Is the market at the bottom?
November 5th, 2008
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)
- Tipping point: Harshad Mehta
- Lasted for 56 weeks (just over a year)
- Sensex Peak at 4547
- Sensex Bottom at 2073
- Decline of 55%
- Time taken in days to cross previous high: 881 (2.5 years)
- 6 months return from the bottom: 34%
- Lasted for 116 weeks (over 2 years)
- Sensex Peak at 4643
- Sensex bottom at 2736
- Decline of 41%
- 12 months trailing PE at the the Bull market peak: 32.9
- At the Bear market bottom: 15.1
- Decline of 54%
- Time taken in days to cross the previous high: 1765 (5 years)
- 6 months return from the bottom: 42%
- Tipping point: Dot-com bubble bursts / Ketan Parekh scandal comes to the fore
- Lasted for 84 weeks (around 1 year 7 months)
- Sensex Peak at 6151
- Sensex Bottom at 2627
- Decline of 57%
- 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%
- 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.
- 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
- 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.
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