Are we in a bear hug?

After the blood bath on that dreadful Monday of May 17, 2004, fear is writ large on the market's face. No amount of cajoling from the finance minister helped the market revert to its astounding run up for the past 12 months.

Reasons are plenty - the unexpected election results, rise in oil prices, talks of US Fed hiking interest rates and an anticipated slow-down in Chinese demand.

All this prompted the bull-run front-runners - foreign institutional investors (FIIs) - to pull money out of 'shining' India.

The million dollar question every investor wants to ask now is: Are we entering a bear phase? We tried to get a fundamental and technical perspective on whether a bear run is on or whether we are still dangling inside a bull-run correction.

Market players across the board insist that a bear phase is still some way off, though it seems that markets are still on trouble terrain. That is going by the conventional definitions of bear and bull markets in technical analysis.

In other words, chartists maintain that this means stocks could plunge more from current levels but will recover sooner than later.

On the fundamental front, analysts have revised their Sensex targets for the year, citing concerns like rising oil prices and domestic economic policy implications.

The technical points
If various technical analysts are to be believed, a market has to retrace at least 66 per cent from its previous high to enter a bear phase. This is based on the Dow Jones Theory widely accepted and followed by technical analysts world-wide.

The primary trend in the theory refers to the long-term directional movement of the market. Established up trends in the market are referred to as bull markets, and normally average two-and-a-half years.

Downtrends in the market, having an average duration of a year-and-a-half, are referred to as bear markets. While the duration of either of the primary trends may vary, identifying the long-term market trend is the essential task of Dow theorists.

Entwined in these primary trends are secondary trends. In a bull market, a secondary trend (which is counter to the established primary trend) may be identified as a retracement of between 10 per cent and 66 per cent of the previous price move-up. A secondary trend is not as long-lived and may last from several weeks to some months.

If any of these conditions are violated, a change in market direction and sentiment may be taking place. Thus, one needs to watch out for the length of the current retracement. If the retracement carries on long enough to wipe out the bull run gains, that is when trouble begins.

The Sensex touched its life-time closing high of 6194 on January 14, 2004, and since then the lowest has been 4505.16 (closing price) on May 17, 2004. This translates into a retracement of 50 per cent of the previous upmove (from levels of 2924 in May 2003 to 6194 in January 2004).

So, if we assume a 66 per cent retracement according to the Dow Theory, levels of 4035 should flash danger signals. "Only if the market closes below 4035 and remains below that mark for a minimum of two consecutive weeks can we say that a bear phase has begun," says Vijay Bhambwani, chairman, Bhambwani Securities.

Besides, such a retracement has to be supported by strong volumes. Bear markets also normally show huge volume build-up as there is large-scale selling across the board.

That is one of the reasons why we may not be in a bear phase - volumes during the market fall (February to May) have been scanty. Since January volumes at the bourses have slipped almost 28 per cent along with being volatile.

Bhambwani also says that one of the early signs of identifying the commencement of a bear market is when 10-20 per cent of mid-cap stocks' market capitalisation is shaved off each day. That is not happening yet.

Hemen Kapadia, partner, Morpheus Inc, an investment advisory firm, who follows the Elliot Wave Theory, also believes that a bear phase has not yet begun.

"We are in for some trouble but this is not a bear phase," he remarks. Elliot Wave Theory is the mother of all technical analysis theories. It is difficult to study, but generally throws up stunning results. According to the theory which is an outgrowth of the original technical market analysis of Dow Theory, market movements of each cycle are defined and predictable.

A bull market is defined by a five-wave movement. Bull markets are characterised by three major moves with the trend, interrupted by two secondary style moves against the trend. Bear markets are characterised by a three-wave structure - two major moves with the trend and a single secondary move against the trend.

Right now we are in the fourth wave of the bull run where a retracement of not more than 38.2 per cent (based on Fibonacci numbers) is expected.

And that is where the trouble lies - markets have retraced around 41 per cent to levels of 4889 (compared to a rise of 3181 points from 3013, the level considered as the beginning of the fourth wave by Elliot Wave analysts, to 6194, we have retraced about 1305, which works out to around 41 per cent retracement). A retracement beyond 50 per cent is bad, says Kapadia.

The fifth wave (which will be an upmove) will be correspondingly weak because of the weak fourth wave. The correction, according to Kapadia, is not yet over though 4450 is a strong support level. If the market breaches that level, we can see support at 4200 and 3900 in that order. He believes that a bear phase may be lurking if the Sensex closes below the 4187 mark.

In technical terms a bear phase exists when the trend of the market is down - market forms lower tops and lower bottoms. There are several indicators that signal this phase - mainly reversal patterns like head and shoulders, double and triple tops, rising wedges (steep-cone formations), rounding tops and descending triangles.

In the current phase, none of these patterns have been formed except one lower top and bottom.

Bull and bear cycles
A look at how our markets performed in various cycles right from 1991 to date (see chart) gives a few interesting pointers. Contrary to text book theories, bull phases in India haven't ever lasted for more than one-and-a-half-years. Similarly bear phases have also been shorter - less than a year normally.

The year 1991 was characterised by an upmove in the market which started from levels of 1039 in February 1991. The key driver for this was the illegal diversion of funds from the banking system into the equity markets (read operation Harshad Mehta).

The markets touched a peak of 4467 in April 1992 - a gain of 3428 points. The bear phase started when Harshad Mehta's scam unfolded. That prompted the markets to plummet for almost a whole year to levels of 2127 in May 1993, amounting to a retracement of 67.6 per cent.

The next uptrend lasted till about September 1994 and peaked at 4553 levels.

Critical factors that influenced this move were the setting up of the National Stock Exchange (NSE), the entry of FIIs and private mutual funds and a booming primary market that saw large retail participation.

This move ended - though not so drastically as the previous one - at levels of 3036 in December 1995. The retracement amounted to 62.5 per cent of the upmove.

The next phase that lasted for two years (1996-1998) was a rather range-bound market. The Sensex lost a mere 7 per cent during this period with no major peaks or troughs.

This period was, however, charaterised by small rallies. One of the key drivers during the period was the re-jig of the Sensex to include some financial institutions, pharmaceutical companies and public sector units. The fall in the market towards the end of this phase was triggered by US-64 recording negative reserves.

Then began the big bull run led by technology stocks - not just in India but world over. Markets jumped from levels of 2810 in December 1998 to 5883 in February 2000.

That translates into a gain of 3073 points. The markets peaked at these levels and plummeted following the global technology meltdown and the revelation of Ketan Parekh's scam. It was shot down to levels of 2765 in October 2001, wiping out all the gains of the bull run. The retracement? - a whopping 102 per cent.

From late 2001 to mid 2003 the market remained more or less range-bound. There were triggers in between like 9/11 and the accounting scandal but domestic markets seemed insulated by these moves. The next spectacular upmove began in May 2003 from levels of 3013.

This time around the triggers were global liquidity which induced foreign investors to allocate more to emerging markets equities which coincided with the unfolding of the 'India shining' story. Sensex peaked at levels of 6194 in January 2004.

What we can deduce from these phases is that a bull run in India has lasted roughly for a period of one to one-and-a-half years. And this time the rally lasted just nine months (May 2003 to January 2004).

Therefore, even though we are in a range-bound market right now the bull run could well be expected to last for some more time. Bear runs, too, have lasted for about a year in each case.

A fundamental perspective
Analysts who track fundamentals tend to agree with technical analysts. "We are now in a transition phase and not in a deterministic phase," says Jaideep Goswami, head of research at HDFC Securities. The market has been range-bound for the past three weeks, signifying its dilemma as to which direction to move.

Corporates are posting impressive results and are expected to keep up the good show for the next two-three quarters at least. The economy is expected to show strong growth numbers, too. But the impending Budget and rising oil prices are turning out to be big concerns.

The burden of populist measures in the form of higher corporate taxes or hike in freight costs could diminish corporate profitability. The outcome of the Budget will apparently decide the direction of the market in the immediate term.

The fear among experts is that the market may actually be tilted towards a bear hug. Experts believe that the probability of factors going against the market are higher than they turning in favour.

The reason: Unlike past bear phases where a sector or a scam brought the markets down, this time around the triggers are of a macro scale and, therefore, the possibility of bringing down the whole market seems greater.

The down trend in the market in the past few weeks began with the exit polls when the National Democratic Alliance (NDA) led by the BJP saw its chances of coming back power dimming.

This was coupled with an increase in oil prices, the slow-down in China and a possible rise in interest rates in the US. But this down trend is not like the previous ones where internal factors and specific sectors drove the market up and down.

For instance, the previous bear phases were a result of a single sector melt-down and scams but this time around the story is different. The fear of a bear phase this time emanates from the fact that since reasons for concern are not restricted to a particular sector, we may see an all-sector downfall.

With liquidity from domestic and foreign investors evaporating and hardly any triggers in sight to take stocks up, experts say, markets may remain range bound for a while. Whether or not the broad-based rally will be back depends on the policies crafted by the new government and how foreign investors view the India story.

Fundamentally speaking, the future course of oil prices and budget proposals expected in the first week of July will determine the direction of the market. Technically the bear phase is yet to begin. The crucial level to watch out for will be 4035. In any case, the bears need not cheer yet.