BSE Sensex down 35%.What to expect now?

Vivek Bhargava

A question that is on every investors mind is what to do now. BSE Sensex has tanked by 35% since the peak of 20869 on 9th January 2008 to a close of 13454 on 4th July 2008. The mid cap and small caps have lost a lot more, wiping out the gains made over the last two years. The problem is should one cut losses and get out now or just wait till things improve.

Deluge of bad news

Bad news has been coming from all directions to make things worse by the day. It started with the sub prime crisis in the US, which led to the collapse of the US financial system, compounded further by a steep rise in the price of oil by more than 50% over the last six months. The world is going through one of its worst periods and the Asian markets have also been caught in this mess.

Various market experts and economists world over have differing opinions on what’s going wrong, when things will turn around and what should be done to overcome this downturn. But there is almost unanimity in the belief that the US markets are in a recession and the world is caught in a stagflation putting the Central Banks of developed economies in a dilemma.

Key points
Any effort to contain inflation by raising interest rates is likely to put the economies into a deeper recession and keeping interest rates down is likely to stoke inflationary fires. Everyone is digging into historical references to evaluate and find answers. In all this one thing is sure, the world needs to go through a structural adjustment phase in terms of commodity prices, equity markets, housing prices, currency rates, interest rates, etc, all of which are related to each other. And this process will take time.

The key points that seem to come out of the various discussions may be summarized as under:

1. US consumer confidence, which is already low, is likely to dip further once the impact of over a US$ 100 billion US economic stimulus package, dissipates over the next quarter or so.
2. Housing prices are falling in the US and are likely to bottom out only sometime next year.
3. Falling housing prices will put more pressure on the banking system in the US and Europe.
4. Credit card institutions are seeing increasing delays in collections from its 52 million customer base whose average credit rollover is around $5000.
5. Most developed economies are believed to be or getting into a recession.
6. Asian economies, which supply goods and services to the developed economies, are also likely to see a much smaller growth rate going forward.
7. Oil prices have been projected to touch $ 200 a barrel by end 2008, but there are varying opinions on what really will happen.
8. With expectations of a high inflation, commodities seem to be the most preferred investment. Equities are definitely considered a bad alternative, while bonds are also likely to lose as interest rates are raised to contain inflation.

Indian situation
In India, we have added problems on the political front. This is the election year and it is widely believed that the government will try to fight inflation, which has already run away from 4-5% levels a few months ago to over 11% now, in every which way possible. Cement and steel companies are being forced to cut prices. Exports of key agricultural commodities have been banned to keep domestic prices in check. The subsidy bill of the government is likely to push up the fiscal deficit – directly or indirectly. Capital has become scarce and costlier. Government spending in infrastructure will get squeezed going forward.

Coming from a situation where corporate India has had an easy going over the last 4-5 years, the outlook must appear quite grim. Many of the companies that had announced major investment plans might be forced to defer them till a clear situation emerges. The increase in commodity prices has been hurting profit margins during the last two quarters and things might deteriorate further in the coming quarters. The crash in the stock market and the ongoing correction in the real estate market, coupled with scarcity of capital, may adversely impact the consumer purchasing power going forward.

Bear grip getting stronger
So whether we look at India or the world at large, the outlook has definitely soured over the last 6 months. The global markets have entered into a bear phase, and going by historical experiences, bear markets can take at least 12-18 months to bottom out. Since we are witnessing a global meltdown, this could be a longer bear market and therefore we might still be quite far away from a bottom.

Considering that the bull market had started in 2003, when the Sensex was around 3000 points in May 2003, we need to get the perspective right. The Sensex had gone up 7 times over a period of 4 ½ years and is still more than 4 times the level it was at just 5 years ago.

The market crash till now has only been on expectations of bad days ahead, but we are still to see the bad news hitting growth and corporate earnings. And when it does, the going for the markets will actually get worse. Bad news has a way of feeding on itself to bring down markets to new lows during a bear phase, and the second phase of the bear market is actually much worse than the first fall, which always seems like a bull market correction.

So what does all this mean?
The answer is never simple and I am not sure if any one can say with certainty. The only thing that is certain today is that the risk reward ratio is not favorable in the foreseeable future. The melt down will most likely continue as the risk appetite of investors keeps going down and the panic increases. This is obviously not going to be a downward sloping straight line. There will be technical bounce backs because of oversold positions and also because market may have declined ahead of the bad news or because the bad news is not as bad as it was expected!!

Having lost more than 20% in just seven weeks, where several stocks have lost more than 50%, the market definitely appears to be oversold for the time being. And it seems to be the case with most global markets. With the earnings season for the quarter ended June 2008 just about to begin, we are likely to see the markets reacting positively creating a fairly broad based rally across global markets and also in India. But let’s not get fooled by this rally. Investor would do well to take this opportunity to withdraw money from the equity markets. Cash is always king in a bear market!!

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