The global equity markets
have been overly volatile over the past few months. This has left many an
investors gasping for breath. Now, if somebody studies the great bear market
bottoms of the last century – 1907, 1921, 1932, 1949, 1974 and 1982 from where
equities multiplied in the coming years along with the study of human behavior,
mass psychology, behavior finance and the “madness of crowds” spanning back by
around last 500 years including the minor financial revolution of the 1550s,
troubles of Henry VIII, Francois I, the Fuggers, the Genose and eighteenth
century “madness of crowds” like the South Sea Bubble, Tulip Bulb craze and the
Mississippi bubbles, then certain conclusions can be drawn from history.
What do
we learn from financial history? How do we identify a great bear market bottom?
There are lots of factors which are common to the great bear market bottoms.
However, it’s very difficult to anticipate it. Some of the common factors which
we find at bear market bottoms are as under. Also, the current positioning of
the Indian markets in regards to them are given alongside:
Ø Commodity price stabilization: There should be stabilization in prices of
commodities which precede an equity market rally. The most important commodity
which is of prime importance in determining the stabilization of commodity
prices turns out to be copper. This is currently happening globally.
Ø Price stabilization: Improving demand for certain goods at lower levels,
particularly autos. This has still not happened currently in India but it seems
that we are going through the worst phase for the auto industry and it is
likely to improve over the coming months.
Ø Reduction in Central Bank controlled interest rates: This has worked in all the great bear market bottoms
of the last Century in the US – 1907, 1921, 1932, 1949, 1974, 1982. RBI policy
is one of the most powerful tools in determining the equity market bottoms
because there is no other factor as important for equity valuations as is
interest rates – it affects the profitability of companies through change in
the finance and interest costs, valuations through change in discount rate and
competes with equities for the same investment surplus.
Ø Rally in Government Bond prices: The rally in Government bond prices has preceded a
rally in high grade corporate bonds which has preceded a rally in equities with
the exception of the 1949 great bear market bottom. However, that was an
abnormal period when the Fed was controlling its policy interest rates due to
the extra ordinary deflationary fear prevailing at that time post World War II.
Currently, in India, 10-year GSec yields at 7.15% are closer to 3 ½ year
lows.
Ø Rally in Corporate Bond Prices: Rally in high grade corporate bonds follows rally in
Government bonds (except in 1949 as described above) while precedes rally in
equities. This phenomenon is currently playing out in India.
Ø Rising volumes on strong stock market and falling
volumes on weak stock market – this has still to be established in the current
Indian markets.
Ø Rising Short interest and the reluctance of shorts to
cover on rising equity prices.
Ø Positive signals from Dow Theory: Of all the technical methods, Dow Theory was the only
one which correctly predicted the bottom at all the major bear market bottoms
of the last century in the US. Every bottom in the Indian indices is a higher
one and each subsequent “corrective move” is shorter in time and value.
However, the rally in the large cap indices has turned very narrow and
confirmation is required from the mid cap indices.
It is not
that a new bull market has begun for Indian equities but maybe we are close to
some kind of a bear market bottom in the Indian equity markets. To conclude,
the conditions seem to suggest that the bear might be losing stream. However,
that does not mean that the new bull has taken birth. The new bull may take
birth only when certain macro factors like growth, inflation, interest rates,
currency, deficit, corporate earnings etc stabilize or appear to be stabilizing.
