Indices are past their 200 daily moving average (DMA) for the first time since February 2011. Sector rotation has hit a 15-month high. Cyclicals are back and the so-called defensives have underperformed. These are tell-tale signs of a new bull market. Is this a case of the market telling us where the fundamentals are heading or is this a head fake? Simply put, are we in a new bull market?.
New bull markets are started by favourable liquidity conditions and attractive valuations. At the end of December, both the ingredients fell into place. Bull markets make progress as fundamentals improve. Fundamentals can come in various forms, such as technology changes and favourable demographics, but ultimately all these changes imply upward revision in growth forecasts. Not surprisingly, fundamentals remain fuzzy. The market continues to have support from sceptical positioning and low expectations. We expect upward progress, although the pace of the recent move may induce volatility.
If this is indeed a new bull market, the preceding bear market at 60 weeks and -26 per cent return will prove to be the shortest and shallowest in 20 years – a far cry from the average 50 per cent fall seen in previous bear markets. Valuations are around 30 per cent higher than what they were at the end of the previous three bear markets. This could create doubts about this being the start of a new bull market.
What do we need to be sure that this sustains as a new bull market? The key difference between the 2003-08 period and now is that global growth is no longer supportive. To that extent, it needs an extra policy push to pull India’s growth rate back to trend. Companies are suffering from poor profitability – inflation needs to remain moderate for that to improve. That will also help rates to fall. The key risks remain Europe and oil. India needs time to adjust its macro to absorb risks from Europe and oil. If these risks do not unfold in, say, the coming six months, the second half of 2012 may prove to be even stronger for equities. None of these is a differentiated insight, but the good news is very few believe these events will happen, and markets sometimes favour climbing walls of worries.
For now, people who have not participated in the rally could probably wait for a consolidation or correction.
While valuations and sentiment are not overdone, the fact is the market appears overbought. If this turns out to be a bear market rally, we may be nearing a top, based on the metrics we track.
Our strategy is to continue to focus on stock picking.
The author is managing director, Morgan Stanley Research
