Thursday, 6 June 2013

In Search of the Bull’s Birth

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.   


  1. Very good analysis.
    The global slowdown could actually be a blessing in disguise for us as our inflation recedes allowing us to cut interest rates and restart the investment cycle. While the real economy may have hit the bottom, the markets are trading at mean valuations. A tough call on whether one should enter cyclicals at the moment.

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