A Silver Lining In Bear Markets

Wealth destruction and bear markets are considered to be synonymous. However, historical evidence suggests that bear markets do provide lucrative opportunities to those who show conviction in equities. Geyatee Deshpande explains how the bounce-backs are sharper in bear markets, thus offering ample investing opportunities for investors.

As of now, equity investors are faced with a precarious market situation where on one hand the opportunity seems to be too good to resist with some of the world’s foremost authorities in the investing world calling this a “once in a decade” investment opportunity and on the other hand the current crisis keeps on deepening with no signs of stability in sight. It is that phase of the markets where one can easily defend both – the most optimistic of the lot as well as the most pessimist of the lot – since anything can happen from here on.

That is to say we may come out of this global crisis swiftly without any permanent damage to global economies or the crisis may persist longer than we all think and thereby lead to some heavy permanent damage to the global economy. If there is no permanent damage to the economies, chances are that the recovery post the crisis will be a classic V-shaped structure and with that assumption the equity markets do look extremely attractive at the current levels. It’s an excellent level to enter the markets and indeed an opportunity that may not be repeated again.

On the other hand, if the crisis persists for a longer than expected time frame and there is permanent damage to the supply capabilities of economies – which is unlikely – the bottom for equity markets could be much lower from the current levels. Each economy is unique and so is the way in which any economy recovers post a crisis. However, the current crisis is more global than most of the previous crises we have seen in the last 100 odd years. Global recovery this time around is quintessential.

We need to ask when the recovery will happen and whether we are headed into a deep recession and hence into a long-haul bear market as a consequence. The US equity markets, also known as the mother of all markets, have fallen by more than 30 per cent at least nine times since 1920. Indian markets, over a historical span of 40 years, have corrected by more than 25 per cent on at least four occasions. 

There is no doubt that the markets have almost always recovered. But that is probably not something investors are worried about. There are some more specific questions bothering investors, namely:

1. How far lower can the market go from the current levels?

2. How long will it take to recover and attain normalcy for both the markets and the real economy?

Unfortunately, there is no objective answer to the first question at least and that is leading several investors to remain sceptical about the markets. That said, a majority of the market participants are confident that it’s just a matter of time before recovery begins to take place. History tells us that in the US markets one in three bear markets conflate with recessionary periods. While the odds of the majority of the developed world entering into a classic recession increase each day as the crisis persists, India and China are the only two large economies in the world expected to escape from getting into a recession.

What it essentially means is that the annual growth will cover for the losses incurred in the crisis period, in India and China at least. The same cannot be said of the developed western economies. However the stimulus announced in various developed economies can help push the troubled economies to come out of the crisis with minimum damages.

Bear Markets and Bounce-Backs

For most investors it is a foregone conclusion that bear markets are not to be invested in. Our observation suggests the contrary. It is actually in the bear market that one gets sharp bounce-backs and a chance to make quick returns. No bear market is characterised by a straight fall without any bounce-backs. In fact, the bounces can be as sharp as we recently witnessed, pushing stocks up by more than 20 odd per cent in less than a couple of trading sessions.

For example, in one week of market bounce-back between March 23 and 31 we find at least 34 stocks with the BSE 500 basket recording gains of more than 20 per cent. It means there are opportunities to profit in bear markets as well. But here timing is most important and not every investor can time the markets. Plus, there is always the risk of catching a falling knife. 

If we simply look at the YTD returns and decide to construct a portfolio at the end of difficult market years, we have some interesting observations. When we compare the results of investments, if one were to invest in a bear market as against a bull market, what we can see is that high positive returns can be made in the bear markets post hefty correction as well and at times the returns can be higher than compared to the bull market. The table below highlights the data for both bear and bull market periods.

The average returns if one invests in difficult, uncertain market environment (after markets have corrected more than 20-30 per cent) is much bigger than investing normal, bull market environment.

If we consider that the years 2008 and 2011 were difficult periods for the markets and if one were to invest in a portfolio manner with selected Sensex stocks we find that the average returns in the first three months are equal to a whopping 93 per cent in 2009 and the average returns for the same selected stocks in the first six months of 2009 are an impressive 213 percent. Similarly, looking at the dismal performance of the markets in 2011, if one were to invest in these markets, the average returns for the same set of stocks in the first three months of 2012 would have been an unbelievable 94 per cent while the average returns in the first six months of 2012 would have been approximately 43 per cent.

Here, in this case, what an investor does is simply construct a portfolio when markets have fallen steeply over 25 to 30 per cent. Let’s see what happens when investors construct a portfolio of the same stocks when the markets conditions are normal to bullish. Investors usually wait for markets to stabilise and rally before participating in the markets. For example, in years 2010, 2015 and 2018 when the markets were bullish and investors were confident of market stability, the returns in the first three months of 2010, 2015 and 2018 were 22 per cent, 27 per cent and 1.54 per cent respectively – much lower when compared to investing in periods of uncertainties.

The returns in the first six months of 2010, 2015 and 2018 have been 13 per cent, 9 per cent and 17 per cent respectively. Remember that all the three preceding years have been extremely good for the markets i.e. 2009, 2014 and 2017. Such a performance encourages investors to participate in equity markets as the expectations built in from the markets are high. One can easily see the difference in returns when one invests in difficult market conditions and when uncertainty is high as against when one invests during market conditions that are normal or bullish. 

Conclusion Even if we were to enter into a recessionary environment conflated with bear markets it does not mean that equity will keep delivering negative returns. There will be bouts of recovery and every bounce in the market will present money-making opportunities. In fact, when the stock prices correct as sharply as they have done in recent market correction phases, the chances of sharp bounce-back always exits. Without hunting for a perfect bottom, constructing a portfolio and accumulating stock as market falls is the best strategy that can be adopted.  

No one can tell for sure if we will experience a V-shaped recovery from the current crisis or will witness a U-shaped recovery. An L-shaped recovery is out of the question right now. Even if there is a U-shaped recovery, all is not lost for the equity markets as there usually is no structural damage while the growth phase resumes, albeit slowly. For those investors who have cash and can show courage at this moment of crisis, the opportunity is priceless.