The sentiment was so bearish leading into November that market participants seem to be falling for the same trick again & again. Last time it was the delta variant that spooked the global markets in July 2021. July 19 had a similar global rout with all major indices of the world down. S&P500 down -1.7%, DJIA - 2%, DAX -2.6%, Nifty -1.1%. The bond yields were also down. US 10Yr yield was down -7%. Even Crude was down - 7%. Inaddition to the Covid news flow, fear was exasperated with the Evergrande crisis, something that was seen as the death knell to the markets. But 4 months on, it has petered out and markets made new all time highs.
Fast forward to November 2021, it is a very similar setup to last July's panic. The new (Nu) variant isn't fully understood, but speculated to cause havoc to the world by the media. Markets picked up the story to continue a technical correction. All global markets were already off all time highs few days ahead of the news. General market philosophy is, news is considered as the final sentiment extreme and is usually followed by a reversal. The news hit the market on a US trading holiday for Thanksgiving. Once the US Futures started dropping on low volumes, the rest of the globe picked up its cue to fall along with it. European markets fell the hardest, down 4+%. Emerging markets, Crude, Bond Yields, Dollar, Cryptos, everything fell (except Gold). Could a reversal be on the cards now? Once the carnage was done, another news flow came from South Africa where the Variant originated, which said that there is no evidence yet to conclude that the vaccines are not effective against the Nu variant. If the vaccines are proven to be effective against the variant, the correction looses all its validity.
Nifty was already down 6% from ATH since October and the negative news only aided for sentiment to reach an extreme. A neutralising news can do the exact opposite to the markets. But traders seem to be ignore it, as they did back in July. There is one difference between July and November 2021, though. Last time, both investors and traders were fearful. Now the investors are mostly bullish, indicative of the steady mutual fund inflows and the fact that the markets were making new ATHs despite heavy selling by FII in October. But traders are still bearish and their bearishness has only worsened. A significantly low PCR of 0.6 indicates too many retailers are short on the market by selling Call options more than Put options. Such a low level of PCR is generally associated with market bottom because such extreme positions of traders are susceptible to short covering rallies and is more powerful when too many call options are written.
I've already explained on an earlier article how Traders also need to extremely bullish, for a market top to occur. In a bear market both traders and investors lose money due to wrong directional trades at first and by volatility next. With most traders bearish, they only set up for a nice sharp rally. Traders panic much more quickly than investors do. Leverage is the reason. The volatility of derivatives swings the P&L statements wildly and it can lead to change in sentiment and market direction quickly.
The CBOE VIX (The fear index) is a great sentiment indicator. The VIX spikes have resulted in market bottoms followed by new ATHs in the current bull run. The correlation charted by the superb @MacroCharts is a top sentiment indicator which I always take note of. The VIX spiked once again with a speculative, repetitive news, that confirms the trader's bearishness. With most trades set on the short side of the market, this is a sentiment extreme and we could be near a reversal to fresh ATHs.
Why could ATHs be on the cards? That's also due to the trader's fickleness. It doesn't take long for bearish traders to become extremely bullish once they start seeing technical indicators complete the bearish cycle and start indicating bullish momentum. The investors buying the dip coupled with a changing trader sentiment will be a potent force for a melt-up in the markets. You need all hands on deck, to break this bubble, not a news that's washed, rinsed and repeated every quarter. New Covid variants, inflation, currency dynamics, supply chain issues, Fed tapering and interest rate hikes, etc have been in the news for a few quarters now. These are definitely risks for a bull market, but it cannot be a belated trigger. There is no such thing as a belated trigger. A trigger for a major crash has to be a new event. Once such an event occurs, then these valid risks can act as an add-on to feed a market crash. We are yet to see an unknown event unfolding. And we are yet to see a melt-up. But that could change if this is indeed a shakeout with the global markets and the melt-up could be straight ahead of us. The recent correction could be the catalyst that converts the last vestiges of bearish into widespread bullish sentiment.
Coming to Nifty, the structure is inherently bullish, though it has fallen about 10% from the high of 18604. Fib retracement points to some residual selling in the coming week. Probably we make a bottom around 16700 which is the 0.618 fib retracement level of the latest rally from June or we rally from 17k itself. But if the correct correction is enhanced with a new event, the inherent bullish structure could change. If the market breaks the previous base from which the July rally started, only then we need to revisit the market structure and explore the possibility for a deeper crash. Until then the bull run is intact. For now, the market movement would be swayed entirely by subsequent news flow and news flows are never favourable for the majority (bearish traders). Supporting macros such as the dollar index and crude which impact the emerging markets the most are also turning favourable. DXY is likely to form a cyclical top and trend lower following the recent sharp rally. Easing crude could be a bonus. The FII flow has consistently been negative in the secondary markets. But is that really the holistic data? FII in the same period they were taking money out of secondary markets, have been pumping in money into the primary market. About 40k crore out from secondary market and 29k crore into primary markets, making a net -11k crore for October and November, which isn't as grim as how it's made out to be. With PCR at 0.6, the traders are right in the deepest bear zones and are positioned to be washed away by another wave.
Socionomics has a deep psychological basis to stock market. Markets perform well when the social mood is positive and vice-versa. Though I am not aware of why sentiment is negative the US, in India its quite positive, that is probably a reason why Indian markets have outperformed the global peers in 2021. Such sentiment doesn't change dramatically unless a far fetching new event occurs that spills to or takes cue from the stock market. Until such an event unfolds, its wise to bet on the ongoing trend.
The next week is crucial in that aspect and subsequent news flows need to be watched. With whats already known and discounted, the recent news flows do not add weight to expect a bear market. But expect the market to add one more twist.
Very Nice writeup Ashwin.