Don’t expect a quick recovery

Don’t expect a quick recovery. That’s the conclusion from our ‘8-year’ equity cycle model. To support the model’s conclusion are weakening fundamental and economic factors, which suggest that a quick recovery in the Indian equity market is a far dream. The equity cycle though is a lead indicator that digs into past data and throws a likely trend. Having depicted a crash in 2008 post Sensex peaking at around 22k levels, the model now shows some pain before consolidation. For a small retail investor, it’s a boon. Such investors can now get the opportunity to accumulate at regular intervals for the next boom in the Indian equity market.

History: The 8th Year Itch phenomenon
When I first proposed the 8-year cycle in December 2007 for the Indian equity market, there were absolutely no takers for the theory. The reasons were valid. The equity market was in strong hands and in the midst of a terrific Bull Run. There was reasoning for every irrational behaviour. No wonder a model that showcased a sharp correction was completely ignored. Also, there were just three cycles before 2008 (for which data was computed) and data was marked by home grown scams. That could have put off some investors. What was however ignored was the fact that these three 40% plus corrections occurred over 28 years (though, Sensex was officially launched in 1986, it has a base of 1978/79 and is back computed). These data points appeared strong enough to base a theory and confidence sparked from the fact that trend lines were replicated every eighth year, though the band inched higher every cycle. So, in all probability, the correction had to happen.

The 40% Plus Corrections
1984 – Riots, Assassination, Bhopal Gas Tragedy, Economic Crisis
1992 – Harshad Mehta Scam
2000 – Ketan Parekh Scam/Dot com bubble bust
2008 – Sub prime meltdown

And then, one fine day in January 2008, it all came raining down. Sensex tanked and within a few trading sessions lost over 25%. Since then a lot has changed, fundamentals have deteriorated and economic events worsened. The Sensex is struggling to regain lost glory. If the cycle is to be believed, the recovery may not happen as yet. There’s still some pain left.
As evident from above, the corrections in every cycle were steep and fast. This was followed by a long cooling period, which could be 15-25 months. Once the base is built, the benchmark index swiftly moved up to achieve the earlier top that takes 27-46 months. At these levels, bouts of profit booking occurred from investors who believed a healthy correction was needed for markets to smoothly sail ahead. Eventually the underlying momentum on the back of strong fundamentals came into play and the index zoomed ahead to make newer highs.

The Current Phase

The 2008 cycle, in all probabilities, is the latest cycle. The benchmark index has corrected 30% odd and has witnessed some bounce back. If the cycle is to be believed, we may see some more pain in the offing – 10% or more.

The bounce back lacks strength. If you observe the chart below closely you would see that once the correction started, the Sensex has made lower tops and lower bottoms. These are signs of weakness in the equity market.
Weakness in the current equity market is evident – oil issues, MTM losses, inflation concerns, fiscal deficits, and US subprime concerns among others. There is no escaping to this fact. The market knows all these and seems to have been factored such events. FIIs have already pumped out $5.6bn out of India and are reducing India Inc. ownership.

The other element one could consider is the US Presidential cycle. According to the theory, the US equity market bottoms out 1.8 years into the Presidential term. And recently we have seen that Indian equity market is not decoupled with the US market.

The Future

India’s long term infra led growth story stays. However, we need to go through the current pain in order to witness the new Bull Run. As of now, Sensex EPS is expected to slow down. A 10-15% range would take Sensex EPS to Rs 950 valuing the market at 17 times FY09 earnings. Looking at the current market conditions, it appears expensive.
All said, expected the unexpected. The equity market is a strange creature. It has a tendency to follow differently under similar circumstances. But, one of the investors would have learnt from the past is that emerging markets is difficult to emerge from post a fall down. So, don’t expect a quick recovery. Chill for a couple of years. As life takes a full cycle, so I guess, does the Sensex.

SOURCE: CNBC-TV18