The ongoing rally in the stock market has been striking a discordant note, primarily due to the exuberance displayed in stock price movement even as the world grappled with the worst health-care crisis in a century.

But there is a method in the seeming madness displayed by the stock market and this becomes apparent when the up and down cycles recorded by the Sensex over the last 50 years are examined. While in the initial phase, the reversal in stock prices from bear market lows may seem disconnected from reality, the optimism appears justified when seen in hindsight.

A study of the past cycles in the Indian stock market benchmark, the Sensex, since 1979 (data prior to this is hard to acquire) reveals that the past bull markets or the up-cycles have been very strong, resulting in average gains of 382 per cent. They have also lasted over many years, interspersed with minor corrections and prolonged sideways movements. More important, the up-cycles have coincided with important turning points in the economy.

While it’s true that there is lot of froth building up in the Indian equity market at this juncture and a correction will be useful to temper the speculative fervour, the current up-cycle has the potential to extend for much longer, albeit with intermittent corrections.

It ain’t done yet

The sharp upward movement in stocks since the pandemic low recorded last April may have been startling, but when stocks record a steep decline in compressed time-frames — the 2020 correction shaved off 34 per cent of Sensex value in just three months — the reversal is equally swift as investors get a whiff of revival and rush to bargain hunt.

The market decline in the first quarter of 2020 corrected one of the longest bull-markets in Indian markets, which lasted more than 10 years and made the Sensex gain 421 per cent from the March 2009 low (see adjacent table). Up-cycles in India have been quite strong and have unfolded over many years. We have considered decline in Sensex exceeding 30 per cent as the end of an up-cycle.

With the exception of the dotcom rally between November 1998 and February 2000 when the Sensex gained 124 per cent, all the other bull markets have resulted in the Sensex gaining more than 300 per cent. The pre GFC bull market between 2003 and 2008 was the strongest making the Sensex gain 623 per cent in five years. The up-cycles have also lasted much longer than down-cycles which have been relatively short-lived. There have been long-dawn consolidation phases within these upcycles and also many sharp corrections of 20- 25 per cent. The bull market from the GFC low and the rally between 1979 and 1986 were particularly prolonged and interspersed with extended periods of sideways movement.

The market down-cycles have, on the other hand, consumed lesser time, at times lasting just few months. The structural trend in the India stock market is up, resulting in buyers willing to support stocks in sharp market declines, thus stemming market corrections. Similarly, the structural up-trend results in buyers willing to purchase at stretched valuations, leading to speculative excesses.

Method in the madness

To a layman the precipitous declines and steep rallies may seem irrational, originating from the twin emotions of greed and fear. But a study of the past bull market shows a strong fundamental underpinning to these bull markets. Let’s begin with the up-cycle between April 1979 and June 1986 that lasted 96 months and took the Sensex 431 per cent higher. While this was the pre-liberalisation period, the seeds of economic reforms were sown in this period.

This was pointed out in the paper by Arvind Panagriya in an IMF working paper, “India in 1980s & 1990s: A triumph of reforms”, where he says, “The fragile but faster growth during the 1980s took place in the context of significant reforms throughout the decade but especially starting in 1985. While this liberalisation was ad hoc and implemented quietly, it made inroads into virtually all areas of industry and laid the foundation of the more extensive reforms in July 1991 and beyond.” Stocks seem to have reflected these nascent reforms, resulting in the first prominent bull-market of the country. The period between 1988 and 1992 was very eventful for the Indian economy with GDP growth hitting 9.6 per cent in 1989 thanks to the initial set of reforms, to be followed by the balance of payment crisis and the consequent economic liberalisation. The stock market recorded two large up-cycles interspersed by a down-cycle in the four-year period.

The period 2003 to 2008 was another watershed phase for the economy with 7- 8 per cent growth, led by infrastructure and real estate. Exports surged and companies embarked on large capital expenditure projects. The gains in the bull market between 2003 and 2008 were the strongest, at 623 per cent.

Another economic upheaval

No one will dispute the fact that the Covid-19 pandemic has disrupted lives in unimaginable ways and has made the government kick-start some far reaching reforms towards improving manufacturing, boosting exports and helping farmers. Listed companies have also managed a robust growth in earnings in FY21, justifying the trust that stock market placed on them.

Going ahead, there are various triggers that put listed companies on a strong footing including lower interest rates, deleveraging by companies, higher public spends by government and revival in real estate demand.

With new-age tech IPOs lining up, the market capitalisation as well as the valuation of Indian markets is likely to move higher.

That said, correction in the benchmark indices of 10-15 per cent from current levels is par for the course and is necessary to remove the speculative froth that is currently building up in many pockets. There could even be a consolidation phase for an extended period, even exceeding a year.

But going by past up-cycles, investors should stop trying to time the market and take a disciplined approach to investing in equities.