How robust is the rally?

Markets have rebounded by over 2,000 points, or 25%, from their recent lows. We analyse whether the uptrend is sustainable in the long term.

It's a moment that comes several times during bear phases, a question that plagues every investor: is it the beginning of a stock market rally? The corollaries to this question are also standard. Should I buy now? Should I wait? Should I sell my existing portfolio? The reason such questions are being asked is optimistic, yet apprehensive. Since early March, when the Sensex hit a low of 8,160, the index has gained over 2,000 points, or 25%.

Will The Sensex Mirror The Dow?
Since the late 1990s, both the Sensex and the Dow have stabilised at pre-determined lows. While Dow breached it in early 2009, the Sensex is yet to do so. Does this mean that the Indian index will fall further, or buck the past trend?

This has made the bulls rush out from their hiding places to claim that the worst is over. "The end of all the previous bear markets has always been marked by extreme pessimism, desperation, large-scale earnings downgrades and capitulation. We have seen some signs of these now," says Amitabh Chakraborty, president (equity), Religare Capital Markets. He believes that the Indian markets have bottomed out.

However, this theory has some detractors. "What has actually happened is a rub-off effect as the Indian markets are now strongly linked to the global ones," explains Sudip Bandyopadhyay, director and CEO of Reliance Money. What he implies is that the Sensex has taken cues from the Dow Jones index in the US, which reacted positively to Citibank's announcement that its operations had turned profitable in Jan-Feb 2009 and to the positive outcome of the recent G-20 summit.

However, it still doesn't mean that this bear phase is over. "There can be long periods (during or after a bear phase) when nothing happens in the markets and stocks simply move sideways. During such times, the investors' interest too comes down," explains Rajat Jain, chief investment officer, Principal PNB Mutual Fund. So, the Sensex can continue to move in the 8,000-10,500 range for the next few months, or even a couple of years.

What should the investors do now? How can they figure out where the market will head in 2009? Take a look at historical technical data to find the answers.

Near All-Time Low Valuation
The Sensex is at a forward PE of 11.3 compared with the 15-year median of 13.3. But it is still higher than the 2003 low of 8.7.

How low can the indices fall?

During the past few bear phases, the Sensex has bottomed out after touching the levels from where it had started during the previous bullish runs. Therefore, the bottom has been at the same level each time. In the case of the Dow, it has breached its lowest points in 1997, 1998 and 2002. But the Sensex is still above the levels it plummeted to in 1998 and 2001. So, while analysts are sure that the Dow is on its way up, they are uncertain about the future of the Sensex.

However, there is a catch. As the Sensex is coupled with the Dow today, any upward movement in the latter is bound to impact the Indian index. Therefore, the chances of an upside in the Indian markets are as high as in the case of the Dow. More importantly, the current downturn, which started 15 months ago, has shaved off 50% from the Sensex, which is higher than the average loss of 45% in the past four bear phases. In 2008-9, the 30-share index lost 38%, which was not as bad as its steepest fall of 47% in 1992-93.

The other 'hope' indicators

Comparing ratios like forward price-to-earnings (PE) and price-tobook value (PBV) for the Sensex in the past 15 years can also provide some clues. In March, the Sensex PE was at 11.3, the same level that it hit during most of the previous bottoms. But it was higher than the 2003 low of 8.7. Similarly, the Sensex's PBV in March was at 1.9, a tad higher than the 2001 low of 1.4. Thus, some analysts claim that the chances of an upturn are higher at these, or slightly lower, levels.

Price-To-Book Value Is Also Low
The Sensex price-to-book value multiple is at 1.9, well below its 15-year average of 2.3, but above its 2001 low of 1.4.

"This is a great time for investors to analyse balance sheets and invest for the long term because you can find bargains which have been unjustifiably hammered down," advises Jain. Adds Bandyopadhyay: "Regular investing will make capital grow optimally provided the selection of the investments is done with due diligence. We continue to believe that investors should invest with a time horizon of three-five years and constantly review their investments."

The election factor

All these positives can be undermined by the elections in April-May this year. "With the announcement of the poll schedule, the markets are likely to witness a short period of uncertainty and volatility," feels Bandyopadhyay. The real downer can come in the form of a fractured mandate. A recent poll by INDIA TODAY shows that none of the three coalitions—UPA, NDA and the Third Front—is likely to get a majority. In such a case, the markets might witness a free fall, especially if Lalu Yadav or Mayawati becomes the next prime minister.

On the flip side, a coalition at the Centre is not a definite recipe for market disaster. In the case of the past four coalitions, since V.P. Singh's government came to power in December 1989, the Sensex has taken a dip initially, but has climbed up towards the end of the governments' tenures. In addition, says Banyopadhyay: "A good monsoon and some signs of recovery in the global markets will ensure that the current lows (of the Sensex) are not breached further."

Equity Versus Debt
The current Sensex earnings yield-to-bond yield is 1.3 times, close to the all-time peak of 1.4 times. Are equities more attractively valued than bonds?

In a recent report, Sonal Varma, an economist at investment banking firm Nomura, observed, "By the time the election results are known, the economy should be showing nascent signs of bottoming out. However, we do not expect a quick economic rebound. (But), aside from poor fiscal finances, India's economic fundamentals are in a pretty good shape. India's potential structural economic take-off story still remains valid provided the reforms continue."

So, what do investors do now?

"The best way to play a bear market is to wait for a consolidation to take place and then invest with a longterm perspective. Our markets have seen a consolidation phase after October 2008," says Chakraborty. He says investors should focus on fundamentally sound companies and follow a disciplined strategy.

Experts contend that investors should avoid chasing bear market rallies, which could merely be bullish spikes that one witnesses every now and then. So, don't be taken in by sudden upturns like the one this time. They could turn out to be mere blips. Either invest consistently at each low or, if you don't have too much cash to spare, wait for the uptrend to concretise. The fact is that no one, not even Warren Buffett, can time any market perfectly.