The Hindu Business Line : Defining bear markets

Are we in a bear market? The question dominates media channels across global markets. Funnily enough, many experts seem to just shrug their shoulders and say, “Hard to say. You never know”. Apparently, you can only identify a bear market in hindsight.

Those of us who tuned into the markets only in the last four-five years probably have a tough time understanding what a bear market is. We have now seen quite a few 15-20 per cent ‘corrections’ since May 2004. Were those actually bear phases?

The most widely quoted definition of a bear market is an over 20 per cent decline from a recent peak in a key stock market index. For it to be a bear market, this weakness should persist for at least two months. Some experts believe that for emerging markets such as India, which tend to be more volatile, the correction needs to be steeper at 30-35 per cent. In bear markets, liquidity is extremely tight, volumes tend to be low and market breadth (the number of stocks that advance relative to the number that decline) tends to be poor.

A vote of confidence?

Needless to say, bear markets are dreaded. The bear market of 2001-02 saw the US S&P 500 shed more than half its value. That does not even compare to the bear market of 1929-1932, the onset of the Great Depression, which saw the Dow Jones Industrial Index nose-dive nearly 90 per cent.

The Indian markets have been in a corrective mode for the last six weeks or so. Having bounced back from the lows of the January 22 crash, we are now only 16 per cent below our highs. Should the recovery not be a vote of confidence for the Indian markets? Why isn’t anyone ready to dismiss the idea of a bear market in India just yet?

Well for one, many experts are beginning to affirm that the US stock market has entered a bear phase. Given that the movements in the Indian markets are closely tied to international markets and the US market, in particular, and the growing doubt that the Indian economy can completely de-couple from a US slowdown, market men are cautious and inclined to be pessimistic.

Dead cat bounce

There is another reason why such recoveries tend to be viewed with caution. In every bear market, there tends to be bear market rallies or a bear market pullback, where the market rises 10-15 per cent only to decline yet again. A dead-cat bounce, if you will. This listlessness in the market tends to affect investor sentiment more adversely. The bounce-back usually occurs when some stocks or sectors are ‘oversold’, to borrow a term used by technical analysts.

At this point in our markets, it is sentiment and expectations that matter the most. A market launches into a bull phase when sentiment turns buoyant, which is usually because of a series of positive developments that beat expectations. For example, Indian stocks have surged in the last five years as earnings growth recorded by Indian companies has constantly beat expectations. The slowdown recorded recently has been sharper than expected, which is a cause for concern. Bear markets occur when news flow tends to be worse than expectations, causing investors to sharply punish stocks or sectors. This has happened in the US where more bad news on the sub-prime front and US economy data has stifled even the briefest of market recoveries.

If all this talk is wearing you down, remember that great bear markets usually precede great bull markets. Understanding that markets work in cycles of bull and bear phases is essential for those who wish to own equity.

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