Do the Charts Support a 70% Sensex Surge?

Apurva Sheth
A few days back, Rahul Shah, Equitymaster co-head of research, predicted a rise in the Sensex over the next few years. His rationale was that if profit margins of Sensex companies, which are currently at 12.2%, revert to their ten-year mean of 13.5%, and if EPS grows at its long-term average of 15%, the Sensex could go up 70% in the next two to three years.

That's music to a trader's ears. If the Sensex actually goes on to rally 70% in the next two to three years, now could be the best time for equity traders. As a market participant, it helps to know where the markets could be two to three years down the line.

But as a trader, I am keen to know where things stand right now.

I am more interested in knowing 'how the market is acting now' rather than 'how the market should be acting'.

And to find out how it is acting now, I rely on charts and data. So today I will share a few charts with you and give my view on where the market is now.

Like seasons, financial instruments are cyclical. Summer is followed by monsoon, monsoon by winter, and winter by summer. Then the cycle repeats. Stocks and indices go through similar phases.

First comes the accumulation phase. Stocks stabilise in a range after a prolonged downtrend. Value investors who find the stock attractive begin to enter the stock while the majority mood is still negative. The conditions improve over time and other investors enter the stock. Their buying pushes the stock higher. The stock starts to form higher tops and higher bottoms. This is the markup phase.

The uptrend lasts only as long as there is fresh demand. Every successive rally becomes harder because everyone who could have bought the stock has bought it. Smart investors start to exit, and retail investors usually enter at this stage. This is the distribution phase.

Late entrants eventually lose their patience and start to exit the stock at negligible profits or at a loss. Stocks fall on much less volume as there are few players who want to buy the stock. This pushes prices lower, which attracts more selling until it becomes a vicious circle. This is the markdown phase, the last and final phase before the cycle repeats.

The entire cycle normally lasts three or four years, which is the same as the normal business cycle. But since stock markets function as a discounting mechanism, they change direction long before the actual business cycle turns.

Now let's see where our markets are in this cycle.

NSE Nifty through Various Phases

In the above chart, I have marked various phases the Nifty has gone through over the last decade. You can see a rhythm to how one phase follows the other. Currently, the index is in the mark down phase. The Nifty topped out at 9,119 on March 5, 2015, and has been forming lower tops and lower bottoms ever since. If the Nifty were to follow the same cycle it has been, then the next phase will be the accumulation phase.

But the question is - is the markdown phase over, and when will the uptrend start?

Well, nobody knows that for sure. But let's see what the charts are telling us. I have a monthly chart of Nifty here...

Timewise and Pricewise corrections in Nifty

I marked three major down cycles of the last ten years and included the duration of the fall and the top-to-bottom drawdown percentage. To the extreme left is the fall of 2008, when the Nifty collapsed about 64% from top to bottom in ten months. The next major fall occurred in 2011, when the Nifty dropped about 28% from top to bottom in 14 months. Finally, the recent fall from March 2015 to February 2016 has been about 25% in 12 months.

The index generally spends anywhere between eight to 14 months in a markdown phase. The current downtrend has already lasted 12 months. It looks like the index is about to or may have already completed its timewise correction. Pricewise, it has already corrected close to what it did in 2011. From this chart, it looks like we could be in the last leg of the markdown phase.

The index chart suggests this, but do the Nifty stocks also support this view?

Let's find this out with the help of following chart...

Percentage of Nifty Stocks Trading Above their 200 SMA

In the above chart, I plotted the price of the Nifty in blue (RHS) and the percentage of Nifty stocks that are trading above their respective 200-day simple moving average (SMA) in orange (LHS). In a bull market, the majority of stocks trade above their respective 200 SMA, so the percentage is usually above 50. On the other hand, only a few stocks trade above their 200 SMA in a bear market, so the percentage is smaller.

Apart from being a measure of the overall participation in a rally or decline, this indicator helps us identify key reversal points. Extreme readings in the percentage indicate an exhaustion of the ongoing trend and possibility a reversal. A reading of 20% or lower indicates oversold conditions, while a reading of 80% or higher indicates overbought conditions.

The index hit its lowest reading of 4% on February 11, 2016. This means that only two stocks in the Nifty were trading above their 200 SMA. This is the most extreme reading in recent times, suggesting that worst could be over for most Nifty stocks.

All three charts above suggest that we may be at the end of the downtrend that began in March 2015. As per the market cycle model, we could see the accumulation and mark-up phases in the next few months. This means the downside could be limited and there could be scope for a big upside in the Sensex in the next two to three years.

But nobody knows with absolute certainty whether this will happen. Nor does anybody know how exactly it will shape up. But you and I know that investing is a game of probability, not certainty.

Trading is all about looking at things from where they are in the present. And based on that, one has to figure out what could be the most probable outcome. What you expect may or may not happen. The key is to manage your risk well and review your outlook periodically so that you don't go off track.

At Swing Trader, I keep a regular check on the markets and update my subscribers every week. With this, I make sure that our short-term trades are aligned with the larger trend. This helps us trade effectively. What about you?

How do you ensure your trades are aligned with the long-term trend? Share your views in the Club or share your comments here.

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4 Responses to "Do the Charts Support a 70% Sensex Surge?"
14 Apr, 2016
Worse for the market is not yet over. Positive monsoon prediction, rally in crude, global trend all contributed to the present rally of almost 1000 nifty points since budget. But once the earnings season tumble out the euphoria will lose steam and reality will face the market. Any uptrend depends only on better results by the companies. Thus, the accumulation phase may continue throughout 2017. Crude oil price is always a double edged sword for India. It fuels the market sentiment and silently hurts the fiscal deficit and value of currency.Like 
Nizar Ahmed
14 Apr, 2016
Yes the conditions appears to be favouring an upsurge in the index in the near term ,at least a minimum of 50% in the next two years .Iam not a chart analyst or follower of technical analysis .The fundamentals alone will see a gradual increase in the index if and only we receive a good monsoon this year.The external factors seems to have stabilized a bit for the time being with FED expected to hold the rate in June review and US economy changing gear , Oil prices reversing and the only negative is if and any expected from China . For the Indian market the annual results and the progress of the monsoon will decide the course in June.Like 
priotosh deb
13 Apr, 2016
The article makes good reading. However it does not factor the political factors. The Indian market is driven by the political factor at large. See how stocks rallied after the 2014 election. Did the fundamentals change between say 2012 Dec till the election results in 2014. A big NO. Why market rallied ??? The market will decide on the rally when an assessment is carried out some time in end 2017 whether the present NDA government is likely to succeed in 2019 election. If so markets will rally if not the down slide will continue. Take a look at the dollar vs Rupee, before every election barring one or two elections about six to nine months before the elections the rupee slides in its value. why this happens ???Like 
Chandravadan Ajmera
13 Apr, 2016
My Dear Apurva; I always like the Technical reading you are giving about the markets a whole and sometimes stocks in particular. I know Equity Master is basically a fundamental service but your presence makes it a holistic one. I also feel within next one or two years the market should give a handsome return to the presently invested investors. But the tragedy is that average retail investor will enter the market again at near its peak and will lose the money when smart investor has exited. Thanks for the analysis and no one subscriber of equity master will be a loser.Like 
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