Nifty Analysis: Low VIX, high Nifty telling you to do a portfolio recast, use hedges

Over the past couple of weeks, the Indian equity market has been on a roll. It has not only managed to take out a double top resistance at 15,431, but also closed at a new lifetime high of 15,670. The extent of the buoyancy has been such that Nifty has accumulated nearly 1,000 points of gains in just three weeks.

The volatility, as represented by INDIA VIX, has fallen another 8.40% and the index currently stands at 15.9400. This is by far its lowest level in recent months. This low point was seen previously only in February 2020.

The Volatility Index and Nifty50 always share an inverse relationship with each other. So, with the current low levels of the Volatility Index, it would be interesting to see what insights it throws up in the current technical setup.

What does low levels of volatility actually mean? Persistent low levels of volatility means market participants are not afraid of anything, and there is an absence of fear in the market. It also means market players have become complacent. However, it needs to be noted that phases of low volatility are often followed by highly volatile periods. And even more importantly, major intermediates or minor tops tend to get formed during this period.

The current persistently low volatile period warrants caution. This is vindicated by the Relative Rotation Graph, which compares equities with other asset classes when benchmarked against the Vanguard Balanced Index Fund (VBINX).
Equities, as an asset class, has slipped inside the weakening quadrant. Safer assets like US Treasury Bonds are going strong, rotating northeast while being placed inside the improving quadrant. This means equities may continue to perform individually as an asset class, but when it comes to relative performance against other assets, they may relatively underperform.

Coming back to the Indian market, the sectoral performance on a year-to-date basis has been extremely skewed as reflected by the relative comparison chart below.

As evident from the above chart, the economy has been facing headwinds, but different high-beta sectors have run up a lot this year. On an individual basis, metals have outshone every other sector; Nifty Metal Index has gained 63% on a year-to-date basis. This was followed by PSU banks, PSE, Infrastructure and Energy Indices, which have gained 37.69%, 28.75%, 20.64%, and 19.98%, respectively.

On the other hand, the traditionally defensive sectors like FMCG, consumption, pharma and IT — all marked with thick and bold lines — have put up a poor show. They have gained 2.81%, 5.68%, 9.17%, and 11.32%, respectively

The Relative Strength (RS) charts of these four defensive sectors (pharma, Consumption, IT, and FMCG) show that although the RS line has been moving sideways or even falling, it is resting at its major support areas with the RSI showing bullish divergences.

So, what do we conclude from these observations? The conclusion is pretty much straight forward. Markets are buoyant and as a market participant, one is obviously supposed to follow and trade with the trend. It also needs to be emphasized that the above reading does not in any way imply that it is time to go short.

However, the current technical setup is showing mild warning signs that call for making some changes in the methods and approaches while we trade and invest. It does not say one should go short this week, but the technical setup is showing signs that one needs to turn cautious at these levels.

This caution can come in different ways for different market participants. For the traders and investors, who are currently long in the economy-facing high-beta stocks, it is the time to keep your trailing stop losses in place. If triggered, they will help you take some money of the table and protect your profits. Anyone contemplating fresh purchases should focus more on the defensive sectors.

Though they are languishing mildly at present, they will offer good protection and resilience if the market consolidates again in a broad range. For long-term investors, this, perhaps is the best time to create hedges for their portfolios.

(Milan Vaishnav, CMT, MSTA is a Consultant Technical Analyst and founder of Gemstone Equity Research & Advisory Services, Vadodara. He can be reached at milan.vaishnav@equityresearch.asia)