Bottomline: Bears can wear you out

So, sit out, sit tight and wait for the Bear to tire if you really want to go hunting.

History reveals that markets can erase significant gains in bear phases, eroding over 60 percent of value at times. And that’s for the benchmark indices. The mid and small caps that come alive in bull markets will likely lose most of their value and liquidity.

A study of big declines in the S&P-500 index reveals that in nine such phases in the past, the average period of the down phase lasted 15 months, and the average loss was 34 percent. Compare this to what we’ve seen so far in this decline and we come up with five months and under 16 percent. A pure mathematical inference would imply another 10 months of pain and perhaps another 18 percent of downside. If you do the math, the S&P-500 could bottom near 3200-3180. That’s a steep decline from near 4000 today.

A look at the oldest Indian index benchmark reveals a similar picture. A look at the four most recent declines suggests an average 10-month period of decline and an average drawdown of 39 percent. That would put the Sensex near 38,000, far below the current 54,800 level.

 

Each period is different, each day is different, each hour is different, so it isn’t quite right to compare one period with another and assume what happened in the past will happen in the future. That’s always a risk in forecasting, but history also offers the best clues for managing risks of the future. Learning from past mistakes is a popular adage. And using that as the basis, here’s a glimpse of what can lie in store.

Going by empirical evidence, the likelihood of a bear phase stretching for many months and leading to a sharp erosion in value, is quite probable. From what we’ve noted above, such phases can easily stretch to a year. So, maybe we’ll be feeling more bullish at some point early next year. We may also (if this truly is a bear phase) get an opportunity to buy stocks 15 percent to 25 percent cheaper, if not more.

A rough scenario building suggests the Nifty could bottom out anywhere between 13,500 and 12,500, which is still a fair distance from where we are. So, if you are already partly invested in the market, hold your horses. Don’t go bottom fishing just yet. There will be opportunities to invest, whichever way the market goes. But if we really are in a bear phase, you’ll at least have some dry powder to use when the time is truly ripe.

Invest safely.