Though unintended, Reforms have weakened National political parties
B S Yeddyurappa, former Chief Minister of Karnataka, is eager to return to his former post, which he was forced to vacate after the State Lokayukta held him responsible for corrupt practices relating to allocation of plots to his family members. Karnataka saw a scam in illegal iron ore mining under his rule. Despite being so obviously tainted, Yeddyurappa not only continues to command the support of a sizable number of MLAs in the BJP from Karnataka, but also is able to threaten the BJP High Command in Delhi with revolt if he is not reinstated. Earlier, we have seen a whole host of Congress leaders like Mamata Banerjee, Sharad Pawar, etc. walk out of the Congress Party to set up their own regional outfits. What enables a politician like Yeddyurappa to defy the party’s central leadership with impunity?
Yeddyurappa is not the exception but part of an overall fissiparous trend where power is shifting from the Central leadership of political parties to the States. This is obvious when you consider how various States have been able to hold up implementation of central legislation in areas like the GST, FDI in Retail, NCTC, etc. Indeed, TMC and DMK have even been able to scuttle or modify foreign policy initiatives of the Center with neighboring countries. The trend has been brushed aside as either the inevitable result of a weak coalition government at the Center or an affirmation of India’s federalism. Were it so, there would be no cause for undue worry. However, Yeddyurappa’s easy defiance of BJP High Command, despite being in the dock on corruption charges, points to much deeper forces at work in shaping our polity than mere regionalism or federalism. It is time to dig deeper into the phenomenon.
India may have been a cultural unity for thousands of years but it was never a political unity. Instead, it was a political patchwork of small regional satrapies of varying hues and quality living together in uneasy coexistence. Prior to the British rule in India, we had no experience of a strong central government, common currency, central army funded by nation wide taxes, and a national market for goods, services and finance. If culture and religion transcended the fragmented political principalities, it was despite them, not because of them. Their mutual wars and jealousies kept India divided with disastrous consequences for the region as a whole. Therefore, it well to bear in mind that the nation wide political union that our generation of Indians takes for granted, is a very recent phenomenon in our long history. There is no natural constituency to protect and preserve Delhi’s power over the Union above and beyond the Union Government itself.
Back in the days of our dalliance with socialism and the dogma of central planning, every little economic and political initiative came out of the womb of a faceless central bureaucracy. In many areas, untouched by reforms, it is still so. What gave the Union its power over the States was our system of taxes wherein about 70% of the taxes are collected directly by the Union and then devolved to the States by a formula devised by a Finance Commission every five years. This enables the Union to maintain an army, pay for a large central police force and to dictate the developmental programs that States adopt. Reforms have not changed the formal system by which the Union exerts its influence on the States. However, parallel to the formal structure, was a less formal way of political control over regional leaders followed by mainstream political parties.
The Congress party has an organizational structure that closely mirrors the formal State structure with a central leadership led by its President, aided and assisted by a Working Committee that looks suspiciously like the Union Cabinet and has many common members. At the State level, the party is similarly constituted state wise right up to the District level. A group of States are “looked after” by General Secretaries at the center, who report to the President. These General Secretaries are often former Chief Ministers from different States. In theory, the Party High Command exercises tight control on who is the Chief Minister in the State, who gets into his/her cabinet and the clutch of policies the State follows. BJP closely mirrors the Congress party structure functionally but with a different nomenclature.
In many ways the formal, legal structure for Union’s control over the States cannot work without the political party structure through which the Chief Minister and his/her cabinet colleagues are appointed. In fact, in normal times, it is the political structure that overrides the formal Union. And Yeddyurappa’s defiance of BJP high command, or the walking out of Congress by Mamata Banerjee to form her own TMC, like many others before her, must be understood more as part of the changing political dynamic following reforms.
Political parties are hungry cash machines with very little income. Money drives everything in a political party, from publicity expenses, staff salaries, and office bills to the fortunes needed to fight elections. Not surprisingly, he who pays the piper calls the tune. While all politicians and parties prefer to obscure this evident fact, we need to examine its influence on the polity in some detail. Needless to say, all political parties are guilty on this score. We should not miss the woods for the partisan trees. Absent a viable legal source of funding, all political parties raise monies through rent extraction from businesses using government controls, favors and assets. Public donations are a fiction.
Prior to reforms, under the license permit raj, businesses needed a license or government favor to expand, import a raw material, or to manipulate markets through changes in excise duties, import duties, or even raid a rival for tax evasion. Rent extraction under such a scheme was easy. Corruption was pervasive leaving nothing untouched. Rents were key to profits. Funds were raised by trading favors with businesses. Since most of the favors were in the power of central government to give or withhold, fund collection was centralized. Money flowed to the Party High Command from where it was distributed to regional leaders when required. Under this system, revolt against the central leadership of a political party, though not unknown, was rare. To revolt or defy meant certain banishment into arid wilderness without money.
With dismantling of the license permit raj, a whole system for corruption and rent extraction vanished. New sources had to be devised. Lacking other devises, these have been found in sale of government held assets like spectrum, mines or land. The shenanigans in this area are in the press daily. But what should concern us are two things. Firstly, in mining as in land, the control of assets is squarely with the State Government or the local Chief Minister. So rent extraction now happens at the State or the Regional level rather than the central level as before. Secondly, if the political party that is in power at the State but not the Center has a defiant Chief Minister on its hands, it has no coercive power to put down the revolt. That is BJP’s predicament regarding Yeddyurappa. In both, BJP and Congress, the center depends on the States to raise funding. If the loss of control by the central leaders on Congress party apparaus is not so stark, the reason owes more to brand equity of the Gandhi name as a vote getter within the Congress. Over time even that will attenuate.
Devolution of formal powers, as envisaged in the Constitution, should be carefully distinguished from the breakdown in political control of regional leaders within political parties. The two are different and distinct issues. We need more formal power delegated to State, cities and municipalities, not less. We need some 500 new cities which are self managed to cope with urbanization. But along with that we need strong national level political parties. Necessary reforms for these are urgent and obvious. Firstly, we must mandate open, transparent, independently conducted, intra-party organizational elections through the Election Commission. That will ensure a measure of inner-party democracy that parties sorely lack in order to reconcile internal differences. Secondly, we need to grasp the nettle of political funding. That cannot be delayed any longer. We are but one step away from mafia rule in some states because corruption has ceased to be an issue that turns off voters. Yeddyurappa demonstrates that phenomenon. Note that the Union Government is no more than a mute bystander in the Karnataka imbroglio despite its implications for the country’s governance. Given our long and disastrous history of regional satrapies to allow central institutions to weaken further would be playing with fire. This is one unintended consequence of reforms that we need to address urgently.
MARKET NOTES: Toppish US markets yet to confirm a downtrend
Spot Gold: Having failed to pierce through the $1800 overhead resistance on 28th February, gold has been in a steady down trend after the initial collapse in price on 29th February. It is currently positioned at $1662. Gold is approaching “crunch time” as far as alternative wave counts go. Going by the one that I have been using to track the price action, gold should continue in a downtrend until the middle of April at least with $1550 being the target price. Should it get there, gold will have signaled a fairly long bearish trend.
NYMEX Crude: After having touched at intra-day high of $110.55 on 3rd March, Crude has been flattish but in a mild down trend and currently stands at $105.16.
Since the last significant bottom at $32.4 in December 2008, Crude has closely tracked equity markets. The wave count from the low of December 2008 suggests that crude is not yet done with its way up and could make a new high by the middle of April, and the target for the high would be $115 or higher.
It would highly surprising to see a wave 5 failure in crude. It would be even more surprising if crude did not overshoot its target much like the US equities have done. Not bearish on crude in the near term.
10 Year US Treasuries: 10 year Treasury notes hit a high of 132.367 on 31st January this year and have been on the downtrend in terms of prices as yields demanded in the market to hold them have gone up. They currently stand at 129 implying a yield of 2.24%.
The downtrend should test the price level of 127.5 in the coming weeks. The price action around that level will reveal to if the interest rate cycle has finally turned up. Should the support level be taken out decisively, the entire dynamics of the financial markets will under go a systemic change. It is a crucial gauge to watch in the coming weeks.
Spot Silver: Silver triggered a death cross on 21st March 2012 at price level of $33.26. It currently stands at $32.18. Barring the regular reactive pullbacks, there is nothing bullish on the charts for Silver. The metal is headed for a first target of $30 followed by an even lower target of $26. It has time until the middle of June to get there. Silver could collapse faster than gold.
NYSE Composite: Taking up this composite index because it is one of those that are largely ignored by traders. Also it happens to be one of the more difficult to “manage”. At market turning points it can reveal more information that market makers tend to do their best to obscure in the more widely followed indices.
Note the index made little effort to make a new high in relation to the peak at 8678 it made on 29th April 2011. All other narrower indices such as DJIA and S&P 500 have done so. Going by the wave counts, NYA is done its rallying and is now headed south. It is too early to predict what shape the correction will take. That will be known only in the coming few weeks.
S&P 500: Is the S&P 500 done it’s rallying from 669 to 1412.66? As noted in this blog over the last few weeks, this rally proved itself after having achieved a target of 1350. Anything after that is really a function of shorts trapped in the market and that’s impossible to predict. All one can say is that the process of top formation is currently underway. It could take time. But the upside to the market from these levels is definitely very limited and not worth the risk chasing it. Too early to say how the correction will play out. Investors should take profits and traders should stay out till the market confirms a downturn. Early bears are easy meat.
Shanghai Composite: The Chinese index nicked 2350 levels on Friday closing at 2349.5. The nick is not significant yet but raises a cautionary flag for my bullish wave count. A violation of 2320 would actually invalidate my wave count making it necessary to go back to the drawing boards. So stop loss set for 2315, which still yields a decent profit from the lows of 2110. Having said that, the fall to 2350 was expected as a reactive move and the nick itself is insignificant. So the next week or two will indicate the way forward from here.
$-Index: $-Index made a high of 80.78 on 15th March and is now on the way down. It currently stands at 79.8960. I think the move down is reactive. Should the $-Index make a higher low than 78.15 in this reaction before moving up, it will confirm an intermediate uptrend whose target is 82. Such a rally in the $-Index is consistent with a fall in US equities where a sell off usually triggers a rush into Dollars by overseas investors.
Euro-$: The Euro-$ is currently positioned at 1.32710. It is in a near uptrend with a target of 1.35. Can’t say when it will get there. Interesting that Euro and $-Index are both moving up. If so what’s going to depreciate in the currency world? An interesting conundrum is coming up for currency traders.
S-INR: As anticipated in the last blog post, the $ pierced through the 51 mark on Thursday. A small reaction from there came nowhere near the top of 51. That could be tested again. The direction of the $ against INR is a no brainer. The next target for the $ is 52. I expect May/June will test the previous top. Watch out for RBI intervention, which could moderate the rise, though will not change the direction.
Sensex: Sensex nicked its 200 DMA at 17,200 on 22nd March, closing below it at 17,196.47. However it pulled back the very next day to close at 17,361. Mind, Friday was an inside day so the pullback was likely reactive in nature. The more critical level for the Sensex’s future behavior lies lower at 17,000. It could bounce from there if it intends a rather tame correction. A dip below that level will indicate a much higher degree of volatility in the ensuing correction. Either way, barring regular pullbacks, the correction itself will continue. Watch the price action at 17,000 closely for clues.
NB: These notes are just personal musings on the world market trends as a sort of reminder to me on what I thought of them at a particular point in time. They are not predictions and none should rely on them for any investment decisions.
Budget 2012: Rearranging chairs on the Titanic deck
Budget making in India can never be routine though one hopes we will get to that Nirvana some day. The world is still in an unprecedented economic crisis. US have just come out of one of its deepest recessions. EU has been barely able to keep its currency together. Its climb out of a recession could take longer. China next door has piled on 100% of its GDP has bank debt to keep its economy growing through the last 3 years. It needs to slow down to trim its huge internal debt. It will see a once in 10 years regime change next year that has humongous implications for us. Peak oil, the crisis over Iran’s nukes, oil sanctions, etc. adds to the sense of multiple challenges we face. Government response to these challenges is something that must find a reflection in its priorities and budgets.
At home the litany of problems we face are legion. There is a global crisis in food. Food prices have tripled over the last decade and will at least double again over the next 5 years. To an economy like India, that is both a challenge to feeds its billions, and an opportunity to bring into play our vast reserves of unskilled labor and semi-arid lands. We produce virtually no oil while running one of the most oil intensive economies in the world. As oil prices trend towards their peak, and they could reach as much as $200 a barrel in the next 3 to 5 years, we need to figure out ways to adjust to them. Our population, never mind glib talk about demographic dividends, is simply too high & growing too fast, in relation to critical resources such as fresh water and sustainable energy. Add to that, we have a thicket of internal constraints ranging from under governance and dysfunctional politics, to the legacy of our socialist past that prevent us from truly earning our way in this world.
The idea that the Earth’s resources are finite, and that we as a nation have to compete with others for them, has simply not registered either with our people or politicians. This competition for resources is no longer by war. In the modern world this competition is primarily through trade and economic competition. Simply put, if you wish to live well, you should produce something that others value. Instead we meander thru life on the vague presumption that the world, like our own Mai-Bap-Sarkar, owes us a living. That is simply not true. As the world grows from 6.5 to 9 billion people, we have to be able to compete economically with the rest of the world. In fact we need excel it by a fair margin in order to better our living standards. Point is, we may not even be secure unless we are able to step up our economic act to provide for the money needed to protect ourselves and secure our access to critical resources. The competition is going to get fierce.
So as we look at the budget, keep the above broad resource picture in mind to assess if the Government has a broad plan of action that will enhance our ability to compete successfully with others for markets and resources. The key to survival in this world, as any school student knows, is [a] how well you compete with others that include friends and foes and [b] how well you plug into the ecosystem of the world around you. That reality is no different for nations and its people. The effectiveness with which you enable your people and businesses to compete is the key to survival as a prosperous society. Anything else is really irrelevant. How does the budget address the task of making us competitive in the emerging world?
Obviously the budget cannot address all the problems at one go. They have to be addressed one by one. To illustrate why the budget is not part of a cohesive and cogent plan lets us take a look at just two or three emerging problems – food and oil and infrastructure – because they represent a threat that can be converted into an opportunity.
An UN report projects food prices will at least double over the next 5 years after having tripled over the last 10 years. The reasons are demographic and emerging resource constraints of arable land and fresh water. The crunch is worldwide. We have 3 things going for us. Vast reservoir of rural labor, vast tracts of sparsely rain fed land that is not currently used for cultivation and a technology base to turn these semi-arable lands into viable farms for producing crops like corn [maize] soybean and other coarse grains that we no longer eat but are used abroad to feed live stock. Putting together a plan for cultivation of such crops and their export to China, the world’s largest importer of food, is not rocket science. We have the experience in Soya. What is required is elimination of dysfunctional rules and laws – land ownership, land acquisition for farming in the corporate sector, lease of land, farmer shareholding in agro-corporations – that enable these businesses to come up.
One is not asking for subsidies, technical knowhow, easy loans – nothing. Just the minimum legal and regulatory framework required for enabling these businesses needs to be put in place. All capital and investment can come from the private sector. Mark this does not requite funds from the budget. It only requires intellectual and political capital. Intellectual capital is required to see how the existing rules can accommodate the new business model & political capital to sell the scheme to farmers. With minimal budgetary support government can [a] spur agriculture development in semi-arid areas and [b] cut down the need for doles to rural poor. Now look at the budget to see what it indicates in this strategic area. It is zilch.
Lets get to oil. We import 75% of our oil needs. This isn’t going to change. Over the last 10 years oil has moved from $40 to $100 and in the next 10 years, if not earlier, it will hit $200 even if shale gas proves out. Clearly two things are necessary. [a] We have to cut down the need to for oil by looking at alternatives and [b] where oil use is inevitable, the efficiency with which we use it must improve. What do you see instead?
Firstly, Government doesn’t recover the full cost of imported oil from consumers and instead begs, borrows and steals, to subsidize its price. That actually promotes inefficiency and distorts everything from cost of private versus public transport to alternatives between oil fired power generation and solar cells. Secondly, what’s government doing, say in solar energy? Look at China next door. Faced with the same problem China has poured billions of Government money to promote research & development in solar panels. 5 years later they have the world’s cheapest solar cells and at prices where the power generated can compete with gas fired power plants, though not coal. Everywhere such strategic investment is driven by Government and then exploited by the private sector. We reverse the process here. The government wants private sector to pour research dollars into such things as solar panels, and if something does fructify, it will be there with a whole regulatory framework to siphon off the profits in the name of preventing profiteering. How can local businesses compete with those from China? Does the budget offer anything to say government is alive to this vital structural problem?
Whether it is FDI in retail, which is nothing but stimulating more completion in the whole sale distribution system to break cartels, or reforms needed in say transportation system, the same lack of strategic thinking manifest itself. Let us just take an example of out of box thinking – say in infrastructure like roads, ports and power plants.
We need massive investments in infrastructure. And the Chinese need massive export orders as their local business dries up and exports to US & EU drop. Chinese have $3 trillion of reserves, which they are desperate to spend just to preserve their real value. What prevents us from drawing up a plan to invite Chinese investment in our roads, railways and ports? We burn with resentment as the Chinese build roads, railways and ports in our neighboring countries all the while whining about encirclement and the like. Chinese firms are as much driven by profits as any other. Their billionaires control the Chinese politicians in much the same way as our tycoons control ours. Chinese would be happy to build the infrastructure for us and we should be smart enough to invite them to. What if there is a war? Well in a war the Chinese can’t carry away our roads, or railway lines or ports nor will we let them shut down power plants. In fact the best way to prevent war is to hug China tightly in a strategic clasp where they can’t think of a war. Be that as it may, the point is are we thinking? Is the Government thinking? Do we see those plans in the budget?
The budget is evidence that we have no strategic plans to successfully compete in the evolving world. If this government were running a business, the board would fire it without a second thought. This lack of a holistic strategy, and the effort to sell the strategy as absolutely necessary reforms, is disconcerting. The budget looks like the government is busy rearranging the chairs on the Titanic deck as our ship of state hurtles towards a certain wreck against icebergs that we all can see.
UPA2: Dressing up to go nowhere
The UPA2 government has been generous to a fault. Economic reforms pursued since the 90s began to yield dividends in faster economic growth. Moderate taxes lent buoyancy to tax revenues that inched up to almost 17% of GDP. For a change the Government had money to spend. Unfortunately, instead of thinking afresh on how to spur growth in a manner that drew the rural poor into the development process, government chose to go back to discredited subsidies as means of poverty alleviation. And so it was back to open ended subsidies with a vengeance. Petro-products, fertilizers, food, and programs such as MREGA, blossomed into insatiable cash hungry machines. All told, subsidies now pull in something like $40 billion from a $1.4 trillion GDP or 3% of GDP. With government revenues of $252 billion, subsidies now absorb roughly 16% of all government revenue. These subsidies yield little by way of return either to government, or to the economy, and are clearly unsustainable.
Adverse economic developments in world economy, combined with near total policy paralysis together ballooning subsidies, has led to a slow down in the economy with growth rate dropping from 10% to about 6%. Relatively, revenues have shrunk while expenses have continued to rise. And subsidies continue to grow with increased coverage and expansion of the base. As a result, the fiscal deficit has shot up from something like 4.5% of GDP to something over 6.5%. Such a high level of fiscal deficit, along with a fragile balance of payment position, has sent alarm bells ringing from Delhi to Washington. Government has therefore pulled out all stops to somehow contain the fiscal deficit to a figure closer 5%. What else can a bankrupt government do but to sell the family silver? Hence the race to sell some equity in PSUs in order book some capital receipts that can cover the revenue shortfall and help pay out the subsidies.
Fire sale of PSU equity is being touted as privatization, or at the very least, disinvestment. However, the whole idea of privatization is to shed government control in management of state enterprises so that they can be run on normal commercial principles in order to generate profits and wealth for shareholders. The fact however is that, barring a few cases; government has never shed management control in disinvested enterprises. Instead it has used disinvestment as means of raising revenues to fund government expenditure and subsidies while making cosmetic changes in the way PSUs are managed. In cases like ONGC, and OMCs, government has in fact followed some of the worst corporate governances practices that have in effect robbed their private shareholders in order to meet government revenue and other political objectives. The attempted disinvestment of ONGC, its failure to attract bids in the auction, and the subsequent sequestering of LIC’s $2.25 billion to rescue the government from the ignominy of crass failure, amply illustrates the wrong corporate governance practices that government itself imposes on its enterprises.
ONGC is actually a crown jewel. It is India’s only oil exploration company with substantial proven reserves, extensive operating experience in onshore and offshore fields, and an a track record of efficient performance with operating profits. When the PSU was first offered for disinvestment in the market, the Government swore operational autonomy to its management and non-interference in its commercial operations. More to the point, the government promised to ensure that its gas & oil would be sold at market-determined prices to OMCs. Based on these solemn promises incorporated in an offer for sale document, ONGC shares were sold to a large number of foreign institutional investors. While ONGC enjoys a measure of operational autonomy, the government never shed control over company’s strategic management. In particular, as crude prices surged in international markets, the government foolishly failed to muster the political will to pass through the price increases to consumers. Instead it sought to subsidize them by passing on 1/3rd of the subsidy to ONGC, 1/3rd to OMCs while funding the rest through the general budget as an outright subsidy. This additional burden on ONGC was nothing but a disguised tax on its profits that were properly belonged to, and in fact were promised to, ONGC shareholders. The additional tax on ONGC amounted to $3billion per annum; a value that ONGC shareholders were unfairly deprived of. Had any private promoter pulled the same breach of promise on its shareholders it would have been dragged through courts for fraud. Quite naturally, foreign investors, fully aware how they were cheated out of value by the government, refused to buy the new shares offered by the government. Once bitten twice shy. Besides the boycott was intended as clear message from markets to the government.
The Government’s use of LIC to rescue it from the ONGC fiasco is even more shameful and illustrative of how the Government misuses its control over PSU managements to further its political objective of the moment in complete disregard of the PSU’s strategic objective and obligations to other stakeholders in the enterprise. LIC is not just a financial institution. Like banks, over and above its obligations to its shareholders, LIC has a legally well-defined obligation to its policyholders to manage their investments in the most prudent manner. To help Government salvage the ONGC auction, LIC permitted the government to commandeer $2.25 billion of its funds at just a few hours notice for buying ONGC share in the auction that others had pointedly refused to take up. Every prudential norm applicable to equity investments was thrown to the winds in the process. $2.25 billion is about 50% to 75% of the net funds that LIC earmarks for deployment in equity annually. LIC knew it was effectively underwriting the government and could have demanded a discount of at least 5% to the floor price to put in such a huge bid at the last moment. No such thought crossed LIC’s mind. It blindly obeyed government orders to deploy not its capital but policyholders’ capital. Could there be a more telling lapse of fiduciary responsibility? LIC incidentally has been working without an Executive Chairman [who is its CEO] for the last 9 months. What more can you say of the shoddy example government itself sets up for other promoters to follow? It is no wonder minority shareholders are regularly taken to the cleaners by most promoter groups in India.
Will the ONGC and LIC fiasco deter the government from proceeding further to window-dress the national accounts for what it assumes are gullible domestic and foreign investors? Unfortunately the Government has a far worse scheme up its sleeve to rob the poor minority shareholders for cash rich corporates like NTPC, NHPC, LIC and banks. These captive agents of the government, supposedly blessed with autonomous managements of the ONGC and LIC kind, are being offered shares in other PSUs of their kind! Is the government pretending that NTPC & others have not already earmarked their surplus funds for investment in their own businesses? Or is it that the PSU shares on offer represent a good investment opportunity? If so why not let in the public through an auction to discover a fair price? The simple fact is that government needs money to “reduce” its fiscal deficit and finds it convenient to commandeer the cash surpluses of these rich PSUs by offering them shares in other PSU that it cannot sell in the market because there is no buyer at the price it demands.
The methods being used to window dress the fiscal deficit will fool no one, least of all foreign investors or bodies like the IMF. Instead it will result in loss of confidence in the government’s sincerity, veracity and probity – a far greater loss than the mere embarrassment of issuing a mea culpa and promising to set things right. Let us pray that wiser counsel prevails and the government will not proceed with such obvious subterfuge merely to save its face in domestic politics where it still can fool most of the people some of the time.
MARKET NOTES: The process of the top formation can be boring, and disconcerting.
In so far as the World equity markets were concerned, the past week saw most of them make new highs. Market turning points are always disconcerting for those trying to call tops and bottoms – usually a fool’s errand. Nevertheless, one has to make sense out of the markets while respecting their verdict. Markets by their nature test conviction. If they didn’t, trading would be child’s play. With that in mind let us see what the markets are trying to tell us. This time we look at the US and major EU markets because the onset of an intermediate correction in Indian markets is more or less confirmed.
CAC: THE French market looks to be the most bullish in the near term because [a] it has long under-performed its peers in the EU and [b] it never made it anywhere near to a new high in the madness that gripped other markets in the second half of 2007. Instead CAC has had an orderly correction from the high of 6950 in January 2000 to a low 2700 in November 2012. The correction, or bear market in French stocks, has spanned 12 years. My preferred wave count for CAC says the French market began the 1st leg of an impulse wave up from a low of 2485 in September 2009 and completed the leg up at 4160 in February of 2011. The fall from there to 2700 was corrective in nature and that was completed in by end of September 2011. CAC hasn’t finished it correction though. A wave II correction usually has rounded tops and two legs to the fall, the first of which is usually very sharp and the second a dilating top stretched out over time. CAC is in the second leg. Therefore, the prognosis must be that CAC could continue its rise with the next target at 3800. Can it go beyond 4160? That is possible but unlikely. Near term then CAC is bullish, in a new bull market, but it is in a wave II correction mode.
DAX: Unlike its French cousins, DAX did equal the highs of 2000 in 2007 along with the rest of the world markets. So its wave structure is more in tune with US markets than the French. Nevertheless, it is instructive to analyze it like the CAC to see what shows up. And the answer is the same as that for CAC. Namely, the correction in the German markets can be said to have begun from a top of 8130 in March of 2000 and completed its course in March of 2009. Incidentally, while not a conventional position, that view can be justified even in the case of S&P500. If that be true, the run up from March 2009 to 7600 in May 2011 was the first leg up of a new bull markets and the run down from there the first sharp leg of a Wave II correction that will stretch out in time. It could even make a new high like its American cousins. But the Wave structure leaves little doubt that [a] DAX is in a new bull market, [b] has completed the first leg up and [c] is now into an extended wave II correction that can make a new high but not for any significant length of time or very significantly higher than 7600. DAX, have broken through 7050 has a target of 7400 next. Hard to say when it will top out in terms of time or price.
FTSE: Not surprisingly, the FTSE is even closer to its Atlantic cousins than the DAX or the CAC but still manages to retain its European character. The analysis, using CAC as template is straightforward. FTSE completed its major, multiyear correction from 6960 in 2000 in March 2009. The run up from March 2009 to July 2011 is the first leg up and from there on we go into a Wave II correction that will stretch out over a fairly long period of time though a new high beyond 6100 is not ruled out. If the new high does happen, it is unlike to be significantly higher or hold for very long. The next target for FTSE is 6100.
S&P 500: Having discussed the CAC structure for the 3 indices, the case for S&P 500 should be straightforward but isn’t. S&P500 incorporates the NASDAQ that has followed an independent path since the 2000 tech bubble. It has completed its correction and has broken out after 11 years. That makes S&P500 a lot more bullish in its first leg run up that it would be in the absence of the tech stocks. Nevertheless, the run up in the S&P 500 from 668 in March 2009 to 1354 in May 2011 can be seen as the first wave of a new bull market. That puts S&P 500 in a wave II correction the first leg of which took it down to 1074. The new high since then would still fall into the pattern of a wave II correction though not in the conventional sense. But, as in the case of European markets, a high beyond the 1354-point on S&P 500 is unlikely to be sustained for long. Having broken through, it become hard to predict just when the market will turn down. Prudence however demands that one stay on the sidelines and wait to sell short till the market itself signals a convincing turn in trend. As I have stressed repeatedly while indicating a top, early bears are easy meat at market tops. So exercise caution even as one recognizes one is near a top.
Gold: Gold needs to fall below $1600 before it can show any significant bounce up. Unless Gold dips significantly below 1600 level and stays there for a while, the prospects for a bounce back in the price before July this year are rather dim.
Sensex: There is still a slim possibility that Sensex could lunge for 18,500 before the end of March in line with World markets. If it does so, the high may not last very long. Every other thing points to a fairly longish leg of correction down from 18,500 to 15,000 till the end of this year. That will tie in nicely with world markets if my prognosis holds out.
Will look at Commodities and Currencies in a separate blog post during the week.
NB: These notes are just personal musings on the world market trends as a sort of reminder to me on what I thought of them at a particular point in time. They are not predictions and none should rely on them for any investment decisions.
MARKET NOTES: What do the Europeans say about equity markets?
Despite a common currency, [excluding UK] the European markets show a great amount of diversity in their equity markets. Here is quick look at the state of play in these markets after the second LTRO when the Greek problem is supposedly behind us.
French CAC: CAC did not make a new high in July of 2007 and stayed below the high mark of 6780 made in September 2000. CAC has an important long-term support at 2400, which for many years used to be the top of the French markets in the 90s. After the peak of 2000, CAC has come back to test the 2400 support twice. It was first tested in February 2003 and then again in March 2008. Needless to say, it held firm both times. Going by the wave structure from September 2000 to March 2008, CAC should have completed its almost decade long correction! So why is it languishing here at the 3500 mark?
One hypothesis would be that CAC is keeping pace with world markets though even that doesn’t explain its level of 3500 when the US markets are relatively placed much higher. Note that CAC bottomed out recently at 3000 exactly on the long-term trend line that spans from 1988 to date. One would be foolish to be a long-term bear in such a market.
Nevertheless, CAC has faithfully followed the US market gyrations from July 2007. While there is no reason for it to continue to do the same, there is no compelling reason to break step either. Accordingly, CAC could correct along with US markets though the correction will be much shallower. In price terms a correction down below 3000 is unlikely. The point to note is that CAC may be coiling up for an explosive breakout sometime towards July/August this year. Time for any lurking bears to cover shorts.
German DAX: DAX is positioned more or less like the CAC but is not as out of kilter as the formers. Firstly, DAX equaled its July 2007 top with the one it made in March 2000. So it didn’t under perform as much as the CAC. Secondly, its current value at 6840 is not as low as that of CAC relatively speaking.
DAX too keeps pace with the US markets in terms of ebb and flow though not valuations. That implies DAX too will correct more or less line with US equity markets up to July/August. The correction may not be as shallow as that of CAC but may not be as steep as that of US markets either. Significant that both the major EU markets have already bottomed out.
UK FTSE: The wave structure of UK markets mirrors that of it European cousins rather than the cousins across the Atlantic being very close to what the DAX has been doing since September 2000. It is currently placed at 5790 and headed into a correction till July/August this year. It is hard to see the FTSE correcting significantly below 5000 levels by then. So time for bears to exist in the ensuing correction.
Greece General: Back in 1993, Greece began a great bull run from 560 to hit a high of 6375 in June 1999. It has since dropped hitting a low of 664 in January 2012 when I first mentioned that the Greek markets might have bottomed out in this blog. After a rally to first overhead resistance at 830, the index is correcting again. It will probably correct in line with other European markets and may come back to retest 660 again. There isn’t much to lose in Greek markets but conversely, unless you believe in miracles, the performance too may not be all that great.
Spain, Madrid General: For a technical analyst this one is a no brainer. Note the trend line spanning from 1984 to date. Every major correction has ended on this trend line the latest being in November 2011. While Spain may not break ranks with other European cousins, and break out from here, it doesn’t have much of a room to go down other unless it breaks the long-term support line. Hard to see why it should do so. Also note Spain did not rally with the other European or US markets and so is unlikely to follow them down. This is one market that bears should exist pronto before they are gored by Spanish bulls.
NB: These notes are just personal musings on the world market trends as a sort of reminder to me on what I thought of them at a particular point in time. They are not predictions and none should rely on them for any investment decisions.
MARKET NOTES: The Bull Run ends but a new high in US markets still possible.
S&P 500: The Bull Run that began at 667 on the S&P 500 in March 2009 probably ended on 1st March 2012 at the level of 1376. The Bull Run spanned a period of 3 years and saw a rise of almost 105% from the low.
The ensuing correction saw the index fall from a high of 1376 to 1340 before a pullback to 1366. This pull back can make a new high. Even so, that would be an extension of the run in order to make room for a fall. One may note that there are major divergences between the broader market indices, such as the NYSE Composite and the Russell 2000, and narrower ones like the DOW and S&P 500. The broader indices started their correction much earlier and have fallen further than the DOW and the S&P 500. So any new high during the initial pull back is unlikely to last for long.
Since we will be correcting for a 3-year bull run, the correction that follows will be stretched in time. The price itself will probably not be as sharp as in the correction following the 2007 peak. It may not make new lows either. It is too early to predict the shape of the correction to come or its first target. Suffice to say sell rallies from hereon. Watch for the first pullback though. As mentioned above, sometimes it can make a new high though this time the probability is low.
Sensex: The Sensex has been in an orderly correction from its high at 21,050 in November 2010 and made a low of 15,135 in December 2011 in 3 major waves. From there it rallied to a high of 18,470, which I flagged as a bear-rally. It has since fallen off to below its 200 DMA and is currently at 17,145. While a minor pull back is possible in tune with world markets, this fall is likely to retest the floor at 15,135 established in the previous fall.
The correction will get more volatile as we approach year-end with sharp bear rallies and equally sharp falls. But the trend until then is likely to be down keeping pace with the correction in markets abroad.
Shanghai Composite: The Chinese markets corrected from a high of 2478 without breaking its long-term trend up that looks set to achieve its target of 2550 despite the turmoil in other world markets. I would keep a watch on China and Japan as possible counter trend markets because both have followed a different correction path from other world markets. Will cover Nikkei from next blog post.
$-Index: The $-Index gave its first indication that the ongoing correction from June 2010 may be nearing its final stages. It broke pattern to rally from 78 levels to high of close to 80 topping the preceding top at 79.75. The Index has a downward sloping trend line stretching from its peak at 88.5 to its last major peak at 81.8. On the other hand, it has an upward sloping trend line stretching from its last floor at 72.8 to its low of 74.8 in October 2011. The $-Index is likely to be triangulated between these two trend lines and a break out on the upper side is like by September end. What the charts say is that the final major leg down, now under way, is unlikely to take the $-Index below 76.5. It is too early to turn a $ bull. But a retest of 72 is more or less ruled out unless 76 breaks. That’s unlikely if my triangulation scenario holds.
Euro-$: Without going into my wave counts, let me point out the significance of the 1.25 level on the Euro-$ chart.
Firstly, from a all time low of 0.8275 in October 2000, the Euro rallied to 1.27 in August 2004 establishing the 1.25 as the top. From there followed a shallow correction spanning nearly 3 years clustered around 1.25 before the Euro rallied to its all time high of 1.6 in April 2008.
Since then the Euro has tested the 1.25 mark on 4 different occasions under a variety of circumstances but the top has held out without a decisive breach.
Its most recent test, the 4th, came in January 2012. Not only did the floor of 1.26 hold but it made a higher low exactly on the long-term trend line that stretches from December 2000 low of 0.82 to the low of 1.18750 in June 2010, validating the support line.
From its recent low at 1.2624 in January 2012, the Euro is in a bullish uptrend and after a high of 1.3465 has repeatedly tested the new floor at 1.31. That in my view confirms the start of a new bullish run in the Euro with a first major target of 1.38. Barring the usual corrections, a run up to 1.38 can happen in a matter of weeks.
$-INR: As indicated in the last blog post, the $ broke through the first overhead resistance at 49.75 to shoot for 51 meeting RBI intervention at 50.75. Unlikely that RBI will be able to hold down the $ below 51 for too long. Conversely a breach of the first floor at 49.75 looks unlikely. Retain 51 as the first target followed by 52. RBI intervention makes trading in INR too risky. Use it for strategic hedging because RBI intervention means a large supply of $ that will be difficult to find in a normal market. RBI will realize it is being gamed and shrink its intervention accordingly.
Cotton [NYSE]: Cotton made a high of 227 in March 2011 and has been in a free fall from then making a low of 84.35 in December 2011. The 84 price level represents the top of the Cotton market over a period spanning 30 years of trading in the commodity and is therefore a well established support.
Cotton has rallied from 84.35 to 99.5 its first overhead resistance, and come back to successfully retest 84.35 bottoming out at 87.5 twice. That’s confirmation of the corrective uptrend, which has 100 as the first target followed by 105 and 115. Mind the move up is corrective but from the low base the relative upside is pretty major for a commodity like cotton. No wonder markets spooked on an Indian ban on cotton exports.
Gold: Gold confirmed its orderly correction underway by not breaching the $1800 mark as pointed out in my last blog post. Barring a corrective pullback, gold is now headed for a retest of $1500 before July end, possibly multiple times. Gold should be looked at for investment once it completes this cycle of correction by the end of July this year if or if it rallies past $1800. Not bullish on gold no matter what the gold salesmen spin out. Must note though that gold may not have peaked out at 1920. That will be known only from the price action after this correction. Until then it is wise to respect the bear trend.
MARKET NOTES: Have the markets turned down already?
S&P 500: World equity markets have had a long Bull Run spanning from the lows 668 on the S&P 500 in March 2009 to 1374 on the same index in March 1012. That’s a bull run spanning 3 years – typical length of period – nearly doubling the index during the run. By all accounts this Bull Run is now mature and due for a correction for the run-up in the index from 688 to 1370.
This bull run was driven by unprecedented liquidity – indeed virtually unlimited liquidity at practically zero interest rates – as the FED and other central banks literally printed money to kick start economies that had stalled after the crash of 2007. That phase in excessive liquidity may be coming to an end soon as growth has picked up in the US, inflation is beginning to rear up its head and the interest rate cycle begins to perk up. ECB’s LTRO 2.0 could be the last of the major liquidity injections that we see in the world economic system.
The markets are untested without this unprecedented liquidity sloshing around in the system and nobody has any idea as to what the valuations would look like in the world markets without it. The market needs to find a level that reflects true value in the absence of steroids injected into the system by central banks. The ensuing correction will be all about finding that true comfortable zone of value.
Having said that, it is too early to confirm if such a correction is setting in. For that to happen, S& P 500 has to close below 1250 and we are a long way from there. On the other hand, Russel 2000, which represents a broader universe of stocks, has fallen from a high of 834 achieved on 2nd February this year to a low of 800 on 2nd March 2012. In other words, it hasn’t made a new high for almost a month while the more avidly watched narrow indices have been inching up. The pattern of correction in the Russell 2000 looks like that of an impulse wave down and the index may be signaling a broad correction much earlier than the S&P 500 or the DOW.
At the very least, the divergence between Russell 2000 and the other two indices set up cautionary flags for an imminent correction. While I expect a long drawn flattish correction for reasons given above, it is too early to say what shape it will take. So watch out for the US equity markets to confirm a correction without further notice.
$-Index: The $-Index continues to be bearish declining from its recent top at 82 in January to its recent low at 78.1 on 29th February. It has since spiked up to 79.5 in what looks like a corrective move and will probably resume its orderly descent soon. Its next logical target on the downside is 76.5. Not bullish on the $ despite being bearish on US equities! That’s is almost blasphemy but correlations have been all tops-turvy in these markets. Expect the disarray to continue!
Euro-$: Will stick my neck out and reaffirm that I continue to be bullish on the Euro. The currency has been in an uptrend from the low of 1.26 and recently made a high of 1.3471 on 28th February. It has since fallen off sharply, correcting to a low of 1.3200 yesterday. The fall, in my view, is corrective and the Euro will resume its uptrend against the $ soon if not from Monday.
Gold: As expected in my last blog post, the $ failed to break past the $1800 level confirming that the bearish trend in the metal is not yet over. The sharp fall from $1790 to $1688 in fact confirms that there is considerably more time and price correction in the metal to come. Gold’s next logical target on the downside is $1540. The fall may come along with the fall in US equity markets.
Since gold has off late been positively correlated with equity markets, the sharp sell off in the metal should be seen as yet another dangerous divergence in the asset markets.
WTI Crude: Crude continues to be in an uptrend that began $75 on 24th January this year and currently stands at $106.7. Nothing on the charts says the uptrend is over. On the other hand, the wave counts indicate another leg up to the rally that could take the price to $115 and above. While I don’t buy peak oil theories, crude has had a huge Iran premium in the price and anything is possible. Pure technicals say crude won’t be turning down with other commodities in this fall. That’s bearish for all markets in fact.
Silver: I used Silver to illustrate why the rally in gold prices was deceptive in last blog post. So to be fair, revisiting the chart although I don’t trade the metal, as it is too volatile for my risk appetite. Silver in my view has completed a full bull run from 1991 to August 2011. It topped out at 50 and has been in a downtrend since then. Silver is actually in the middle of a corrective pull back. It recently topped out at 37.5 as a part of the first leg of the pull back. A break of 34 will accelerate the fall. It remains to be seen if during this fall it will go all the way to $26. That will provide a clue to the future course of correction in the metal. Continue to be bearish.
Shanghai Composite: The only Index that I am currently bullish on had a logical target of 2540 for the current rally but it is languishing at 2430. The Index charts a fairly independent course from world markets and may still surprise although it ebbs and flows with world sentiments. However, until it actually tops out 2540, it would be foolhardy to discount the possibility of a fall in sympathy with the rest of the markets.
Sensex: Sensex presents an interesting picture. First point to note is that having turned down from 18,500 the Sensex confirmed that the correction in the index that began in November 2010 is not yet done. So the index continues to be in a downtrend. Second point to note is that in terms of wave counts, the run up from its recent low 15,000 is not yet over. In short the Sensex has time to rally one more time if it wants to. Lastly, Sensex fell before the rest of the world markets. That was quite “unnecessary” unless somebody had a bull AND a bear trap in mind. Such is the deviousness of our market operators. Recall I said earlier that Sensex doesn’t usually fall away without multiple attempts at forming a top.
So while I am by no means bullish on the Sensex, a rally from current levels back to 18,500 cannot be ruled out to trap bears. There is both the time and the place for such a rally. Having said that, I continue to be bearish on the Indian market well into rest of this year.
$-INR: The $ appreciated sharply following the ONGC debacle. Since LIC will pay for ONGC in INR there is more room to go! The $ is an uptrend against INR with first logical target 49.75. A break past that level will take the $ 50.5 or so. Equity markets have been propping up INR. That prop is likely to slip away after the ONGC debacle and as correction in equity markets begins to bite deeper.