Gripped in a Bear Hug

Gripped in a Bear Hug

Since the beginning of August, BSE Mid-Cap & Small-Cap indices have underperformed the frontline indices by decent margins and a stark difference has materialised. In this article, Armaan Madhani elucidates the actual definition, causes, and examples of a bear market along with other key concepts that investors should be cognizant of. The report also highlights stocks that are currently trading in the bear market territory. 


It is well known among investors that the ‘bear market’ phenomenon gets its name from the way in which a bear attacks its prey—swiping its paws downward. This is why markets with falling stock prices are called bear markets. However, a pertinent question still remains: what is the precise definition of a bear market? A bear market is a condition in which a market index or the share price of a company declines by 20 per cent or more from its recent highs over a sustained stretch of time, generally two months or more. Hence, if a company’s stock price drops by 30 per cent from its peak on account of weak earnings, one could say that the share price is trading in bear market territory.

A company’s stock price reflects the future expectation of profits and cash flows. However, if growth prospects deteriorate over time for whatever reason, share prices take a big hit. Herd behaviour becomes prominent among market participants and there is a rush to protect downside losses, which leads to prolonged periods of depressed stock prices. Therefore, during a bear market phase, pessimism is rife and investor sentiments turn negative. Investors become risk-averse, often abandoning their high-risk investments for safe havens and sure bets such as gold, debt funds, fixed deposits, etc. Keep in mind, a bear market can last for months and even years.

A bear market is declared when frontline benchmark indices such a Sensex and Nifty fall by more than 20 per cent from their recent highs and persist at that level for 60 days or more. The typical starting point of any bear market is uncertainty and fear among market participants often coupled with economic downturns such as recession. Recession and bear markets are two sides of the same coin and frequently go hand in hand. A sluggish or weak economic environment is the result of negative growth rate of a country and shrinking aggregate demand of general goods and services.

It also includes higher supply, declining price levels, high unemployment, dwindling disposable income, weak productivity and a plunge in business profits. An acute case of recession prompts a substantial sell-off and further exacerbates a detrimental impact on stock prices. Other diverse causes of a bear market would include global pandemics, tensions among global superpowers, socio-economic turmoil, extensive investor speculation, bubble burst, over-leveraged investing, erratic oil price movements and sudden intervention by the government such as hawkish moves in monetary policy or unfavourable changes in tax rates.

Bull Market versus Bear Market

It is common parlance in the investing world that the terms ‘bull’ and ‘bear’ are routinely used to refer to the prevailing market conditions. These terms expressly describe how the stock markets are performing i.e. whether they are appreciating or depreciating in value. The familiar belief about the origin of these terms indicates that the use of ‘bull’ and ‘bear’ to describe the state of the market is derived from the way these animals attack their opponents. A bull thrusts its horns up into the air while a bear swipes its paws downward. These actions are metaphors for the movements of a market. In essence, if the trend is down, it’s a bear market and if the trend is up, it’s a bull market.

In contrast to a bear market, a bull market can be typically defined by a sustained increase in stock prices or index levels. Such phases are shrouded by optimism, gung-ho among investors and there is high confidence that the upward trajectory will continue over the long term. To quote prominent financial writer Adam Hayes from an article, “Bull and bear markets often coincide with the economic cycle, which consists of four phases: expansion, peak, contraction and trough. The onset of a bull market is often a leading indicator of economic expansion. Because public sentiment about future economic conditions drives stock prices, the market frequently rises even before broader economic measures such as gross domestic product (GDP) growth begin to tick up. Likewise, bear markets usually set in before economic contraction takes hold.”

Bear Market versus Correction

The terms ‘bear market’ and ‘market correction’ are often used interchangeably as synonyms by loads of people. However, both these expressions refer to different magnitudes of negative performance in the markets. A bear market is when there is a fall of more than 20 per cent while a correction occurs when there is a fall of more than 10 per cent from the recent highs. A correction is a short-term trend and lasts for a period of less than two months. It can be thought of as an adjustment of the current stock prices which is oft-times followed by a further upward trend in stock prices. It is a conventional indicator of a developing economy in a bull run.

Market corrections present an opportunity in the form of a suitable entry point into stock markets for value investors. Whereas, a bear market seldom provides an entry point because it is near impossible to predict a bear market’s bottom. Hence, a bear market should not be confused with a correction. To parrot the words of notable American author Ron Chernow, “Stock market corrections, although painful at the time, are actually a very healthy part of the whole mechanism because there are always speculative excesses that develop, particularly during the long bull market.”

Types of Bear Market

There are various types of bear market, as described below:

1. Secular:
A secular bear market trend represents longterm economic conditions as a result of changing domestic policies. These trends can have long-lasting effects in an economy. It is characterised by below-average returns on a sustained basis. It spans over a multi-year period, typically 10 to 20 years, wherein stock prices underperform their average gains. Nevertheless, there may be rallies during a secular bear market in which stocks or indices rally for a period of time, but the gains are not sustained and prices revert to lower levels. The most recent secular bear market was observed between October 2007 and February 2009 in the US during the Global Financial Crisis.

2. Cyclical: Cyclical bear markets occur due to business cycle fluctuations in an economy. They often tend to take place towards the end of a business cycle i.e. when markets adjust after a sustained boom period, where there are rising interest rates, high inflation rates and falling corporate profits. A cyclical bear market can last anywhere from a few weeks to several months.

3. Event-Driven: These are bear markets that are triggered by one-off shocks such as wars, pandemics, oil shocks (2015, 2020) and major terrorist attacks.

Santosh Meena
Head of Research, Swastika Investmart Ltd.


Mid-cap and small-cap stocks are underperforming and witnessed a correction in August but we are in a structural bull market where the mid-cap and small-cap stocks tend to outperform. The correction in August is just a part of this ongoing bull market and we can’t say that the mid-cap and small-cap space has entered into bear territory until there are any significant signs of reversal. We will see multiple shake-out phases in the coming days and that will be a buying opportunity in quality stocks. Technically, any stock or sector enters into bear territory when it falls below its 200 DMA or corrects more than 20 per cent from its peak. The BSE Small-Cap index has just corrected less than 8 per cent from its peak while the YTD performance is still up around 45 per cent and is in fact one of the best performing indices in the world.

The BSE Small-Cap index is taking support at its 50 DMA and respecting the important support of 25,000 levels following a correction where the 20 DMA of 26,500 is an immediate hurdle. If it starts to trade above this level we may again see outperformance by small-cap stocks. In any bull market, the first dip is always being bought into and we are seeing buying in some of the stocks from the small-cap space but if the market witnesses a second fall and the BSE Small-Cap index starts to trade below its recent low then we can say that small-cap stocks may have entered into a short-term downtrend but till then the uptrend is intact. If we look at the monthly chart of the BSE Small-Cap index then there is a vertical rise while if we look at valuations then most of the stocks are looking expensive.

That could be the cause of concern for some investors but we are going through an exceptional phase where earnings are depressed due to the pandemic and so the market is betting on normalised earnings and expecting a strong recovery. If we look at the BSE Small-Cap index to Sensex ratio, it topped out at the 0.56 level in 2017 and the 0.66 level in 2007 while currently it is trading at the 0.47 level. So we can say that there is more steam left before any meaningful correction takes place. There is a beautiful quote in the market: “Buy your regrets in a bear market and sell your mistakes in the bull market.” Investors who are stuck with bad quality stocks should exit in this bull run and I believe most of the mistakes were made in the bull market of 2017 market while investors who missed out can enter if there is any correction in this bull market.



Stocks Currently in Bear Territory

In the past year, Indian indices across the board have soared like an eagle in a distinct upward trajectory irrespective of lockdowns, rising corona virus cases, high inflation levels and economic discomfort. Recently, headline indices Nifty and Sensex recorded fresh highs of 16,701.85 and 56,118.57, respectively. However, the since the beginning of August, BSE Mid-Cap and Small-Cap indices have underperformed the frontline indices by decent margins and a stark difference has materialised as shown in the following graph.

This is in contrast to the fact that according to July mutual fund data released by Association of Mutual Funds in India (AMFI), there was a positive bias towards small-cap funds with a 152 per cent jump in inflows on month-on-month basis as compared to a marginal 8 per cent month-on-month rise in inflows of large-cap funds. This was a clear indication of high confidence amidst investors as there are still substantial sums of money being diverted towards smaller cap stocks. On August 9, 2021, BSE announced additional surveillance measures with intentions to curb excessive price movement in securities listed on their trading platform. As per the press release, stocks shortlisted will be subjected to additional periodic price limits viz. weekly, monthly and quarterly price limits.

These add-on price bands shall be in addition to the applicable daily price bands of such securities. This triggered a dramatic sell-off in mid-cap and small-cap stocks and put a damper on the bull run. Other reasons to explain the underperformance could be profit-booking, adjustment in valuations or sectoral rotation and rebalancing, with increasing allocation towards quality large-cap stocks. We extracted data and ran a quick check on how many stocks are currently trading at prices more than 20 per cent below their 52-week high i.e. in the bear market territory. It was observed that 33 per cent stocks in the BSE 500 index are in the bear phase while a whopping 46 per cent of stocks in the BSE Small-Cap index are presently in the bear market territory.

Banking, pharmaceutical and automotive ancillary sectors lost the most ground during the recent market sell-off. In the banking sector, popular large-caps such as Bandhan Bank and Bank of Baroda have fallen by more than 25 per cent from their respective 52-week highs while mid-cap banking stocks such as RBL, IDFC First and Bank of India have taken a beating and are down by more than 35 per cent. Stock prices of major pharmaceutical players such as Cadila Healthcare, Natco Pharmaceuticals and Glenmark have entered the bear territory, plummeting by more than 20 per cent from their respective highs. Battery manufacturers Exide Industries and Amara Raja Batteries have sunk by 27 per cent and 32 per cent, respectively. Headline large-cap indices have demonstrated their ability to continue the bull run. However, mid-cap and small-cap stocks have started showing explicit cues of weakness. Investors should be alert and exercise caution. Whether the recent selloff in mid-cap and small-cap stocks is just a speed bump in the ongoing bull run or a harbinger of an approaching bear market, only time will tell!

 

Rate this article:
No rating
Comments are only visible to subscribers.

DALAL STREET INVESTMENT JOURNAL - DEMOCRATIZING WEALTH CREATION

Principal Officer: Mr. Shashikant Singh,
Email: principalofficer@dsij.in
Tel: (+91)-20-66663800

Compliance Officer: Mr. Rajesh Padode
Email: complianceofficer@dsij.in
Tel: (+91)-20-66663800

Grievance Officer: Mr. Rajesh Padode
Email: service@dsij.in
Tel: (+91)-20-66663800

Corresponding SEBI regional/local office address- SEBI Bhavan BKC, Plot No.C4-A, 'G' Block, Bandra-Kurla Complex, Bandra (East), Mumbai - 400051, Maharashtra.
Tel: +91-22-26449000 / 40459000 | Fax : +91-22-26449019-22 / 40459019-22 | E-mail : sebi@sebi.gov.in | Toll Free Investor Helpline: 1800 22 7575 | SEBI SCORES | SMARTODR