One of the underlying assumptions of technical analysis is that stock and index prices follow trends which are determined by the interplay between numerous forces which affect price. These can be broadly split into four categories; economic, monetary, technical and psychological. Depending on the direction of these forces, traders in a stock fall into one of two groups; bulls plan to buy now sell later and benefit from a price rise; bears plan to sell now buy back later and benefit from a price fall.
During a rising trend bulls dominate the market and during a downward trend the bears dominate. In a reversal period, where the trend is changing from an upward one to a downward one (or vice versa), there is a temporary balance between the two groups. These transitional periods are often characterized by price patterns which can be used to identify when a prevailing trend is reversing.
The (MACD) Indicator is a technical analysis method first developed in the 1960s by Gerald Appel, a prominent author in investment and trading strategy. MACD stands for Moving Average Convergence-Divergence and is based on the comparison of fast and slow exponential moving average prices. Proponents of MACD Indicator methodology argue it can be used to identify trend changes in stocks and indices.
Picking stocks in a Bear market can be both rewarding (as in the long term you see spectular returns) but also tricky (if you don’t invest near the bottom, then you’re in trouble if the market falls aggressively. Here are some general rules of thumb when it comes to picking stocks in a bear market:
Large Blue chips: Go for large, well established blue chips rather than mid-caps or small caps. While these are the first to be beaten in a bear market, they are also the very first to recover. Smaller shares are more likely to be dependent on one industry, and will have less access / negotiating power with banks for access credit - something that is absolutely critical in today’s environment of a severe credit squeeze.
Neccessity rather than luxury: Focus on buying stocks of companies that sell a product or service that is a neccessity rather than a luxury. The reason is simple: when people’s confidence in the economy, the stability of their job / business and therefore their future income is threatened (as it is in a bear market) they’re going to cut back on all their luxuries including designer clothes, watches, luxury cars etc. They cannot cut back (much) on medicines, food, water, electricity, petrol. Business will also cut back on what they may believe are luxuries - advertising, and expensive offices and furniture. Not only will companies cut back spending on real estate, but individuals and households will also avoid ‘large spends’ on new houses, cars etc.Sectors which have shown to have done well in past bear markets include major pharmaceutical, food producers, tobacco, telephone (now more likely cellular phone), basic household products, oil and energy and utilities companies. This is pretty much in line with what we’ve seen thus far - companies like Hindustan Lever, which is actually up since January, or GSK pharma, which has only lost about Rs. 20 since its January highs.Sectors which have shown to do poorly in bear markets are house / real estate builders, motor vehicle related businesses, industrial materials or machinery / capital goods, advertising or advertising dependent companies, and financials. With real estate, most motor vehicle, and every financial stock suffering (financials are down between 70-90% from their January highs) this general rule of thumb seems to be highly applicable.
Domestic focus: Choose stocks that have a focus on the domestic economy and are not reliance on exports / foreign operations, especially outside of emerging markets and in the US / UK / Europe.
Low ‘beta’ - less than 1: Beta is a measure of how much the stock tends to move with a market move, or crudely, its relative volatility. For example, a stock has a beta of 2 then a 10% fall in the Sensex would typically lead to a 20% fall in the stock. Picking stocks with a low beta means that when the market recovers, your stocks may not ’soar’ but this certainly protects you if the market continues to fall. If you pick a stock with a beta, of say 0.5, then a 10% market fall is likely to only lead to a 5% price fall for that stock.
High dividend yield shares: Dividend yield is how much the annual dividend the company pays out divided by the current market price. So if the stock price is Rs. 100, and the last dividend that the company paid was Rs. 20, the Dividend yield is 20%. Buying stocks that have a high dividend yield is a useful way of protecting yourself against further falls in stock prices. If for example, the stock price falls by 10% and the dividend yield is 20% (provided you hold the stock long enough / at the right time to be eligible for that dividend) then the overall return is +10%.Of course, make sure that the dividend yield is over the prevailing (risk free) fixed bank deposit rate - you need to be compensated for the fact that while the fixed deposit rate will give you guaranteed returns, a company could cut its dividend as and when it feels like it. Be careful however - high dividend yielding stocks can also spell trouble: very high dividends means that the company may be spending too high a proportion of its profits on dividends. If profits fall, the dividend will get suddenly cut, and the stock price will plummet because nobody likes a stock that cuts its dividends. In order to guard against such instances, trying buying a stock with a dividend cover of 1.8 or more. ‘Dividend Cover’ is Earnings per share divided by dividends per share. If the company’s profits are stable, and it has a dividend cover of 1.8 or more, you can be assured that the company is unlikely to cut dividends suddenly.When looking for dividend yielding stocks, also try to focus on well established, well known blue chip companies, because they’ll avoid cutting dividends in order to protect their name and reputation.
Stocks to avoid: Stocks with high PE ratios and low dividend yields are likely to see a price correction, and dividend payments aren’t going to be sufficient to protect you. Stocks with few or no tangible assets are also vulnerable. The lower the tangible assets, the lower the company’s ability to get access to cheap credit, especially in an environment such as this, where liquidity has dried up. At the same time, avoid companies that have a lot of debt (a debt to equity ratio of higher than 25%) - in a high interest rate environment such as this (even to interest rates are being cut), those companies saddled with a lot of debt are likely to default, and unlikely to be able to raise further credit.
Timing - carefully examine support / resistance levels: While a stock might be fundamentally a good buy, it makes sense to try and purchase it near its support (the price level that the stock falls but bounces back from) rather than resistance (the price level that the stock keeps rising to but falls back from). Determining support / resistance levels is not very difficult if you look at a company’s stock chart.
Its not really news when I say that we’re in a bear market (the widely accepted definition for western equity markets is a sustained 20% drop is much smaller than the 50% drop of the Nifty from our January high of 6357). But the question on everybody’s mind is - where are we in this bear market? The beginning, the middle, or at the end (the bottom)? Let’s have a look at the past three Indian bear markets and see if we can get some clues (data below sourced from Morgan Stanley Report, “India Strategy: How to Cope with a Bear Market”, published on 13 March 2008):
First: 2 April 1992 (top) - 26 April 1993 (bottom)
12 months trailing PE at the Bull market peak: 33.9
At the Bear market bottom: 13.6
Decline of 60%
Time taken in days to cross the previous high: 1425 (4 years)
6 months return from the bottom: 34%
From the above data we can see that:
A bear market leads to an average decline of 51% of the index, and upto 60% decline in PE ratios
If you managed to invest at the bottom, 6 months down the line you’d have made an average of 35% return (although spotting the bottom is near impossible - so this is rather misleading)
It lasts anywhere between 1-2 years
It takes anywhere between 2.5 to 5 years for the market to ‘recover fully’ to its previous peak - therefore the bear market is accompanied by a considerable ‘horizontal’ market
The bull market peak is over 32x earnings (PE ratio), and tends to more than halve at the bottom.
Now lets compare the above learnings from above to the ‘Bear Market’ of 2008:
Tipping point: Subprime leading to FII exit
If October 27 low, was the bottom then it has only lasted about 9 months
Sensex peak at 21,207
Sensex October 27 low at 7697
Decline of 64%
Nifty peak at 6357
Nifty October 27 low at 2253
Decline of 65%
12 months trailing Nifty PE at the Bull market peak: 28.3
At October 27 low: 10.7
Decline of 62%
Clearly we have overshot the average index decline of 51% that we have seen in previous bear markets, by a significant 13 percentage points. We have also seen large declines in index PE ratios - 4 percentage points more than the last bear market. Moreover, the PE on October 27 was an astoundingly low 10.7 - the lowest ever for the data since January 99, as I talk about in my post here.
This begs the questions - how much longer do we have to suffer such a market?
History tells us that there seems to be 3 ‘phases’ of a bear market:
First phase: A sharp initial fall - ‘capitulation’
Middle phase: A bear market rally on low volumes, where some investors a lulled into the false sense that the bear market is over
Final phase: Long slow downward grind in price where market valuations hit rock bottom
Clues that the bear market is coming to an end:
Indiscriminate selling leading to sharp falls
A major potential corporate or political crisis
Highly negative but irrational rumours about financially sound companies
Very low PE ratios for blue chip companies - often in single digits.
Based on history and what we’ve seen above, I’d wager that we’re at the beginning of the final phases of the bear market. We have seen a lot of volatility, and quite a significant rally over the last week, from 7967 to over 10,000 - a rally which seems to be coming to an end as I write this.
Globally, we have already seen unprecendented collapses in the banking and insurance sector - AIG, Lehman, Bear Stearns, HBOS etc. just to name a few. We haven’t seen an bankruptcies / defaults in India at such a significant scale, although rumours of ICICI bank collapsing, and then Unitech defaulting were rife. As far as PE ratios are concerned the Nifty’s trailing PE was at its lowest in a decade last week. All these point to us having crossed the bottom.
Do note however, that the 7697 low was not lower than the previous bull market’s peak, something that seems to be a pattern. Moroever, as I reported here, FIIs have only pulled out 20% of their investment in India, and I expect that this is not the end. Whether they like it or not, they may be forced to pull more out of our market even at these attractive valuations, in order to meet liabilities or liquidity pressures due to redemptions.
Well, the interest rate cycle has already turned, indeed quite aggressively with the Congress government trying do do everything it can before the elections in March next year, including leaning on banks to cut rates (which has worked). Inflation is on its way down, so that’s also pretty good news. Corporate earnings results have been really bad this quarter and we might see another couple of quarters of bad results before they start to improve. Therefore I think there is a lower bottom down the line. When will we see it? After another round of FII money getting pulled out, optimistically, I think we’ll probably see it over the next 6 months, pessimistically - given the grave global scenario - 12 months. That would make the bear market period 15-21 months.
As far as recovery is concerned, ’strong economic fundamentals’ can be cited in favour of the arguement for a shorter horizontal period. Fundamentals, however, doesn’t really seem to help when the global economy is in the toilet, and there’s no foreign money to push the market back up to the levels that it saw in this bull run.
The crash of the Indian Stock Market since January 2008 has been widely attributed to FIIs pulling their money out to meet liabilities and redemptions. According to this article, however, FIIs have only pulled out $12.7bn and still have another $53.7bn, or almost Rs. 270,000 Cr. left in the market.
A lot of market experts are talking about the market being near the bottom (”Valuations just cannot get any cheaper! The Indian growth story is sound, even at 7%!”) Let’s be clear on this: these falling prices are not about fundamentals - its simply about lack of liquidity. FIIs are not exiting the market because they want to, but because they are being forced to - nobody wants to book such massive losses, and nobody would argue against the fact that as an emerging market India is looking pretty cheap.
The fact that there’s so much FII money still in the market - 80% - is quite scary (more…)
So this is what happened in the US. Banks started giving mortgages to people who had a poor credit record (sub-prime), and clearly couldn’t afford to pay back the loans. They knew this but thought that since house prices would always go up, borrowers could always refinance their loans against the additional equity due to appreciated house prices. Alternatively, banks thought that they could take over the defaulter’s home and sell it for higher than the original loan amount. Of course, what brought the house of cards down was the fact that of course house prices didn’t continue to go up: borrowers defaulted en masse so banks were stuck with a ton of houses (increase in supply of houses), and since they now stopped lending to people who couldn’t afford to pay, demand for houses fell. Falling house prices lead to more defaulting, which lead to a further fall in house prices and so on.
Why wouldn’ this happen in India? Two words: Black money. Property in India is purchased using both declared income, on which taxes have been paid (white money) and undeclared income, on which taxes haven’t been paid (black money). When a borrower takes out a mortgage in India, he’ll obviously only get the loan for the amount paid in ‘white’. However, if he defaults, the bank will take possession of the entire house, which is probably much higher in value because of the ‘black’ component. Only if there is an extremely aggressively fall in real estate prices - so much so that the black component is wiped out (which given our fairly strong domestic economy, is unlikely), do we have something to worry about.
So black money serves as a protective cushion - who would have though it?
What’s different: Our groundbreaking Member Rating System
It zeroes in on the high performing Investors and Traders so you’ll know who to follow.
We believe that a member rating mechanism is the most important part of any investment community. We believe that our algorithms are superior to any others available in the Indian market.
We are keeping the site invitation only, so please register your interest above
In this meltdown of stock market, realty sector is bleeding the most. It is down 65% from its peak. The sector is under performing due to hardening interest rates and rising commodity prices. Many of the realty are now available at attractive valuations as a result of re-rating in this sector.
One of the growth pick in this segment is HCC. HCC is an integrated group with eight decades of experience and has interests in construction, real estate, and infrastructure development. HCC specializes in technical complex, new age construction in infrastructure projects, as well as EPC, BOT, integrated projects and townships. (more…)
One of our reader’s comment on Gautam’s post brought up an interesting point, regarding oil and it’s affect on the dollar (and by association the rupee). The question arises: Why has the Rupee done an about-turn against the dollar? The Dollar Smile Hypothesis developed by Stephen Jen at Morgan Stanley helps explain the correlation.
In very general terms, currency valuations are based on the growth rate of the particular nation. Since the US economy has been growing at a slower clip, the dollar should weaken against the global basket of currencies. We have seen exactly that, especially last year where we reached 39 Rupees a dollar from 46. However, a curious thing has occurred in just the last couple months: the dollar has in fact strengthened against the world’s currencies including the Rupee as we can see:
The theory suggests that the dollar has a convex relationship to US economic growth. Thus while it remains (more…)
There has been a lot of chatter in the market about FIIs staying away from the Indian markets because they feel that the valuations in India are still relatively quite expensive. Index PE ratios, when looked at in comparison to historical levels are a good way to determine how cheaply/fairly/expensively the companies that make up the index are relative to their historical levels.
But first, an explanation of how an ‘Index’ is calculated: There several ways to create an ‘index’ but the method commonly used is the ‘free float market capitalisation methodology’ where very crudely Indices are calculated adding together the market capitalisation of each of the companies chosen for that index based on some sort of criteria, dividing that figure by the sum of the market capitalisation of those companies that met the same criteria in a base year and then (more…)
Marshall Wace has taken the concept of social investing / wisdom of the crowd investing to a whole new level. These guys created a trading system called Trade Optimized Portfolio System (TOPS), which basically ranks analysts from brokerages on the performance of their tips, benchmarks them, and follows the investment recommendations of the best performers. They’re not exactly small fries either - with an estimated $15bn dollars in Assets Under Management (AUM), they’re responsible for some 3-4% of the daily volumes of all equites traded on the London Exchanges, and are ranked amongst the 10 biggest hedge funds in Europe.
As one investment banker put it, the idea behind TOPS was simple (in concept, though probably fairly complex in the algorithms used). It was the equivalent of ’skimming the cream to get the best investment ideas’. The incentive system is clearly in place, as well - if you rank highly according to the the ranking table spat out by the TOPS system, then Marshall Wace will not only take your advice, but transact through your brokering outfit - and this means millions of dollars in (more…)
Until a few weeks ago a target price of $100 for crude would have been laughable. The market seemed sure prices would steadily climb towards $200.
So what has happened since then, other than the 25% fall in price?
For a start, many people now predict a fall in global demand, as economies adjust consumption in light of growth forecasts and the high price. This reduction in planned consumption has released the pressure which kept oil at $140 per barrel.
However, it was well known several months ago that further rises in the price of oil would damage the economy; in other words that $200 was not sustainable.
Why then were we so happy to believe prices would continue to rise, and why are we not now revising growth forecasts back up, in light of the recent fall in oil price?
That growth forecasts are not being seriously revised is due to tight global credit markets and perceived instability in the financial system restricting investment, while commodity price inflation is still hurting consumers’ real spending power.
The question of why we were willing to believe oil would continue to rise is more challenging: I believe the markets underestimated the speed with which the US credit problems would spread to the real economy outside the US. This led to an early reduction (more…)
*Update*: MoneyVidya.com has launched a credible stock picking community for Indian investors and traders. Our groundbreaking Member Rating System zeroes in on the high performers, so you’ll know who to track.
We’re currently in development but will be releasing our alpha soon. We’re going to keep our community private, because we’re really keen on ensuring that our early adopter base is made up of knowledgeable and enthusiastic traders and investors. Register your interest here.
I believe that retail investors – that is those of us that invest in the stock market – have the odds stacked pretty heavily against us. The biggest one really being that we’re pitted against large institutions – people who have had far greater resources in terms of research and analysis, and indeed training in high finance.
Even if we did have all the resources, and the knowledge, we just wouldn’t have the time. The guys working for large investment banks, literally do this for a living, and many retail investors – well, don’t. We have day jobs – and most of us cannot watch the trading screen and read research papers all day.
Despite being aware of these facts, we continue to choose to invest directly. Why? Because of the allure of high returns, the thrill of picking the right stock, and the excitement of watching our stock move in the right direction. Moreover, we like being in control of our own finances.
One keeps hearing all sorts of anecdotal statistics from various studies – one revealed that over a decade, only 20% of asset managers managed to beat the S&P 500. One can react to this statistic in two ways: either the retail investor thinks to himself that if sophisticated financial analysts have such a poor record, they don’t stand a chance.
Alternatively, they might think to themselves that the belief that ‘investing is best left to professionals’ is false. I tend to agree more with this view. If anything, statistics such as these should only serve to further encourage retail investors to participate more actively in the market. If professionals have such a poor success rate, we might as well give it a shot ourselves (more…)
I read a really interesting article about ‘prediction markets’ in the McKinsey Quarterly about a month ago – and its really stayed in my mind. The idea really appealed to me. Many companies, most notably Google are essentially setting up futures markets to make more accurate predictions about important events (more…)
The articles in this blog are personal opinions of the authors' and should not be construed as investment advice.
What I'm Doing...
@hawkeye the answer is to put together a citizens interest/lobbying group but w/ funds, large number of people and an abilty to influence. in reply to hawkeye2008-11-28
#mumbai Evidence of 40 terrorists having landed in Mumbai (NDTV). So where are the remaining 30? 2008-11-28
#mumbai I'm involved in chain emails of anger. Divisiveness, however is not the answer. Reactionary responses are irresponsible. 2008-11-28
One of the underlying assumptions of technical analysis is that stock and index prices follow trends which are determined by the interplay between numerous forces which affect price. These can be broadly split into four categories; economic, monetary, technical and psychological. Depending on the direction of these forces, traders in a stock fall into one of two groups; bulls plan to buy now sell later and benefit from a price rise; bears plan to sell now buy back later and benefit from a price fall.
