Bear market ahead?

Stock market crashes, it would appear, bring out the best-or should that be the worst-in e-mail forwarders. Last fortnight, some time when the BSE Sensex was headed southward-by 542 points on July 27, 615 points on August 1 and 235 points on August 6-an e-mail did the rounds stating that previous bull markets reached their tops in years ending in '7,' after which came massive sell-offs, marking the beginning of a bear cycle. The market in question here is the us bourse which, according to the mail, crashed 40 per cent in 1917, 10.2 per cent in 1927, 49.1 per cent in 1937, 24 per cent in 1947, 19.4 per cent in 1957, 25.2 per cent in 1967, 26.9 per cent in 1977, 35.1 per cent in 1987, and 13.2 per cent in 1997. The clincher? The majority of the sell-offs began in July-August!

To be sure, the e-mail forward isn't the work of an idle, panic-mongering punter, but based on what's known as the decennial cycle of the 20th century. As per this theory, the us markets typically bottom in a year ending in 2, peak in a year ending in 6 or 7, before rising to another peak in a 9 or 0 ended year. Since 2000, the decennial cycle has been true to form so far, with the US markets bottoming out in October 2002. The trillion-dollar question? Have the markets peaked out in 2007, and is a global bear market in the works?

Theories aside, last fortnight's global turmoil was triggered by concerns of a slowdown in the US economy, set up in turn by a giant wobble in the housing market. Whilst the Dow Jones plunged by 6 per cent between 23 July and 3 August, all other major markets went into crash mode, signaling perhaps the onset of a global bear market.

Are things really so bad? And should the Indian markets-which seemed pretty much self-assured till only recently as the Sensex spurted from 15,000 to 15,869 in just 13 days-be really that concerned about catching the flu? Says U.R. Bhat, Managing Director, Dalton Capital Advisors: "It's an indirect impact. It (the Indian market) has been more liquidity-driven than a market riding on fundamentals. Concerns of a slowdown in inflows from foreign institutional investors (FIIs) have turned the sentiment bearish." That concern is manifest in the selling by domestic mutual funds in July, even though the FIIs were buying. In July, FIIs pumped in over Rs 18,500 crore ($4.5 billion), as against a Rs 900 crore outflow from funds.

However, by the first week of August even the go-go FIIs had battened down the shutters. Says Suresh Soni, Director & Chief Investment Officer, Deutsche Asset Management: "In the immediate term, markets would be driven by the movements in global equity markets. The us sub-prime mortgage issue is a us-centric problem and is unlikely to affect some of the key long-term drivers of the Indian markets like the strength in manufacturing and the strong domestic consumption. But if this issue leads to reduction in global risk appetite, then further volatility cannot be ruled out. In the immediate term, Indian equity markets will largely mirror the movements of some of the key equity markets globally." Adds Sandeep Sharma, Head-Private Banking (India), Societe Generale: "The sub-prime mortgage troubles may worsen, with worries now spreading to investors (hedge funds and private equity players) holding securities backed by these mortgages."

Whilst lower housing prices in the US have doubtless spooked investors globally, back home it might have also been a case of punters unnerved by an arguably overheated market deciding to press the sale trigger. The US crisis in that sense was just what wannabe sellers were looking forward to. After all, the Sensex is trading at a price/earnings multiple (P/E) of over 21 on a trailing basis, and 19 times on forward earnings. As Soni says: "There are markets across the world that are still cheaper than India." What's more, earnings of companies that make up the Sensex are lower than they were in the previous five quarters, and their operating margins are also under pressure.

For the first quarter these margins grew by 17.8 per cent, compared to 35 per cent in the fourth quarter ended March 2007. Says Bhat: "The room for error is much higher than the room for appreciation, as most of the positives in the market have been discounted." The silver lining of last fortnight's brutal dive is that Indian equities finally got the correction they deserved.