Nifty to test 17,800 before the big fall: Elliott Wave analyst Rohit Srivastava 

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Last time, you had said 16,660 if it is 50% retracement from the entire fall from April, and 17,000 if there is 61% retracement. So is there a possibility of a higher upside like 17,300 and 17,800? How are the charts indicating this?

Yes, they do. We call this an X-wave, which is a bear market rally. An X-wave sees 50-60% retracement from the prior fall. If I take the entire fall from the October high, then 61% retracement is 17,300, which is why it is the first key level. The 17,800 is like an overshoot because some levels can overshoot, and it is the level that falls on the trendline you get when you join the January top and April top. To be exact, it would be 17,740. But if it goes beyond that, then it would make us think that something is not right, in terms of the patterns we are marking as of now.

When you say that for it to overshoot this, there has to be a fundamental shift, should we be looking for a sharper fall in commodities? Or are there other cues we need to be watching?

The dollar index or USD/INR for our currency is an important cue to watch out. If they will continue to weaken. The USDINR we have already seen falling from 80 to 79, the question is if it will continue to drop further. Or whether the dollar index will go down to 103-104, which is what it broke out of to touch a new high (105.9 as of July 29). The dollar index is breaking out after a five-year consolidation, so for it to fall back below 104 looks tough. Eventually, the DXY going higher will be a pain point for markets. 

Economy wise, a slowdown, which is quite apparent in the US, will eventually lead to lower earnings for US companies in the next two quarters. This is because for one there is the rising dollar and two there is the rising cost of labour, and so tightening margins will result in lower profitability for most businesses. That will show up in September end numbers. 

So, this particular rally is more like short-covering. 

In our own market, at 15,100, the FIIs had a short position of 1,45,000 contracts which was the highest since the pandemic. After expiry, which was a few days ago, the short position on Thursday had come down to 17,000 contracts. On Friday it had reached around 24,000 long. There is no short position in the market now, and therefore we are coming to the end of this upwards move. May be a few hundred points and then it has to stop. 

In the US the situation is not exactly similar because, in the last four weeks, even as the US market has been trying to move up, we are seeing an increase in short positions. The US markets had just started to bounce back right after the Fed meeting, because it has sort of acknowledged that the economy is slowing down and therefore it may go slow on rate hikes, and the markets might rally a little longer because of short covering. These are what is driving the sentiment there right now. But, once the bounce back is over i. e after the S&P would have seen 50% retracement of the six-eight month fall, what comes after?

If the earnings growth is still negative, which it looks like, then the market will eventually roll over. Then, this entire bounce will end up being purely a technical bounce. That is, it was oversold and people were short covering. 

So we need to watch the dollar index mainly? Any other indicators?

I could have said bond yield. But bond markets will anticipate that interest rates are coming down, so bond yields will drop even before the rate cuts happen. So for all you know, bond yields may have already seen a low point in the US. Yields may continue to decline over a period. That doesn’t mean that equities will turn around because yields are going down. This is because rate cuts could continue to happen even as equities fall in the latter part of the phase because earnings are degrowing. In that environment, people will sell equities and buy bonds. Then there is an inverse correlation between equities and bonds. In rare periods, like the last six months when both were falling together, the bond markets bottom out first, then equities bottom out. Bottoming of the bond market might be the first signal that we are at the end game.

Any levels you have for the dollar index?

Between 103 and 104 is the support range. It had made a high of 103.5-103.8 in 2017 and 2020, and it went past that this year. It was a double top and it broke out of that. So, now that becomes like a support. If it falls back to that level, you won’t expect it to go below that, and it would probably go back higher again. But, if it goes below that, then it would be a warning. Then, it would indicate that it (the DXY climb) was just a spike and it’s done.  

In which case, do we need to completely revisit this theory…

Yes, below 103, we will have to revisit this theory (of a bear market rally) and whether a larger uptrend has resumed.

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It has been perplexing how the market has been interpreting this recession, and the Fed’s intent and action. It’s becoming increasingly clear that we may have to live with both recession and inflation. How do we interpret economic data going forward, especially what the inflation data and yield inversions suggest?

The best way to look at these would be to study maybe the closest two examples, which would be 2000 and 2008. In both cases, you had the 2-5 year yield curve inversion and the Fed started to cut rates, they had to cut rates at least five to six times before the markets started to stabilise and the economy started to improve. If history has to repeat, then we have to reach a point where the Fed has to acknowledge that things have slowed down enough and then start cutting rates. It may not work with the first rate cut. 

We are seeing a rally of some kind now simply because people hope that there will be some reversal (in rate hikes). But if the Fed is still doing quantitative tightening and inflation is persistent therefore interest rates can’t be cut significantly, then these will continue to slow down the economy. Even if they start cutting rates in October, things would have slowed down so much that the first cut may not work. One of the theories was that, if the Fed has to cut rates six times, then they have to raise it so much (laughing). That is one of the reasons why they are raising rates so fast, with 75 basis points at a time, then if they reach 3%, they can keep cutting 25 bps for the next two years. But will the first 25bps cut really work in reversing economic slowdown? The answer may be no. 

There is a theory on why inflation is persistent, which is that it (inflation’s persistence) isn’t even related to Covid but it is from change in working patterns around the world. Earlier people were going to office, then consumption patterns were different. With a lot of people working from home, consumption patterns have changed. Also, the entire supply chain has been built to work with the earlier pattern and, since that pattern isn’t coming back, even when everything has reopened, there are supply-chain bottlenecks. That might require fresh investment in supply-chain infrastructure. It means that you can slow down inflation but it (economic slowdown) may not get resolved easily. So net net, things will probably get much slower before they improve. 

Therefore, equity prices can drop 30-40%, if earnings start to degrow. US earnings for this quarter is showing -10% based on the companies reported so far, but by September quarter, the earnings could be at -30%, then the stocks may not react positively.

Do you have a view on the level at which the Rupee will settle?

I am looking at support at 78.90. If it does break that, then the next one below would be 78.60. But, if it does not go beyond that, if we hold 78.60-78.70, I would think that the USDINR would head to 84-85.