Market Crash: Time To Catch The Falling Knife?

Sir John Templeton warned us that the four most dangerous words in investing are – “This time it’s different”. And in the midst of the current predicament that investors and investment managers find themselves in; Sir Templeton’s humble but priceless words ring true, louder than ever.

By January this year, the Price to Earnings (P/E) Ratio of the bellwether NIFTY Index was nudging 29 times – a tad more than the heady heights of 2008 that preceded the brutal crash which is now part of investment folklore. And yet, theories substantiating these valuations were a dime a dozen. Investment managers put on their rose-tinted glasses and deployed indicators like Market Cap to GDP Ratio, Price to Book and Credit Offtake to justify their bullish viewpoints; studiously ignoring the fact that a 12-year long dry spell for domestic corporate earnings growth had drastically overextended valuations in many frontline stocks. To put this in perspective, the EPS (Earnings per Share) of the NIFTY grew at less than 6% per year on an annualised basis between 2008 and 2020. From 2004 to 2008, the growth in the NIFTY EPS had been a blistering 25%.

And then along came COVID-19, and the house of cards toppled; proving yet again that mean reversion in stock prices is an inevitability. Only the triggers are different – in 2015, it was global uncertainty. A year later, it was demonetization. And in 2020, it’s been a global pandemic. The large caps that had swelled to unjustifiable valuations crumbled by nearly 50% on average, and even mid and small caps that had already taken a drubbing since 2018 came under heavy fire, singeing all but those investors who had maintained a disciplined asset allocation strategy.

To be fair, nobody could have predicted the sheer ferocity of the selloff that will forever mark the month of March 2020. On the 23rd, the SENSEX lost 3,934.72 points (13.15%) and the NIFTY plunged 1,135 points (12.98%) to 7,610 points in a single day, as fear and panic unhinged traders. As is often the case, a semblance of rationality has since returned to the markets, with the NIFTY rising nearly 20% and edging past 9,000 points barely two weeks after the crash.

The ubiquitous question is – what now? Truth be told, it’s quite impossible to tell if the bottom has been hit. The present situation is a highly dynamic, evolving one – and incoming news flows and data prints are likely to keep markets volatile for now. Contrarily, the crisis may even have unlocked some advantages for India. Controlled inflation has allowed the RBI to take extraordinary measures to protect the economy. A lower trade deficit with China is on the cards, as is an increased level of credit flow over the long run. Lower Global Interest Rates & Higher Liquidity can bring more capital allocation to India once the dust settles, and we may even witness a supply chain disruption that will drive more companies from China our way. Unlike six weeks ago, equity valuations are no longer stretched gossamer-thin. Today’s stock prices definitely warrant more aggressive portfolio allocations across market capitalizations with a 3-5-year investment horizon, but in a staggered manner rather than through lump sum bets. It’s a tragedy, then, that most retail investors will consciously choose to sit this one out.