Market Mayhem - Inflation blues or an impulse?

The Indian central bank, Reserve Bank of India, said fighting inflation is the most important agenda. Central Banks across the world have an important role in price stability. RBI has been behind the curve and this move is quite an important turning point in the macro economy of India. I have repeatedly mentioned inflation, INR depreciation and the health of the central government as the three important drivers which would give hope to the long term investors. In the last two weeks, we got some answers.

The government at the center survived a rather scary opposition in the confidence vote and markets took it as a positive. Though a fall in the government at the center would have been equally good if the opposition didn't think of forming a government with unprecedented parade of regional parties. On the monetary policy front the RBI raised rates showing willingness to tackle the inflation problem. INR too appreciated by nearly 100 paisa in the last three weeks. All these factors have to hold in order to give some credibility to the current upward momentum.

Dealing with inflation is now an important policy issue. RBI has been using interest rates to cut aggregate demand and this step is important to reduce excesses in real estate, infrastructure and credit growth. Tightening the money supply would lead to lower demand, lower propensity to spend and a clamp down to wage growth. However, very strict monetary policy measures is not cure for such high level of inflation. The Reserve Bank should look for reducing credit growth in housing sector as it appears to be overheated. INR appreciation should be used as an important tool to tame inflation. This would mean spending Forex Reserves to appreciate INR and reduce the burden of high energy costs and cost of some edible oils.

Though the markets have indeed given an important rebound from lows and look set to rise to some important levels. In the last update I had marked an extension of the downward trend, but it turned out not to be one. As I still continue to see my previous base count as the most probable one, the expectation that we might have seen an intermediate bottom looks strong. Does this mean the broader index should move only up from here ? The answer is NO.

Lets have a look at the long term Elliott wave structure of S&P CNX Nifty -



The primary cycle in this upmove is shown in blue with primary trend shown in purple. We may have formed an important low of the 4th wave of the primary impulsive wave. Whether this is just a three wave downward 'A' or the complete '4' is the important question. From 'Time' considerations, it looks like just the 'A' wave of the primary ABC correction. It may resolve as a flat pattern, that is nearing its previous high, or an expanded flat, making new highs and then falling.

Another very important aspect to note is, we have still not come out of the corrective channel of this ABC correction. This reduces the probability of my present assumption.



The corrective channel -



If S&P CNX Nifty is able to clear 4680 mark on a daily closing basis with higher volumes, the probability of an upmove to 5000 would be on the cards. The current rally may face strong resistance at 5000 and 5300 levels.

Still we should remember that the market is in a bear phase. These upmoves are a mere counter trend rallies which would be sold into. International macro pictures are not turning out too great to command attention. The US economy is witnessing poor growth, high inflation and high unemployment as well.

Misery Index (10.52) = Unemployment rate (5.5) + Inflation rate (5.02) as of June 2008

The above index shows the problems that the US Fed faces as it tries to clamp down money supply. With very low rates and a poor housing market fraught with high default risk and a more than a hundred percent rise in foreclosures the choices are very few. The current prudent choice is an appreciation of the USD and a clamp down on growth along with a raise in short term rates.

The Housing and Economic Recovery Act of 2008 in the US which has been signed into a law would provide some short term relief to the troubled banking market in the US. The point is US economy is in doldrums and recovery would take time. But the cost of recovery is still uncertain and markets would remain jittery.

The Euro Area is no exception. Retail sales in Euro Area are now decelerating and the housing market is on a brink of a steep fall. A fall in Eur against USD would be a devastating blow to the hawkish stance of the ECB rendering it helpless against inflation. The Federal Reserve has already begun its march towards a strong dollar and this would spell havoc for the growth in Western First world.

So growth prospectus in the world market are not promising which would keep any strong impulse capped. Indian market are expected to do well in falling crude oil and rising INR scenario than other markets.

Another important development is the latest acts of terror on the Indian soil. Though cowardly, these incidents can infuse fear in the minds of general public and result in lower demand at retail establishments. The outcome of a fall in demand and retail level for services such as basic goods, entertainment and hospitality. These are the sectors not to be in at this time. With higher interest rates and a tighter money supply, the current situation doesn't look convincing of a strong growth period.

Utilities are smartly up from lows and looks convincing from a long term prospective. Tata Power looks an important pick.

From a technical analysis point of view, Nifty may rise strongly on a rise above 4680. Support is now building up at 4155, the important pivot of this whole move.