Tuesday, June 10, 2008

Bear Market Rally ?

A last hour intra day rally saw the Nifty move up by almost a 100 points from its intra day lows, closing with just minor losses at 4450.
Marc Faber wrote:
"For a market, which has become very over-sold, it is only natural to rebound, but frequently these rebounds are merely bear market rallies, which are subsequently followed by vicious declines."
In 1930, after the famous 1929 market crash, stocks were trading at low levels. Irving Fisher , the best known economist in America, thought that stocks were 'ridiculously low' (subsequently they fell another 80%). In between, there were sharp rallies but these rallies eventually fizzled out.
When we encounter a big up move, we must be aware that bear market rallies are often sharp and sudden. They give the impression that the down trend is over, but this is often a deception. On the other hand, a new bull market will eventually start with a rally of some proprotions. We simply do not know if a rally after the sharp decline is a bear market rally or a resumption of the bull market. With this imperfect knowledge, it is wise to follow the existing trend. The current intermediate trend is down. Thus, rallies are assumed to be bear market rallies until proved otherwise.
Change of leadership. After a bear market, leadership among sectors usually changes. Earlier, it was IT, then Banks & Capital goods. Now, we are in a bear market, but which sectors are likely to lead once the decline is over ? While there is no clear answer to this question, some possible leaders are: Pharma, Cement, Natural Resources (Cairn, Neyvelli).
(disclosure: At the time of writing this, I have recently purchased stocks in Pharma, Cement & Natural Resources.)