The Story So Far….. Lessons To Learn From History

First, some trends gleaned from the charts, for those who don’t follow markets too closely. I have divided the Nifty history from 1990 into the following phases: the Gulf Crisis Boom-Bust in 1990, followed 2 years later by the Harshad Mehta Boom Bust, 3 Bear rallies, and the IT Boom. We will try and look at history to see if there are any lessons for us to predict this current ongoing boom-bust sequence.

Declaimer: This article was originally in December 2004, and some data points may be outdated 

A few important caveats before we launch into the analysis. Numbers can be deceptive, as any economist will tell you.

• The Gulf Crisis coincided with a gigantic shift in reform policy, preceded by Indian insolvency.
• The Harshad Mehta Boom may have started with some hard logic of Indian reforms, which would produce economic growth, but half the bubble was overdone because of scam-tainted funds that flowed into the market. That is why both the top (418%) and the bottom (53%) were overdone. This is an event risk that you run in emerging markets, with some sudden blowout creating an additional layer of risk. At least, that is what we used to say till the US joined us with its recent I-Bank blowout, which follows its Enron/ Tyco/dot-com blowout in the last IT Bubble burst.
• Only twice has the Indian market fallen more than 40% from its previous peak. The first was during the Harshad Mehta Boom- Bust and the second was because of Ketan Parekh, whose bankruptcy created a 3-month dip of an extra 10%. Mind you, this 10% is calculated from the top, but for traders, it was a full 30% from the Fibonacci bottom they were trading.

For example, based on the second-last column, you might think that the market bottom is at 3816, or 3600 at worst. But a sudden event risk could take it down to 3000, which could be driven by a firesale of one of the FII portfolios.

• We should assume that a large part of the current Realty/ Infra Boom Bust was a ‘re-rating’ of India (which is why I would ignore the huge uptick of 736% over 2300 days as an outlier). This is so that readers do not interpret this as a signal that this current Bust will have a deeper bottom simply because it had such a huge top. You will see similar patterns in Japan and China, where similar re-ratings have led to a permanently high plateau.

The biggest criticism of Technical Analysis is that it is based on the assumption that history repeats itself. History rhymes, it doesn’t repeat itself. Before you jump to a simplistic extra.

population of the above trendlines, you must incorporate an understanding of Monetary Theory, capital flows, cost of capital, etc.

Ok, now to the conclusions that we can draw from this historical view of the market:

1. There seems to be a relationship between Columns 10 & 11. Except for Bear Rally III, there seems to be some symmetry between the time taken to reach the top and the time taken to reach the bottom. Given the long period that it took to reach the recent top, I would expect that it will take at least a year from now before we start to see a substantial recovery.
2. Fibonacci and Wave Theory does not work, but for the wrong reasons. Mostly, it is the spikes to the top that seem to be random; but the spikes to the bottom seem to be constant at 3. The exception is the IT Boom, which saw an ‘event’ (the Ketan Parekh bankruptcy) creating an exceptional situation at the bottom of the market. That would suggest that we must be at, or close to the bottom since the bottom is already at 40% below the top. It might be tested again like it has been recently tested intra-day.
3. We might see a few bear market rallies before we see a breakout through the previous top.
4. This last Boom-Bust has been a climaxing of capital flows and Monetary overkill, accompanied by high GDP growth. In that sense, it has been the most ‘perfect’ of rallies, with price discovery being the most genuine. The only other comparable (but lesser) example is that of the IT Boom.

That would suggest symmetry in the amount of time that it takes to make adjustments. It makes me pessimistic about the time it will take to flush out the excesses of the current boom, especially given that the monetary excess has spread to real estate, which is a more widely-held asset class.

5. At the same time, keep an eye out for an opposite possibility, a scenario that comes from Behavioural Economics. The existing redistribution of assets in the financial sector is creating very strong behemoths, who will be sitting on huge capital gains from their asset acquisitions at the bottom of this market, e.g. JP Morgan will be making large unbooked Capital Gains from the assets they have acquired. Perversely, they would emerge from this purge with stronger Balance Sheets, which they are already leveraging. We can already see JP Morgan acquire Washington Mutual, shortly after making a killing on Bear Sterns. Ditto with BankAm, which acquired Merill shortly after Countrywide.

This banking firepower will look for cheap assets outside the US, given the stretched situation there, and India would be an obvious target. If that happens, it will happen VERY fast, making the current chart look like an intermediate bull market and not a bear market at all. Just the opposite of a bear rally….

With this last disclaimer, let me summarise:

• 10% probability, I am looking for an event risk that will take the market below its Fibonacci bottom of 3600, to, say, 3000.
• 75% probability, a long, slow pullback over 1-2 years, with a trading range of 3800- 5200. Nightmare for buy-and-hold, but a paradise for SIPs who churn their portfolios regularly.
• 15% probability, that the Indian market takes everyone by surprise and rockets back to 6200 in 2-3 short moves, based on falling oil prices and renewed risk appetite (or Flight to Safety) by a new set of strong banks willing to take concentrated risks.

Whichever way you look at it, traders will do well, going forward.