Wednesday, March 11, 2009

Why the markets may remain at the bottom for sometime?

After a few months of forced hibernation, the bulls are slowly emerging from the woodworks. A few pundits are suggesting that the stock markets have bottomed out and now may be the right time to enter. In fact, a few others even think that we may be facing the "opportunity of a life-time" to buy equities on the cheap!

As against the long-term PE ratio of 16, S&P 500 has a ratio now of 12.3, leading commentators like David Leonhardt to claim that shares in US are under-valued by 30%. He claims that there is a direct co-relation between the p-e ratio and future long-term returns, and that when the p-e has been between 12 and 13 over the last 125 years or so, stocks have doubled over the next decade, on average.

So what are the prospects? In the US, the Dow has fallen below 7000 and the Bombay Sensex is fast declining to the sub-8000 barrier. If the Dow were any indicator, the Indian equity markets may have quite some more to fall before stabilizing and correcting the spectacular bull run that occured in the 2005-07 period.

The CBOE VIX, an broad measure of equity market volatility, at almost 50, is ruling at two-and-a-half times its normal value of 20.

It may turn out that the equity markets have touched their bottom. But this does not automatically mean that it is time to roll money into the markets. Far from it, even if the markets have bottomed out, given the depressing global economic environment, it is very likely that we may be in for a long period of stable (or stagnating) markets. In other words, the markets may remain at the bottom for some time to come. For a generation of investors accustomed to either bull or bear runs, this may be difficult to grasp, whereas even a cursory glance at the history of the equity markets shows that volatility of the kind seen in the last two decades has been unprecedented. As the historic graphs of DJIA, S&P 500, and FTSE 100 shows, the bull runs since 1995 are without parallel.

And for an example of how markets can remain stuck at the bottom for a long time, we only need to look at the stability (or stagnation) of the Nikkei 225 index for the past two decades.

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