Beware of the speed breaker – Correction can be around 10% globally
Published on Sunday, April 19th, 2009 at 12:13 PMAuthor: Munish Rao (11 Articles)
Beware of the speed breaker
Since March 2009, global equity markets have been the best performers among all asset classes. On an average, the global equity indices have grown by around 30%. This is really one of the strongest rallies since the collapse that begun in late 2007. This rally was primarily fuelled by the hopes of economic recovery. But was the rally driven by the institutional investors or the short term traders that were successful in taking advantage of high volatility? How similar is the movement in the current equity markets to that during the Great Depression? Will the market ride continue to move on the highway or can they expect some speed breakers?
Recent Trough to Peak performance – Global Equities
|
|
Recent Trough |
Current |
Up move |
|
|
Index |
Date |
Level |
Level |
% |
|
US |
|
|
|
|
|
Dow |
9-Mar-09 |
6440 |
8131 |
26% |
|
S&P |
6-Mar-09 |
666 |
869 |
30% |
|
Nasdaq |
9-Mar-09 |
1265 |
1673 |
32% |
|
Europe |
|
|
|
|
|
FTSE |
9-Mar-09 |
3460 |
4093 |
18% |
|
Dax |
9-Mar-09 |
3589 |
4677 |
30% |
|
Asia |
|
|
|
|
|
Japan |
10-Mar-09 |
7021 |
8907 |
27% |
|
China |
3-Mar-09 |
2037 |
2504 |
23% |
|
Singapore |
10-Mar-09 |
1455 |
1897 |
30% |
|
Nifty |
6-Mar-09 |
2539 |
3384 |
33% |
|
Sensex |
6-Mar-09 |
8047 |
11023 |
37% |
Source: Yahoo Finance
Correlation b/w S&P and VIX
The rally started during early march of 2009 when the CBOE VIX (volatility index) was close to 50 levels. At the current levels of 33.9, the volatility index is down 32% against the equity markets rise of around 30%.
Source: Yahoo Finance
Deep analysis of the data on VIX and S&P for the period Oct’2007 till April 2009 suggests a strong negative correlation of -0.81 between the two. The Volatility Index is at a very critical level and considering the technical’s and current market condition; VIX is expected to move towards 40-45 levels during the next 2-3 months. One can expect a decline of 12-15% in the global equities during the same period. Target on S&P at 730-740 in next 2-3 month period. A correction is a healthy sign for markets.
Similarities b/w ‘The Great Depression’ and ‘the fall of 2007/08’
There are many similarities between the period of 1929/1930’s, termed as and “The Great Depression” and the current financial crisis of 2008. The economic environment of both these historical events host one of the major causes for the problem – ‘excessive leverage in the system’. The impact on the equity markets has been severe in both these events, though the current one seems to be less brutal in terms of percentage decline than seen during 1930’s. During the 1930’s Dow fell close to 90% from the peak of Sep’1929. The current market reflects merely 55% decline from the Oct’2007 peak. This data doesn’t show the clear picture of the current fall. More detailed understanding of the data suggests that the current fall is more severe than previously seen.
During the Depression period, though the decline was close to 90%, but the time taken for this collapse was close to 3 years (starting from the peak of Sep’29 to the low of Jul’32). Considering the current decline that has been 55%, took merely half the time i.e. 1.5 years (starting from the peak of Oct’07 to the recent low of Mar’09). So, if the current crisis continues for another year or more from here, how much can we expect the markets to go down? Actually no one knows the answer. The table below shows the Dow during 1929/30’s and Dow during 2007/08.
|
US Equities – SEP’29 TO SEP’32 |
|
US Equities – OCT’2007 TILL DATE |
||||||||
|
Date |
Index |
% change |
Days |
Trend Reversal |
|
Date |
Index |
% change |
Days |
Trend Reversal |
|
Sep-29 |
386.1 |
|
|
|
|
Oct-07 |
14277.0 |
|
|
|
|
Nov-29 |
217.8 |
-43.6 |
62 |
|
|
Nov-07 |
12707.3 |
-11.0 |
46 |
|
|
Dec-29 |
267.6 |
22.8 |
35 |
1 |
|
Dec-07 |
13897.0 |
9.4 |
14 |
1 |
|
Dec-29 |
226.4 |
-15.4 |
14 |
|
|
Jan-08 |
11508.7 |
-17.2 |
43 |
|
|
Apr-30 |
295.9 |
30.7 |
119 |
2 |
|
Feb-08 |
12815.6 |
11.4 |
36 |
2 |
|
Jun-30 |
207.7 |
-29.8 |
63 |
|
|
Mar-08 |
11650.4 |
-9.1 |
19 |
|
|
Sep-30 |
247.2 |
19.0 |
77 |
3 |
|
May-08 |
13171.0 |
13.1 |
63 |
3 |
|
Dec-30 |
158.7 |
-35.8 |
105 |
|
|
May-08 |
10972.6 |
-16.7 |
-5 |
|
|
Feb-31 |
197.0 |
24.1 |
64 |
4 |
|
Aug-08 |
11933.5 |
8.8 |
89 |
4 |
|
Jun-31 |
119.9 |
-39.1 |
97 |
|
|
Oct-08 |
8085.4 |
-32.2 |
77 |
|
|
Jun-31 |
156.7 |
30.7 |
28 |
5 |
|
Nov-08 |
9711.5 |
20.1 |
8 |
5 |
|
Oct-31 |
85.5 |
-45.4 |
98 |
|
|
Nov-08 |
7392.3 |
-23.9 |
17 |
|
|
Nov-31 |
117.3 |
37.2 |
28 |
6 |
|
Dec-08 |
9151.6 |
23.8 |
17 |
6 |
|
Jan-32 |
69.9 |
-40.5 |
83 |
|
|
Dec-08 |
8349.2 |
-8.8 |
21 |
|
|
Feb-32 |
88.8 |
27.2 |
36 |
7 |
|
Jan-09 |
9093.5 |
8.9 |
7 |
7 |
|
Jul-32 |
40.6 |
-54.3 |
127 |
|
|
Mar-09 |
6440.1 |
-29.2 |
63 |
|
|
Sep-32 |
81.39 |
100.7 |
63 |
8 |
|
Apr-09 |
8150.43 |
26.6 |
31 |
8 |
Source: Yahoo Finance
Interestingly, during the period mentioned in the above tables, there were close to 8 trend reversals that gave an average 36% return to the investor who was able to catch the trend 8 in 8 times. The total gain would have been close to 292% that means, even during the great depression, a tactical investor would have gained almost three times his/her investments.
Does this also hold true for the current financial environment. Obviously it does! But the extent of making money is only 40% of what was during 1929/30. During the current decline, a tactical investor would have got similar 8 trend reversals to make money by going long. This would have given him/her an average return of 15% and a total return of 122% i.e. doubling of the money. Current move has already shown a 27% move on the upside. So, is it the start of the 9th trend reversal? If yes, then markets might go down by around 12-15% in next 2-3 months.
Indian Markets – one of the best performing markets for the current rally
As per the table presented above, Indian markets have shown strong performance during the current global rally. Since the recent low as of 9th March 2009, Nifty has grown by 33% and Sensex by 37% illustrating the strength in the markets. This rally though was due to the hopes of better economic cues, but was also partly due to the fact of pre elections. Since, we have already witnesses strong up move in the markets, there needs to be a consistent flow of positive news to carry this forward from the current levels. The near term trigger for the markets is definitely the earning releases. The earnings estimates for top 100 companies by various research houses suggest a marginal year-on-year decline in revenues of merely 1-2% in the quarter ended March 31, 2009. Any negative surprise would hit the markets in a negative way and push the markets downwards. Moreover, the markets seem to be in an overbought zone and certain selling can come to the markets any time soon.
One can call it a technical pull back or profit booking, but the selling might bring in a correction of close to 10% from the current levels in next 1-2 months. This illustrates a fair value of the Nifty at 3043 and for Sensex at 9920. This target is also supported by the below analysis that is based on the last two trend reversals –
|
Up moves |
|
|
|
|
Down moves |
|
|
|
|
Start Date |
27-Oct-08 |
2524 |
|
|
Start Date |
10-Nov-08 |
3161 |
|
|
End Date |
4-Nov-08 |
3152 |
25 |
|
End Date |
20-Nov-08 |
2528 |
-20 |
|
Sessions |
5 |
628 |
126 |
|
Sessions |
7 |
-634 |
-91 |
|
|
|
|
|
|
|
|
|
|
|
Start Date |
20-Nov-08 |
2528 |
|
|
Start Date |
6-Jan-09 |
3112 |
|
|
End Date |
6-Jan-09 |
3112 |
23 |
|
End Date |
9-Mar-09 |
2564 |
-18 |
|
Sessions |
29 |
585 |
20 |
|
Sessions |
40 |
-548 |
-14 |
|
|
|
|
|
|
|
|
|
|
|
Start Date |
4-Jan-09 |
2564 |
|
|
Start Date |
15-Apr-09 |
3497 |
|
|
End Date |
15-Apr-09 |
3497 |
36 |
|
End Date |
17-May-09 |
3043 |
-13 |
|
|
|
|
|
|
|
Also a strong support at 3000-3010 |
||
|
Sessions |
22 |
933 |
42 |
|
Days |
32 |
|
|
Source: Yahoo Finance, Own calculations
Recommendation
The markets might correct, one can book the profits if in the money, its advisable not to build fresh long positions. One can go short if want to aggressively trade the market.
Author: Munish Rao
DISCLAIMER
The information and opinions expressed in this report are compiled by the Author from the sources as are available and which the Author believes to be reliable. But the Author shall not be responsible for its completeness and accuracy. This report is for your private information only and the Author is not soliciting any action based upon it. Opinions and views expressed and statements made herein are of the Author as of the date appearing in this report only and its opinion may change. This report and any recommendations contained herein may not be applicable to specific investment objectives; financial situation or particular needs of recipients of this report and should not be used in substitution for the exercise of independent judgment. If any person takes any action based upon this report, the Author shall not be responsible for any loss incurred by such person.
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