8th Jan, 2009

Indian stock markets had a long bear period between 1993 and 2002 with the 30-share sensitive index of the Bombay Stock Exchange gaining precisely zero per cent.

The Harshad Mehta scam in 1992 saw the sensex tumble by over 40 per cent in just three months followed by a nine-year slump on the bourses.

Going by the current market trend, the bear hug this time may last even longer. The sensex has fallen more than 56 per cent from its peak of 21206.77 in January 2008. It is currently trading at the level of January 2006 wiping out gains of two-and-a-half years.

No one can predict with any conviction when this gloomy period will end but one thing is certain that people who invest in the stock market in this bear phase will reap the benefits in the coming years..

Doom or Boom

Experts like Warren Buffet see thge bear market is a blessing and not a curse. According to such experts bear markets can generate profits twice as fast as bull markets, if you get your basics right. Shelby C. Davis, the investor who turned a paltry $50,000 into a fortune of $800 million to become one of the 400 richest men in the US, once said, “You make most of your money in a bear market; you just don’t realise it at that time.”

Davis made most of his money between 1959 and 1974, which is recorded in the US economic history as the longest ever bear market till date.

Amid the global financial turmoil, Warren Buffett, the world’s richest man, has been buying American stocks. “A simple rule dictates my buying; Be fearful when others are greedy, and be greedy when others are fearful,”

Following Buffet’s example, investors can buy more shares with a given amount of money when the sensex is at the 9000-level than when it was hovering around 20000. Most investors have the herd mentaliy  and are willing to buy equities at higher prices. In 2002, when the sensex was around 3200, inflows into equity schemes of mutual funds were at Rs 4,517 crore. In 2007, when the sensex topped 15000, the inflows increased to Rs 1,07,189 crore.

Stocks to buy

How can investors make money in a bear market on the same stocks that they had bought in a bull market?

When the tide turns, not all stocks will be able to bounce back. When markets rebound, some companies will perform better than the others if:

1) They belong to sectors that offer long-term prospects.

2) They have long-term focused and outstanding management teams.

3) They have proven track records with solid financial fundamentals.

4) They have strong competitive advantages in the form of popular trusted brands, wide distribution networks and good order book positions.

With investors turning pessimistic, they are willing to pay less premium for earnings per share of companies. This may be because of a general slowdown in economic activity, though the financials of companies may not have changed drastically.

For example, investors now are not willing to pay more than Rs 12.50 on an average for sensex stocks for an earning of Re 1 per share. In January this year, they were willing to pay Rs 28.50 for the same earning per share.

Investors were not so negative even in the last bear market in 2000-2003 after the Asian currency crisis and the dotcom bubble.

The sensex traded at a price-earning ratio of 12.5 in late 1998. This signifies that stock prices have been hammered quite a lot and there is not much room for them to go down further.

The basic strategy of making money in the stock markets is buy cheap and sell when they are dearer. But while the “buy and hold” strategy works fine in a bullish market, it doesn’t hold good when the bear goes wild.

Basics of Bear Market

In a bear market, one can make profits in two ways.