Markets: Is a top in place or can we still hit new highs?

It was a turbulent and truncated week which saw a brutal sell-off. By Friday afternoon, the carnage had abated. The question is going ahead is it buy on dips or sell on rallies? Let attempt to see the both scenarios. I think 2 scenarios are clearly possible now and we are at the inflection point:

Bullish Case:
1. As shown in the image the trend line draw joining lows from August have held.

2. The government is having huge PSU divestment in Feb. They will hold up the markets provided global cues are supportive. DII bought 7500 crores from Jan 21st. If FII selling stops the markets will go up.

3. The global markets are also oversold and due for a bounce.



4. If we take rally after the budget from 3918, we can see 4 clear waves:

a. Wave 1 - 3918 to 5181 (1263 points)

b. Wave 2 - 5181 to 4539 (642 points) approx 50% correction

c. Wave 3 - 4539 - 5310 (771 points) Wave 3 is 61% of wave 1.

d. Wave 4 - 5310 - 4766 (544 points) approx 70% correction

e. Wave 5 will unfold 4766 - ???

Now wave 3 cannot be the shortest of waved 1,3,5. So max would be around 750 points which takes us to around 5500 on Nifty. Now wave 3 was 61% of wave 1 and if wave 5 is 61% of wave 3, then 5236 would be the target.

5236-5500 (Sensex 17500 - 18500).

Wave 1 took 3 months and wave 3 took about 2 months to unfold. Wave 2 and 4 took about 3 weeks to correct.

This could mean wave 5 may take upto 1 month, the traditional pre-budget rally.

5. The 1 month rally could well also fall in line with previous history of mega IPOs sucking out liquidity and then the markets tanking.

Now the bear case:

1. FII sold 11000 crores of shares in last 10 days. Market and DII cannot absorb such selling on sustained basis.

2. The trend line joining the lows from July upmove is decisively broken on both daily and weekly basis. This could mean the up move is over.



3. We are just on a corrective upmove of the fall from 5310 to 4766. Retracement levels come to 4973, 5038 and 5100. 4940-4980 is key resistance level for the market. I would buy only above these levels.

4. Tony Caldero talks of a top in US Market. His Elliot count on the S&P has worked very well.
http://caldaroew.spaces.live.com/

5. The PIGS are in danger of a collapse. Portugal, Spain, Greece and Ireland are identified as potential sovereign debt defaults. If this default does happen, Lehman would look like a picnic.

6. Risk aversion would return, emerging markets would tank and the US Dollar would strengthen. This would be a vicious cycle. The Dollar Carry Trade would unwind further leading to FII selling.

To sum up, 2010 looks to be a time of caution.