The Retreat Of The Great Bear

The bear market is following the pattern of a fast retraction. One hopes this pattern continues. A quick fall leaves investors wounded but alive. A long bear market that drifts down for years on end causes far more damage because of the compounding effect of the cost of carry.

In the 1992-93 bear market, the market value erosion was 57 per cent in 12 months. Between 1994-98, the market indices lost around 42 per cent. But the cost of carry meant that the effective losses were higher in 1994-98.

Any discount rate higher than 10 per cent would mean the 1994-98 bear market lost more. In practice, far higher rates were safely available _ the PPF gave 12 per cent for example. IDBI flexibonds yielded 14 plus.

 

To understand this, assume a discount rate of 10 per cent and a principal of Rs 100. There was Rs 43 left after market losses in 1992-93. This is 39 per cent of the Rs 110 available at 10 per cent. The real loss in the 1992-93 bear market was thus around 61 per cent. After 1994-98, the investor was left with Rs 58 versus a possible Rs 146.41 at 10 per cent compounded. That is again 39 per cent. Any higher cost of carry means much higher losses for 1994-98.

There are two scenarios where the bearishness ends quickly. In both cases, the market will fall further. One is that real interest rates will come down and the economic expansion will continue in 2000-01. That will happen only if inflation rises sharply from the current 4.65 per cent.

The other possibility is that the government realises that it is on the brink of an internal debt trap very soon. In that case, more reforms may occur after a six-year hiatus. If infrastructure is opened up because the government runs out of resources, that would immediately boost sentiment.

The revival would be even more marked if the insurance bill is finally passed, subsidies cut further and PSUs sold.

The scenario of rising inflation looks more likely. This would improve credit offtake right now, an estimated 9 per cent of potential credit in excess of SLR (statutory liquidity ratio) is lying with banks.

Unfortunately this would merely be a cyclical improvement, the real problems would remain untouched. It is sad but true that one cannot see a market revival without either high inflation or another fiscal crisis.

Meanwhile, many stocks are already back into interesting value zones. There could be another sharp fall precipitated by a fiscal crisis. They could get cheaper slowly and painfully if reforms remain a topic of cocktail party description and real interest rates don't cheapen sharply. India doesn't have too many defensive stocks FMCGs just about qualify, everything else is a growth play that is apt to cyclical swings. So I would wait the triggers for revival described above will be fairly obvious.