Warning: Markets caught between devil and deep sea

With the Nifty settling below 5,050 on the expiration of July 2012 series, tongues seem to have started to wag again over the outlook for the markets in India.

This gains importance at a time when Europe struggles to keep its feet given the recent decline in the euro against the US dollar and the rally in US ten-year bond prices. So strong has been the influence of these two factors that cool-off in commodities went almost unnoticed by many.

On the other hand, large investors locally have been sceptical on the Indian markets and aren't very keen to participate actively at these levels citing reasons like muted numbers by corporate in Q1FY13, whereas foreign institutional investors (FIIs) have shown faith in India by pumping Rs 51,000 crore (Rs 510 billion) into the equity markets year-to-date.

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What lies ahead is something we all want to decipher and take action accordingly. We believe Indian markets have some more upside left. Another 7-10 per cent is highly probable from the current levels.

With so much of pessimism floating on the surface, expecting sharp cuts in the Indian markets doesn't seem to be a great idea at the moment.

We believe with the pessimism in the atmosphere prevalent at the moment, the odds are certainly stacked more in favour of an upward move than a downward one.

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Then comes the question of what will lead to an up move? We feel the cues would come from outside the subcontinent and to be more precise from the European region.

A glance on the charts of the euro against major crosses such as the Canadian dollar, Australian dollar, US dollar, Japanese yen and the British pound sterling indicate the likelihood of a sharp bounce back in the short term.

Indications from the charts of US ten-year bond prices are of a correction in bond prices in the short term as these signal exhaustion in the price movements.

A bounce in the euro and correction in the US ten-year bond prices would set the tone for the commodities rally and would also help by way of improved money flow into emerging markets.

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India, being one of the most resilient emerging markets compared with others in the pack in the past two to three months, certainly should see some decent money flows which would then help push the Nifty and the Sensex higher from the current levels.

However, it won't be that easy to generate alpha while trading stocks or sectors back in India as we believe that participation in the upmove would commence only after the immediate swing high of 5,350-odd levels are taken out on a closing basis.

That means fence sitters would not be jumping into the arena for perhaps another four-odd per cent move.

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Break-out traders would be more guarded in their approach and would perhaps use the strictest possible filters for stock selection, which in a way is good, but can lead to the possibility of missing out on some early movers.

We expect stocks, which have a connection with Europe, like Tata Steel and Tata Motors, to give decent bounce-backs.

We also expect beaten down stocks from technology to bounce back during the rally in the Nifty.

The author is chief technical strategist - institutional equity, Karvy Stock Broking.