Making advances with stock market declines
Mera joota hai Japani
Ye patloon Englishstani
Sirpe lal topi Russi
Fir bhi dil hai Hindustani
Well, ever since Russia has thrown its red hat into the battlefield, stock markets have been losing their pants and hearts.
Experts have been debating about:
- Beginning of a potential cold war
- China-Russia cooperation
- Spike in inflation
- Diminishing power of the US Dollar in the global financial system
- Federal Reserve’s potential rate hikes
….and the list goes on.
But why participate in endless discussions on topics which are wide open to anybody’s guess at present? After all, most of us just want to know whether in the present market, it’s a good time to buy on dips or exit on rallies.
You see, stock market experts rarely agree with one another on the interpretation of market conditions and perhaps that’s the beauty of equity investing. Because market consensus often lead to extremes, and more often than not, signal reversals of the existing trends.
Hence, we decided to focus on two hardcore data indicators—advance-decline ratio of companies listed on BSE and the monthly performance of S&P BSE 500. To be sure that our data universe is large enough to draw meaningful conclusions, we considered the past 20 years’ of data.
Again, we don’t say these are the only indicators but when used in the right way, these two indicators can fairly tell you how strong the underlying market sentiment is.
But first of all, what is the advance-decline ratio?
Market breadth measured by the number of stocks advancing versus the number of stocks declining is a good indicator of the general disposition of investors.
Here are our findings:
- Market breadth has remained slightly tilted in favour of the bulls over the last 20 years, with 106 stocks advancing on a monthly basis for every 100 declining on an average.
- There have been only 6 occasions when more than 150 stocks advanced in a month for every 100 declining. This was one extreme.
- Similarly, there were only 20 instances of the advance-decline ratio falling below 0.8, i.e., 80 stocks advancing for every 100 declining in a month.
In February 2022; the advance-decline ratio was 0.83.
Now let’s turn to monthly returns
- S&P BSE 500 generated an average monthly return of 1.5% over the last 20 years
- It clocked a maximum monthly gain of 33.3% (in May 2009) and a minimum of -27.1% (in October 2008)
- There have been 15 occasions wherein the monthly return exceeded 10%
- And 31 instances of monthly losses amounting to more than 5%
BSE 500 fell 4.1% in February.
When you combine the findings of advance-decline ratio and monthly return data, you might be tempted to conclude that we are very close to the oversold territory.
We also compared the monthly return data of BSE 500 vis-à-vis its 10-month average at this juncture. We found that the closing of BSE 500 in February 2022 was a tad below its 10-month average.
Historically, the 10-month average has acted as a reasonably good support during bullish phases. Considering this anecdotal evidence, it appears that March could be a crucial month for the markets.
Will markets bounce back? We don’t know.
But it’s noteworthy that:
- Perhaps for the first time in many years, Indian corporates and Indian banks have clean balance sheets
- The government isn’t utilizing deficits for populist programmes and is using them for infrastructure development instead
- Some of the largest companies in India haven’t only weathered the pandemic well but have emerged much stronger
- The on-going downturn might make valuations reasonable
Then isn’t it safe to conclude that:
- Stocks where valuations are reasonable and earnings visibility is high might start looking attractive if markets can get over the present downtrend
- Large caps are better placed as compared to smaller companies since their shock absorption capacity tends to be high during uncertainties
- Given the uncertainty prevailing in the market, it’s better to avoid highly leveraged trades, especially if you are a retail investor
- This is perhaps the time to top-up Systematic Investment Plan (SIP) and take advantage of market volatility
For years together, individual investors have typically been at the receiving end of market downturns, will it be different this time?
A bull might buy the dip while bear might sell a rally, but if you are investing in markets to accomplish your long term goals, you need not be a bull or a bear. You just need to be a disciplined investor.
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