Finding The Market Bottom

BSE Sensex is approximately 4 per cent down from its all-time high levels. Market stability is important for investors as stable stock prices encourage higher participation. With 2023 starting on a volatile note, it will be interesting to understand if there is further downside in the markets and most importantly what the market bottom in 2023 could be. Yogesh Supekar highlights the various ways one can identify the market bottom 

Why buy now when you know the stock prices will or let’s say may come down? It is observed that investors often hesitate to invest when the market sentiment is weak and when there is a probability of market correction. Market sentiment is perceived to be weak when the stock prices fail to react to positive news. In December 2022 and even in January this year so far, the macroeconomic news flow has been positive, both locally and in the US and yet the BSE Sensex has slipped by almost 4 per cent since December 1, 2022. The last two months may have confused several investors as the market slipped despite positive data. 

This explains the market dichotomy very well and suggests how investors get trapped by such contradictions in the market. Normally, on the back of positive news the market should have edged higher or at least remained stable but instead it slipped swiftly. We know now that FIIs have been withdrawing money and the source of selling pressure was from the FII desk. There are a few genuine concerns facing the market and one major event in the short term to deal with. The major concerns include the rapid increase in interest rates and its impact on the profitability of corporates which will start getting reflected in the upcoming quarters as well as the fear of recession. 

Meanwhile, the Union Budget is the major event in the near term which may induce market volatility. In such an environment it is difficult to bet on market direction. One of the most important factors that investors need to keep in mind is the impact of the rising interest rates on the market in the medium term. While the short-term and long-term market outlook may look bullish, in the medium term the market may start factoring in the negative impact of rising interest rates. It must be noted that the US Federal Reserve has increased the interest rate to 4.5 per cent now and another 0.25 per cent rate hike is scheduled for February. 

The interest rate was almost zero a year back in the US and now the rates are at their highest level. While on the one hand the interest rates have risen rapidly, the US Federal Reserve has also managed to suck out a huge amount of liquidity from the system. All these actions have been taken by the Federal Reserve to manage rising inflation. One of the biggest risks facing the equity market is the probability of liquidity crisis. The equity market is known for its resilience i.e. it has almost always climbed the wall of worry nonchalantly but whenever the market has faced liquidity issues the recovery has been a painful exercise and the price damage has been unparalleled. 

Take the Global Financial Crisis (GFC) of 2008, for example. The drawdown in 2008 for the BSE Sensex was almost 50 per cent. During the peak of the pandemic in 2020 we saw BSE Sensex drop by 38 per cent from the beginning of the year. The table below highlights the drawdown seen in those 10 years.

The difference between the major correction during GFC, demonetisation, pandemic and the current market situation is that there is serious threat to overall liquidity as the central banks over the world have in a coordinated effort increased the interest rates to tame the monster of inflation. Liquidity is the key for the stock prices to sustain at such higher levels. With rising interest rates the probability of liquidity drying up always increases and when we have a crisis situation such as the recessionary period staring at us clubbed with inadequate liquidity, the double whammy can cause serious price damage. The current economic slowdown is largely attributed to the Federal Reserve’s deliberate tightening of the monetary policy. It is not a financial or an economic crisis we are facing right now. 

The current downturn is risked by the central bank’s decision to target inflation at the expense of economic growth. All the major market crises we have seen so far have been tackled with a rapid easing of the monetary policy. Hence, the current situation gets a little trickier as history suggests that the bear market tends to last longer in an environment where policy tightening is seen. The probability of liquidity crisis will increase if the interest rate increase continues in a similar fashion in 2023 as it did in 2022 with no major improvement in economic activity. How does one build confidence and conviction to buy equity in such volatile times? How does one find a bottom and most importantly how does one understand that the trend is changing or reversing? 

"You get recessions, you have stock market declines. If you don’t understand that’s going to happen, then you’re not ready. You won’t do well in the markets."

— Peter Lynch

"The best chance to deploy capital is when things are going down"

— Warren Buffett 

Investor Behaviour and Market Bottom

Whenever investors are not happy with their portfolio performance and the frustration gets widely spread amongst them, one can expect a market bottom in the near term. There are instances when investors start liquidating portfolio after holding on to stocks for too long. This behaviour is not specific to any individual and is seen with a large pool of investors. Selling aggravates the market and we see more people willing to sell at lower price which leads to stock prices falling rapidly without much change in the fundamentals of the company. Such a situation indicates that a market bottom is nearby. Investing is all about psychology. 

Says Arun Harde, a long-term investor: “I bought Tata Power shares at around ₹ 270 per share and have been holding them for more than 10 months now. The stock was slipping down continuously and did not recover even when the market recovered. Every time I wanted to sell, I somehow convinced myself to hold on for the long term even when the relative underperformance was visible. Finally, I ran out of patience when the stock price was almost ₹ 200 per share. When the stocks closed below ₹ 200 I liquidated my holdings in Tata Power. However, since then the stock has recovered and is trading a little over ₹ 200. I think the stock may have bottomed out and I may have sold it near its bottom price. That was a lesson learnt.” This is exactly what happens with a lot of investors including the seasoned ones. Investors run out of patience and simply press the sell button. When that happens, it indicates that the market is forming a bottom. 

High Volume at Lower Levels

For investors the study of price volume action reveals a lot of things about the market. Unusually high volume at or near a price bottom can signal a market turning point. Again, when most investors exit their positions or press the sell button leading to above average volume with falling prices, a bottom is being formed. One of the best ways to identify a bottom formation is through identifying higher volumes at lower levels. Normally, there is a spike in volume if the price drops a lot. Even if there is no huge spike in volume, the volume should be high surrounding a price turning point. 

The high volume at the lower level represents desperation and panic selling on the part of the sellers. Such panic selling can happen from the FIIs desk as well and that is where maximum pain has been experienced in the Indian markets historically. Hence tracking FIIs activity is important. It is highly recommended that one observe the FII investing trend. If one is able to spot that the FII selling is slowing down, it also can signal market reversal. For example, FIIs have been net sellers to the tune of ₹ 16,437 crore in January up to the 23rd but in the seven days running up to January 23, FIIs have been net buyers to the tune of ₹ 360 crore. Even if the amount if not significant the important thing to note here is that FIIs have turned net buyers when they have been selling aggressively in the past few weeks. This also signals market reversal or the fact that the market may have bottomed out in the near term. 

News Flow and its Impact on Market

One of the best ways to understand that a market has bottomed out is when the market refuses to fall in spite of the incremental negatives that news imposes on the market. We have seen the Indian markets outperform the global markets in the past six months to one year. The Indian markets made new highs when the news flow was not positive. However, what is interesting to note is that the market did not fall further even when Russia intensified its attack on Ukraine and we knew that the market bottom was close. 

The news flow of poor geopolitical situation led to speculation of World War III but the market refused to slip further and eventually decided to make a new all-time high in December 2022. The market touched a panic bottom in June 2022 owing to the geopolitical situation. Investors have to simply observe when the market is in the lower range and the mood is that of pessimism in the sense that everyone wants to stay away from the market though no incremental negative news pushes the market further down. At the same time, it is interesting to check if any positive news lifts the market. When that happen we know the market bottom is nearby. 

Technical Analysis and Market Bottom 

Technical analysis is one study that helps you assess the market situation better and may also assist you in identifying the market bottom. Even identifying a bottom for a particular stock is possible with the help of technical analysis. One need not be an expert in technical analysis to gauge the market bottom. For example, when you see a green market day in a stock or index after several days of aggressive selling then that is when one should be alert about the possibility of market reversal or the market bottoming out. 

Valuation is one way to identify if the stock is available at a cheap price. For example, when the index PE (Nifty) trades within a range of 16-18, it can be considered cheap. Similarly, investors will have to study the PE multiple for individual stocks and understand if it is trading cheap or available at discount. Observe if the stock price is falling with volume and observe the pattern of red market days and green market days for the stock. If we consider the daily chart of LTTS we find that the stock has gained after continuous selling in nine out of 10 trading session. The daily chart presented below of LTTS explains the price action better. 

Such buying after continuous aggressive selling indicates a bottoming process and the price volume action suggests that the stock may bottom out soon. Technical analysis and chart reading can help us understand when the market is about to bottom out and when a reversal can take place. 

Conclusion

While it may not be practically possible to identify trend reversal and market bottom perfectly, it is worth putting in some efforts to identify the range or levels from where market or stocks are expected to change their behaviour. It is important to understand the trend reversals and the market bottom if one must outperform the market. The naked price action behaviour can also help us understand a lot about market trends. It is not always necessary to use market indicators to understand the market bottoms and market trend reversals. The market fortunes going forward will deepen upon the inflation peaking out and on the valuations which in turn are dependent upon the earnings. As investors, the major variables to watch out for thus will be the inflation data and the earnings quality to estimate the market moods in 2023. 

Any hint of inflation peaking out supported by RBI action on interest rate pause or even reduction may boost the market sentiment which could push the market to record highs. Right now, the bulls are seen running with near-term momentum. However, it is only wise to remain cautious as not all widely discussed breakouts are genuine. Keeping in view the concern on economic growth, investors should look at defensive names for outperformance. High quality and high conviction stocks should be focused on as market volatility and uncertainty may lead to irrecoverable losses in stocks where the quality is poor and conviction level is less. Focus on price volume action and track institutional activity to understand if the market is stabilising and ready to fly. The FIIs flows are crucial and the trend in FII flows can help us decipher the market trends.