well then a bear market might be around the corner. But thats what the experts said in 2011, 2013, 2016, 2018 & 2019 as well !!

Key levels of market

You should track key levels of market which has acted as resistance and support in past few years/months. This will ensure you don't sell of stocks after a steep correction when market are at supports or increase your exposure to stocks when market is at a significant resistance.

Currently key level for SPX 500 is around 3100. Market needs to stay above this level to rise further. Look at how the bulls & bears are fighting to stay above this level

Now lets look at Nifty charts. 

Nifty has respected 100 weekly moving average in last 3 corrections and has bottomed out around this region. This level is around 11000 currently and should act as a strong support.

Today as well Nifty fell to 10800 levels but closed around 11000 levels.

Sep 2019 tax cut was a reforming event in Indian capitalist history, something like 1991 reforms. The base formed there in my opinion is very significant.

Similar to SPX, the trendline for Nifty shows support around 10300 levels. 

And finally the big one, 200 moving average on weekly charts. 

Nifty hasn't broken 200 weekly moving average since 2008. It broke this average only once since 2003 i.e. in 2008 crash. Currently this level is around 10000 for Nifty. In my humble opinion, this level is 'Throw in the towel' level for Nifty below which the current bull market will be seriously challenged. 

So to summarize, there are multiple supports from 11000 - 10000 which Nifty should respect and one should keep them in mind while making any buy or sell decision. 

Your high conviction ideas

Suppose you have 10 stock portfolio. Out of this may be 5 are your top conviction bets where you understand the business dynamics well. i.e. you have the conviction to hold. Next 5 are ones which you have some understanding but have bought because someone you strongly follow has convinced you to buy. i.e. you have borrowed conviction.

During market panics, you should think of reducing your low conviction ideas and deploy that capital to high conviction ideas. How does that help ? This helps you stay calm knowing that the stock prices will bounce back. You can then also think of deploying new capital.

Key support levels for your portfolio stocks and identifying strong stocks

Like you should keep a note of key level of market, you should also keep a tab on key levels for your portfolio stocks. Why ? Because all stocks don't bottom at the same point in time. So knowing key levels supports (trend line, moving average, etc.) for your stock does help a lot. This is something I had covered in my earlier post, you can read it here.

Periods of draw-down are very difficult if you are not able to detach your emotions. Process driven approach is something will always help you rather than acting according to your gut feeling. Don't be afraid of taking a loss if your process says so, because human mind is always loss averse & it makes one sell the winners & hold onto the losers.

And last but not least, don't panic due to volatility. Market climbs up using stairs and comes down using an elevator. Get used to days with Index falling 3-5%

Disclosure: I am not a SEBI registered investment advisor. The content in this blog are academic in nature, please consult your investment advisor before taking any investment decision; I may have position in stocks discussed on the blog

Which stocks to buy during 'Corona-virus' market correction ?

Worldwide markets are panicking, Dow Jones is down 15%.
The reason is well known - Corona virus. There is fear that world wide growth will slow down. 
Now when there is a market panic, there is very less rational thinking & usually its basket selling which takes everything down with it. Don't believe me ?

Sales of Corona Beer (#3 beer brand world-wide) have dropped even when it has nothing to do with Corona virus ! Have a look below

We would feel like laughing at this absurd behavior, but hey its our hard owned money that is getting wiped out due to this collapse.

Now the common question that each market participant gets is:

1. Should we buy more stocks ?
2. Should we sell & salvage whatever capital is left
3. Should we ignore the on-going correction & stay put ?

I belong to the school which thinks 'Never waste a market correction'. Reasons ?

1. Agreed that there will be disruption in supply chain due to China & few other major countries shutting down but there have been confirmed reports that shipments are getting back on track.
2. Though the growth will slow down, it should be temporary & we should see a V shaped recovery
3. Central banks world-wide will infuse more liquidity (which has been fueling this current bull market); there is a coordinated interest rate reduction coming up by global central banks along with a surprise asset repurchase programme.
4. Trump can't afford a big negative year for markets when election are due within 8 months (since his appointment, US markets have given excellent returns and he won't give up when he is so near to the elections )

But then the biggest mistake that fellow investors make is that they buy the most beaten down stocks assuming that they will recover the most. This thesis generally goes for a toss since at each bounce that these stocks see, there are sellers who want to liquidate at their cost price & get out. This puts pressure on rising stocks.

The principle to follow here is: 'Buy those stocks who have stood firm in this steep correction. They are the ones who lead the next rally'.

To understand what I mean by stability, first look at this chart of Nifty & see the severity of correction

Nifty

Nifty is down 10% which is very big for a front-line index

I have identified few stocks (this is purely for educational purpose & to check the validity of this thesis) which have stood tall in this correction & are fundamentally strong as well. Remember this, never venture into stocks which are not backed by good earnings growth. These are like pack of cards and go into free fall on slightest of external push.

Midhani

This stock has actually bucked the trend and increased in price; surprised ? Thats called strength.

AU Small Finance Bank

Solid as rock. Thats stability

Divis Lab

One of the beneficiary of China shutting down as it backwards integrated

Metropolis

More patients will opt for diagnostic tests ? May be, but the stock is standing tall.

Another strategy which can be adopted is to buy stocks which are at long term supports and have been giving good earnings. Few of the stocks belonging to this category are:

Info Edge (Naukri)

200 DMA has acted as support, will it work this time as well ?

Bajaj Finance

Credit access

Solara Active Pharma

It will be biggest beneficiary of Corona virus shutdown due to its API portoflio

I am not saying this is an exhaustive list; but this is an important filtering criteria. It has worked in past & good chance it will work now as well.

Another important thing to understand is that you may not have sufficient cash to deploy here. In that case the strategy to be followed is to 'Sell the losers and buy the winners'
People usually do the opposite by cutting the flowers and watering weeds. 
Identify the worst hit stocks from your portfolio, reduce them & add to your strongest ones. 

Stocks which are withstanding this correction are doing it for a reason, respect the price action & take advantage of it.

Disclosure: I am not a SEBI registered investment advisor. The content in this blog are academic in nature, please consult your investment advisor before taking any investment decision; I may have position in stocks discussed on the blog