The severity of a bear market can be assessed by some key factors. One is the degree of capital loss in the overall indices. Another is the breadth of impact across sectors. Another key variable is the time span. How long will prices trend down? Sometimes a very severe downturn is not of very long duration. Or, a single high-weighted industry doing badly may pull down indices while share prices in other sectors aren't impacted so badly.
A sudden burst of panic may have a dramatic impact. But if an investor retains his nerves through such an event, he or she could ride it out. Quite often – in 1992-93 and in 2008-09 for instance – index values dropped by over 50 per cent in a year. But on such occasions, a sharp recovery is also on the cards. Perhaps this is because valuations drop to compelling levels, bringing bargain hunters into action.
A market where valuations are being affected by problems in one high-weighted sector can also be handled, if it's identified in time. The investor needs to re-jig portfolios to be underweight in that particular sector and also braced for trouble in sectors with linkages to the problem area. For example, problems in the energy sector will have a greater impact on power-intensive industries.
We see a related situation when a flat market is driven up by a boom in one specific sector. The global IT – Internet boom of 1998-2000 for example, saw little positive movement in stocks outside the charmed circle of ICE (infotech, communications, entertainment). Similarly, the 2006-07 US boom was driven almost entirely by a real estate bubble. Manufacturing and other sectors were flat.
In many ways, the worst situation for an investor is a long bear market, where every sector or almost every sector is slowly losing value. In such a situation, bargain hunting doesn't come into the picture to shore up values. There's also no way to isolate the damage. So it becomes a question of waiting for an indeterminate time and gritting one's teeth and bearing losses.
The period between 1995-1998 and 2001-2004 both saw long bear markets of this nature. The market drifted sideways, or down, over a long period. There were phases of panic interspersed with recoveries within those four-year timeframes. But net-net, investors suffered losses and once we adjust for inflation, they suffered significant losses.
The period between November 2010 and now has been similar in nature. There's been a gradual erosion of capital and the broad movement has been down. Some sectors have done better than others. There have been periods when the market has moved up. But there's been no escape route for the long-term investor.
Such situations cause uncertainty in terms of both time and quantum of loss. The time factor is always uncertain in any case. But a sharp, short bear market sets up a situation where there is effectively a floor on valuations. The investor who has bought near the floor doesn't mind waiting for a recovery. At least, he has the confidence that he won't suffer capital loss. A long drifting bear market has a downside, in terms of potential capital losses as well as the time-uncertainty.
In such situations, the pragmatic strategy is to continue index-based systematic investments and wait for lower valuations when the odds favour going overweight in equity.
To identify attractive levels for going equity overweight requires building scenarios that take both time and valuations into account.
For example, we can say from historical data that any investor buying at a current Nifty PE of 14.5 or less has made money in a two-year timeframe. At an assumed earnings growth of 15 per cent, a current PE of 14.5 translates into a one-year forward PE of roughly 12.7 and a two-year forward PE of about 11.25. If the assumed earnings growth rate is less or more, the forwards are correspondingly higher or lower.
When valuations fall within the assumed range, investors can go overweight. This helps them to accumulate at better prices. But of course, the timeframe remains uncertain. In this sort of bear market, prices can go sideways or remain depressed for very long periods.
In practical terms, two things could help pull up prices in a sustainable fashion. One would be a turnaround in the global economy. That could push up exports and bring in foreign investments (both FDI and portfolio). Projections suggest a global improvement won't happen for another year at least. The other thing that could push up prices is signs of more decisive policy making by the Indian government.
We may have to wait for the next general elections before that happens.