The Tech Reversal

The scale really changes when you compare the 1 million people inhabited Cluj County with the 23 million strong Mumbai, but even then a drunkard stopping at the church gate on his way back home is a sight full of inspiration. We have religion, economics, emotion, alcohol, mathematics, patterns and cyclicality.
Humans just like the drunkard take solace by blaming uncertainty on randomness. We wrote about randomness on prior occasion in ‘The Taleb conundrum’. This time we are taking it a step ahead by discussing the TECHOLOGY sector index, which seems to have gone out of favor, as randomness of global markets and news of poor corporate governance emerge.
John F. Ehlers in MESA and Trading Market Cycles discussed how the random walk of a drunkard has a pattern about it, if you consider the random variable as momentum and not the direction which the alcoholic takes. Unlike direction which can be up or down for a price, the time variable instead just moves forward. The random motion of the market hence has a pattern, a fractal, a cycle created by the market as it responds to physical phenomena.
This is why just by picking one end one can create the complete structure. This is why looking at emerging market cues for gauging the direction on DOW works. Underperformers can be studied to understand the direction of performers. Moreover, since performance itself is cyclical, even a blue chip underperforms another sector or stock when the performance cycle turns against it. This is why pairs like LONG CNXIT vs. SHORT NIFTY are not strange strategies. The leading sector of yester years has seen the cycle of love turning against it and the cycles suggests that hate has reached an extreme and the TECH outperformance might be near.
I remember a reader asking us early 2007 “How can Infy become half? What about the earnings?” There were a host of other questions asked to us challenging the ridiculous forecast. One of the Orpheus fresher was recently asked about his work and after expressing surprise at how fractals and cycles can be used to predict, another question asked was “What if you go wrong?” We humans have a fancy about many things. We are loss averse and scared to go wrong. This is the same like asking how a market leader can go bust. Well! there are some questions this generation will not ask again. Maybe the next generation will ask the same question again. But that’s a long time.
Unlike all the activity on NIFTY and other indices, the CNXIT has been stagnating. The formation looks like an ending diagonal to us. A five legged overlapping structure, which is generally seen in final exhausting price structure just before a reversal. What this means is that TECH might be ready for a reversal. This is not a small reversal and could see prices push at least 30% from current levels. This is no mean task considering market is concerned about IT jobs and crisis.
This positive view looks tough to digest when you look at NIFTY, which has slid back to previous lows and is nearing OCT 2008 lows. This is where we move from market patterns to market cycles. The average 3.3 year KITCHIN cycle defines cyclicality in the economic cycle, assets, stocks and indices. The reason Kitchin assumes more significance in capital markets has also to do with its periodicity. At 3.3 years, most of us who were around in 2000 have witnessed nearly two KITCHIN CYCLES. Only investors who have been in the market since 1998, (if they have survived the ongoing financial crisis) might have the opportunity to live three Kitchin cycles also knows as a JUGLAR, a 9-12 year cycle. The current Juglar should finish sometime in 2011-2012. We are cycle blind, as a short KITCHIN cycle seems too large for our investment horizon. The KITCHIN cycle on CNXIT has turned up and should see the first leg up extending till May-Jun 2009 followed by a correction and extending gains till end of the year. This is in sync with the reversal formations we mentioned earlier.
We have been bearish on TECH for over two years now. And this is what we said in our INDIA OUTLOOK 2007 two years back in JAN 2007. “Technology: Despite the noise that Infosys and Indian Tech gets abroad, the sector has underperformed every other sector in 2006. The underperformance should continue. Some sectors take over market leadership at some points in the economic cycle and other sectors underperform in the same points (sector rotation). We still believe the technology sector prices should correct sizably from current levels. We will not be surprised if Technology gives a negative return for 2007.”
Now we are betting on a turn here. CNXIT has also shown a move up in ranks in performance over periods of 6 months, 3 months and 1 month. It has come from a negative of -38.16% over 6 months to a positive move of 3.47% over the last month. The index has moved up despite all negative news and a sector leader going bust, a classic proof of relative outperformance.
Apart from the fact that there is a lot of negative sentiment extremities linked with the sector, the CNXIT has been falling for more than 24 months. Even from an annual cycle perspective, a bounce is due. We should also keep in mind that a sector index is different from a company, a company can go bust, but a sector failure is more in the mind than real. Because as individuals we may perish but as a group we innovate, survive and thrive. To assume a sector failure from current levels is like assuming that the drunkard would never reach home, but then he surprises.
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