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Big Story | Covid-19 market crash: Is the worst behind us?

Lokeshwarri SK | Updated on July 04, 2020

We studied steep market declines in India and the US over the last century to understand how deep this correction can go. While economic growth is a worry, adequate liquidity, low interest rates and political will are factors supporting stocks now

Is it a bull market? Is it a bear market? Is it a bullish bear market or a bearish bull market? Questions like these are likely to be plaguing investors in Indian equity markets these days.

This confusion arises because the crash caused by the Covid-19 pandemic is one of the swiftest corrections in the history of Indian markets — shaving off around 40 per cent in just two months. But before anyone could blink, the Sensex and the Nifty 50 had rallied around 40 per cent from the depths in March.

Given the uncertainty around the extent of damage to human lives and the economy, investors in Indian stock markets are far from sanguine. Opinion is divided on whether the worst is behind us or there is more pain ahead.

To get some clarity on the above issue, we compared the ongoing market correction with the past declines in Indian market that had been short and deep. Our finding is that the current decline is quite different from the previous crashes in many ways.

This is the first time that stocks have crashed against the backdrop of an economic recession.

But the good news is that the hallmarks of a typical market peak that precede deep corrections — investors in a frenzied buying mood, rapid expansion in economy and earnings, and rising interest rates — were missing prior to this crash.

In fact, the mood among investors was quite sombre in 2019. That, along with the extremely low interest rates and promise of unlimited support from central banks are key factors favouring the stock market at this point.




Market crashes — then and now

The quantum of decline in the Sensex in 2020 — 40 per cent from the peak — is sufficient to qualify as a long-term structural decline.

A bear market occurs when benchmarks decline over 20 per cent from the peak, and a decline of over 30 per cent from the peak is generally considered a long-term correction.

The extremely short time span need not take away the significance of the current fall.

There have been three deep crashes in Indian markets since 1980 — in 1992, 2000 and 2008 — that exceeded 50 per cent and lasted 12-19 months. The trouble is that Indian stock indices have limited history; data for the Sensex is available only for the past 40 years.

To gain some more insight into how bad stock-market declines can get, we studied the US markets during two severe declines.

In the market slide from 1929 to 1932, that also marked the beginning of the Great Depression, the Dow Jones Industrial Average fell 84 per cent over two years. But in the market decline between 1966 and 1982, the decline was excruciatingly prolonged for over 16 years as the Dow declined 72 per cent from the peak. (More about this in the adjacent box.)

While the current market decline may not get as bad as the above-mentioned phases in the Dow, they serve to remind us how bad things can get.

How different is this crash?

The conditions that lead to the previous deep corrections in the Sensex and the Dow are, however, quite different in many ways from that which lead to the current decline.

This difference also helps us gauge the extent to which this decline can extend.



a) Economy in recession

The three market crashes in India mentioned above took place while the economy was growing, though growth contracted significantly in some periods.

There was less than one percentage point deceleration in growth during the 1992 crash.

When the dot-com bubble burst in 2000, growth declined from 8.8 per cent in 1999 to 3.8 per cent in 2000. Growth in 2008 declined six percentage point compared with 2007.

But this time around, we are facing “the worst recession since the Great Depression, and far worse than the Global Financial Crisis,” to quote Gita Gopinath, Economic Counsellor, International Monetary Fund (IMF).

The global economy is projected to contract 4.9 per cent in 2020, according to IMF’s latest World Economic Outlook (WEO).

India’s growth is projected to contract 4-6 per cent in FY21, according to various research houses.

The trouble is that these numbers are based on the assumption of the lockdown easing in the third quarter of 2020 and demand reviving soon. The numbers can look worse if the pandemic extends beyond March 2021.

According to CRISIL Research, India has faced only three recessions since 1950 (see table) — in 1957-58, 1965-66 and 1979-80.

A recession is marked by two consecutive quarters of de-growth in GDP.

But we do not know how Indian markets behave during recessionary periods due to the limited data on the Sensex. The behaviour of the Dow in the 1929-32 period can give us some indication of how much stocks can suffer if the economy goes in to a tailspin.

But before you press the panic button, here is some good news.

b) Absence of euphoria before the crash

All the five crashes considered by us had a few common features in the period preceding the crash. One, the crashes followed a period of robust economic growth that put more money in the hands of people and businesses.

This was the case in India prior to the 1992, 2000 and 2008 crashes and in the US prior to 1929 and 1966.

But the economic conditions in India were quite dismal prior to the 2020 crash, with GDP growth decelerating from 8.2 per cent towards the beginning of 2018 to 4.1 per cent towards the end of 2019, largely led by contraction in consumption. The earnings growth of India Inc reflected these dismal conditions, stagnating over the past five years.

Two, investor sentiment is usually extremely bullish before large market crashes as many years of extended uptrend attracts sections of the population that had hitherto avoided stock markets. Remember the adage: “When the shoe-shine boy starts giving you tips, it is time to exit the market.” This phenomenon was evident in India in 1992, 2000 and 2007, when your staid banker neighbour asked for stock tips or your sister-in-law began trading Nifty futures in her free time.

But this kind of euphoria was completely absent in 2019, when cynicism was dominant.

This was because, even as a handful of large-cap stocks led the Nifty 50 and the Sensex higher in 2019, mid- and small-cap stocks were plunging lower. Almost 77 per cent of stocks traded on NSE fell in 2019 and 47 per cent of the stocks lost over 30 per cent in value.

Investors were, therefore, far from ecstatic before the crash.

That brings us to the third feature — absence of valuation bubbles. Remember how technology stocks quoted an average PE multiple of 100 times prior to the dot-com crash in 2000?

The Sensex PE multiple and the price-to-book value were far higher than their long-term averages prior to previous market declines. While the valuation in of the Nifty 50 and the Sensex were pricey before the 2020 crash as well, the PE multiple of the Nifty Midcap 150 index was at 27 in December 2019, compared with 56 in January 2018.

With most of the stock universe down in the dumps, the over-valuation in 2019 was restricted to a handfull of high-growth stocks such as Bajaj Finserv and Bajaj Finance, and defensives such as Hindustan Unilever and Nestle.

The tepid conditions in 2019 are highly unlikely to set off a deep correction.

c) Interest rates plumbing new lows

All the major market peaks in India were formed in a period of interest-rate up-cycle.

Among the causes for the 1929 and 1966 crashes in the US markets were sharp interest-rate hikes by the US Federal Reserve to cool inflation. But this time around, interest rates were moving lower even before the crash.

The RBI had been steadily moving its repo rate lower, from 8 per cent in January 2014 to 5.15 per cent towards the end of 2019.

The sharp rate cuts to fight Covid-19, along with liquidity infused by the RBI, have taken deposit rates to a multi-decade low.

(Read more: ‘Savers’ plight: Interest rates across bank deposits, small savings at multi-decade low levels’ -

Low interest rates on fixed-income instruments work in favour of equity. Also, with the recent problems in debt mutual funds of Franklin Templeton and the default of debt papers of entities including IL&FS, YES Bank and DHFL, investors have no other recourse but to park at least a part of their portfolio in equity.

The situation is same worldwide, with interest rates at zero or negative levels in many advanced economies.

None of the previous market peaks occurred amidst such conducive monetary conditions.

d) Political will supporting markets

Another widely known fact is that US President Donald Trump wants the market rally to last forever. (We had captured this in the piece ‘Market and the Modi-Trump effect’ -

With the next US Presidential election slated in November 2020, Trump will be glad to keep stock prices at elevated levels.

But besides what political leaders want, global central bankers have been proactive in reducing the impact of Covid-19 on the economy, unleashing a flood of monetary and fiscal support. The lessons from the Great Depression seem to have been well-learnt as the principle objective behind the ongoing stimuli has been to stop businesses from closing down, and preventing job losses.

The attempts to control demand through monetary policy had been one of the triggers for the Great Depression.

With the Fed as well as other central banks reiterating that they have the assets to conduct further tranches of stimulus, if needed, it may be difficult for stock prices to break below the March lows.

How to read this market

Did the Indian stock market form a lasting bottom in March? A 40 per cent decline is sufficient to qualify as a long-term decline.

Also, while the economic condition is dire, the factors mentioned above — lack of bullish frenzy prior to the fall, low interest rates and political will — may have put a floor to this decline.

But the problem is that the Covid crisis is still unfolding and the pandemic is yet to peak. There is uncertainty over how long the pandemic will rage, whether there will be a second wave, if unlocking the economy will make the number of cases surge, and so on.

Against this backdrop, it may be better to be circumspect. A protracted decline as seen from 1929 or 1966 in the Dow needs to be kept at the back of our mind, though we all hope that does not happen.

Was the rally in May and June a bear-market pull-back or a continuation of the structural up-move? If we look at the time taken by previous market crashes to move past their previous peaks, the deeper declines in 1992, 2000 and 2008 took 5-8 years to break past the previous peaks. It was also seen that, in all the phases, the stocks tested the previous peaks multiple times before finally clearing it.

In other words, the ongoing rally could just be a pull-back in the market correction.

But the pull-back can take the index to its previous peak also. The most likely scenario over the next 2-3 years is a range-bound market with the indices yo-yoying between the March lows and the January peak.

That may give time for the economy to stabilise and the earnings to catch up. There can be plenty of buying opportunities and also many dead-cat bounces that lure in naïve investors. This is the positive scenario, assuming that the virus is contained in FY21. Ultimately, it all depends on how the pandemic evolves.

Deep dives in the Dow

The stock market crash of 1929 that led to the Great Depression is being cited quite often these days. Understanding the reasons that led to this crash can throw some light on the current market phase.

Bullish frenzy was at its peak before it all unravelled. Rapid economic expansion in the 1920s and a roaring stock market had attracted many new investors to the markets. Leveraged trading, using margin funding from brokers, was also rampant.

The Dow Jones Industrial Average was at 984 in November 1920.

By September 1929, it rose to 5,152, gaining over four-fold.

The trigger for the crash ranged from overpriced stocks and sudden interest-rate hike in August 1929 to agricultural recession. By June 1932, the Dow was at 807, down 84 per cent from the September 1929 peak. T

he panic that followed the sell-off caused a run on banks, leading to many banks and businesses closing down, making unemployment spike, with many finding themselves with no jobs and no savings.

There was a partial recovery to 3,377 by January 1937, but the Dow took almost three decades to move past the 1929 peak.


There was another prolonged period of pain for the US stock markets that began with the crash of 1966.

The Dow was on an extended downtrend between 1966 and 1982 that made it lose 73 per cent from the peak.

This crash followed a period of extended economic expansion for six consecutive years, a very low unemployment rate and manufacturing units operating at close to 90 per cent.

In the summer of 1966, a policy of monetary restraint led to conditions popularly called the ‘Credit Crunch of 1966’ that began the stock market decline that continued for 16 years.

A period of stagflation and high interest rates, interspersed with oil-supply shocks, exacerbated the conditions during the 1970s and 80s.

Published on July 04, 2020

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