The last one-and-half years were tough times for the market. Volatility and Uncertainty dominated. Technically, we cannot call this a bear market as prices, even though had wild swings on both sides, are at the same level as they were one-and-half years ago. Prices need to fall by 20 percent or more from the recent top for the market to be technically defined as a bear market.
When markets hit their bottom in June 2022, the Nifty 500 was down 20 percent from its all-time high made in October 2021. But markets made a sharp recovery from that bottom and made a new all-time high by December 2022. At the time, I expressed scepticism regarding the sustainability of the market rally as it wasn’t a broad-based rally. At the time, midcaps and small-caps were much below their respective all-time highs. Nifty 500 is now down 8 percent from its December 2022 high.
There were several much larger and painful declines in prices that are not visible from the performance of broader indices like Nifty 50 and Nifty 500. The Nifty Smallcap index is down 21.4 percent from its all-time high of January 2022. Among sectoral indices, Nifty Pharma, Nifty IT, and Nifty Realty indices are down 16.5 percent, 21.0 percent, and 27.0 percent, respectively, from the highs of 2021.
Bear Market Rally
Bull markets don’t last forever. They will come to an end and will be followed by bear markets. Similarly, bear markets will also come to an end giving birth to a new bull market. But it is difficult to determine when this shift or pivot happens. Since most investors want prices to go up (i.e., a bull market), they shall always be incessantly watching for signs of a trend reversal.
Any sharp rise in prices during a bear market may feel like the start of a bull market. But investors need to be wary of these sharp price rises because they might be bear market rallies rather than a nascent bull market.
Bear market rallies are sharp price rises ranging from 5 – 25 percent occurring within a bear market. But the rally, although sharp and quick, fails to make a higher top than the previous one. Eventually, the market loses steam and prices will start to fall and makes a new low.
There were three bear market rallies during the current bear market (19 October 2021 – present). The first one occurred between 20 December 2021 and 17 January 2022, when the Nifty 500 gained 7.6 percent but failed to make a higher top, and subsequently, declined 14 percent. The second bear rally occurred between 7 March 2022 and 4 April 2022 when the Nifty 500 gained sharply by 13.4 percent but again failed to make a new higher top. Again, the market lost steam and declined by 15.8 percent from there.
The third bear rally happened over five months. The previous two bear rallies lasted for only one month. In this third rally, the Nifty 500 gained 23.6 percent. Presently, the Nifty 500 is down 8 percent from the market top of the third bear market rally.
As I said earlier, it is very difficult to determine whether a sharp upside price movement is a bear market rally or a nascent bull market. Any attempt to spot the bottom or reversal of the trend is futile. As the saying goes, “It is not the timing of markets that matters, but time in the market.”
Is it a nice time to buy stocks?
“Is it a nice time to buy stocks?” is a question every investor wishes to get answered, even if he had abandoned his efforts to spot market bottoms or trend reversal. I think that question can be answered with reasonable assurance by an investigation into the principal reasons for last year’s poor market performance and to what extent they have been resolved. The current valuation of markets is another parameter that can shed some light on markets’ future direction.
The principal reason for last year’s poor market performance was inflation and sharp interest rate hikes by central banks to control inflation. So it would be helpful to check where we stand on these issues.
The US’s inflation rate (%) for December 2022 was 6.5 percent. The US inflation rate has been slowing down since it peaked at 9.1 percent in June 2022. The US central bank – Federal Reserve (Fed) – hiked policy interest rates in increments of 0.50 percent or 0.75 percent from 0 – 0.25 percent to 4.25 – 4.50 percent in 2022. But in the February 1, 2023 policy announcement, the rates were hiked by a lower 0.25 percent. The reason could be the recent slowdown in inflation and the imminent recession that the US is expected to enter in 2023.
The Bank of England (BoE) – the central bank of the U.K. – made its policy announcement the next day in which bank rates were increased by 0.50 percent to 4.00 percent. The previous hikes were in increments of 0.75 percent. BoE said that it expects the bank rate to peak at 4.50 percent by the middle of 2023 and expects inflation to ease towards 4 percent by the end of 2023. The inflation rate in the U.K. for December 2022 stood at 10.5 percent.
Meanwhile, the central banks – Fed and BoE – reiterated they will increase policy rates to sustainably return inflation to the 2 percent target.
The other parameter is market valuation. The price-earnings (PE) ratio of Nifty 50 was at 20.86 on February 2, 2023, which is close to its median PE ratio of 20. The PE ratio of Nifty 50 was 28 during the peak of October 2021.
Final Takeaway
Things could go wrong in a thousand ways. The inflation slowdown might be temporary and may peak again. We discussed such a scenario last month based on the study of inflation and the interest rate movement of the 1970s.
But as things stand now, the slowdown in inflation, lower pace of interest rate hikes, and reasonable market valuation provide a glimpse of waning risk in markets. Markets have priced in most of the risks. Inflation may have peaked. A large part of the expected interest rate hikes are passed, and future hikes will be lower and spaced longer. In 2022, the Fed hiked rates five times, I believe. In 2023, the expectation is for only two rate hikes. The BoE expects itself to be done with interest rate hikes by the middle of 2023.
It seems to be a proper time to buy stocks, considering the 1) slowdown in inflation, 2) lower and less frequent expected future interest rate hikes, 3) and, finally, the reasonable valuation of the markets.
AMN CAPITAL 