The Hindu Business Line : How (not) to play a bear market rally

Only those with timing, discipline and risk tolerance should try to capitalise on rallies in a bear market. And, instead of trying to join the bandwagon when a rally is on, try and accumulate sound stocks when market sentiment is at a low ebb.

Aarati Krishnan

A bear market may not be such a bad thing after all. The now year-old bear market, which got underway in January 2008, has so far been punctuated by four strong (if brief) surges in stock prices. Call them “bear market” rallies or “relief” rallies, each of these surges, before they petered out, did offer big moneymaking opportunities for investors (or more accurately, traders) — the hardy souls who happened to be in the market at these times.

Here is a look at how they played out. The Sensex made gains of 18-25 per cent (before sinking back below earlier levels) in the four bear market rallies of the past year (we’re excluding the present one, as we can’t comment on its sustainability at this stage). That represented four separate opportunities for investors to earn a 15 per cent return, the annual return that long-term investors in stocks are urged to expect.

Global triggers

Based on how stock prices behaved in each of these rallies, there were certain common features to these. To start with, each recovery in Indian stocks was underpinned by a revival in the US and other global stock markets.

In fact, since this bear market flagged off last year, there has not been a single occasion where the Sensex notched up significant gains without the accompaniment of the Dow Jones. That’s because each of these global revival phases has been triggered by hopes of an early end to the global slowdown (or, as it became apparent later, recession), spurred by a fresh set of US policy announcements.

Sensex beats Mid-caps

Save for the first surge from March to May 2008, each of the rallies saw the Sensex outperforming the mid-cap pack. Mid-cap stocks have been beaten to pulp in the ongoing meltdown and are today available at dirt cheap valuations. Even so, with liquidity in short supply and conviction practically absent, investors have chosen to place their bets more on the index heavyweights, during these short-lived market rallies.

For instance, in the bounce-back from the October 27 low, the Sensex rose nearly 25 per cent in a matter of a week; but the BSE Mid-cap Index managed only a 16 per cent rise. In the rebound from the November trough, the Sensex’s 22 per cent surge was, again, not matched by the BSE Mid-cap Index (a 19 per cent gain). This pattern has played out in the ongoing rally too. Though some mid-cap stocks have gone through the roof, the BSE Mid-cap index remains several paces behind the Sensex, in terms of returns. That suggests that short-term investors keen to participate in any such rally, should place their bets on the indices, instead of lesser known names.

Winners turn losers

In each of these phases, there were a handful of stocks that zoomed by 50 per cent or more in a short time window, ranging from a week to a couple of months. But traders looking to play this opportunity would have been hard-pressed to choose the right stocks, as stocks that led one surge inevitably fell flat in the next.

Consider this. The first bear market rally of March-May 2008 saw stocks such as BF Utilities, Reliance Industrial Infrastructure and Praj Industries gain 56 to 85 per cent. Pushed to the sidelines since then, these stocks have till date plunged 80-85 per cent from their May 2008 level.

Unitech, IVRCL and Nagarjuna Constructions were the frontrunners of the post-Diwali surge, zooming 70-86 per cent in just a week from October 27 to November 4. But these stocks didn’t participate in the festivities thereafter and are now languishing far below their highs. Unitech, which closed the October rally at Rs 56 is today at Rs 26; Nagarjuna Construction is today at Rs 49 (Rs 72), and so on. Nor have the same sectors led each of these recovery phases.

If the surge in the first half of 2008 was led by capital goods stocks, the gains in October and November were driven by the larger realty and infrastructure stocks. In the latest rally, a motley mix of mid-cap realty stocks and IT stocks dominated the gainers list.

What worked

From the above, it should be clear that it is not easy to emerge richer from a bear market rally, attractive though the returns may look on paper. In fact, even traders would have required three attributes to capitalise on the above rallies.

One, timing. Only those who bought into indices or stocks when the sentiment was particularly bleak (as on October 27 or November 20) would have been able to benefit from them. Given that both indices and individual stocks have plunged sharply after each rally, jumping on the bandwagon at the halfway mark exposed you to substantial downside risk.

Two, discipline. Given that the “opportunity” is short-lived and you cannot predict either the extent or duration of the rise, you should have been prepared to take money off the table when you made a target return of say, 10 or 15 per cent.

Three, risk appetite. Not only have the indices sunk back below their earlier lows after each rally petered out, individual stocks that were frontrunners have sometimes collapsed as much as 70-80 per cent from their rally-induced peaks. That suggests that it may be best not to bet on the stocks in the grip of momentum during this kind of a rally. By this token, even short-term investors would be best advised to stay away from stocks such as Akruti City, Everonn Systems and NIIT, which topped the gainers during the past week. If at all you are tempted to play such a bear market rally, taking the ETF route to buy the Nifty or Sensex basket, appears the best bet.

Finally, genuine investors looking to accumulate stocks for the long term should not allow such surges to influence either their stock choices or timing of the investment. Avoid the temptation to buy stocks that are leading a rally in the hope of making a quick buck. Stick to blue-chip stocks that you are convinced about or the index basket.

And don’t try to jump in with a big lump-sum when a rally is on, fearful of “missing the bus”. Instead, as the textbooks say, try and accumulate stocks when market sentiment appears to be at its lowest ebb.