Equity Market . Is the market crash similar to 2008 and 2001?

As stocks fell like ninepins across the globe on Monday, many market old-timers would have been reminded of the market crashes in 2008 and 2001, when stocks seemed to slide down a similar abyss.

On the other hand, most new entrants in the stock market, who began investing over the past decade, would have been shocked by the ferocity of the current down-move, since declines in the market index in a single session have rarely exceeded 2 per cent.

With a large amount of liquidity infused by global central bank policies supporting equity prices, stocks had been on a dream-run through 2019. But the global risk-off sentiment, due to the severity of the Covid-19 outbreak, has set off a wave of panic selling across asset classes and regions.

Large single-day price falls, akin to that witnessed on Monday, were fairly common in the last two major market corrections — following the sub-prime mortgage crisis in 2008 that triggered the global financial crisis and after the bursting of the dotcom bubble in 2000.

How does the current correction in the Indian stock market compare with the earlier corrections, in 2008 and 2001? Are there any similarities? What are the takeaways?

Extent of the fall

If we consider the time taken by the current market correction and the magnitude, this does not qualify as a major bear market similar to the 2008 or 2001 declines. While the decline in the Sensex since the peak of 42,273.87 on January 20, 2020, has been quite swift, it has lasted less than two month so far.

The Sensex has so far lost 16 per cent from its recent peak. Declines from the peak need to be at least 20 per cent to qualify as a bear market and most severe declines have exceeded 30 per cent.

Following the sub-prime mortgage crisis in late-2007, there was a severe global equity market sell-off in 2008 that accelerated following Lehman Brothers’ bankruptcy in September 2008. The stock market decline in India began from the March 2008 high of 21,206 and lasted up to the December 2008 low of 7697. The fall from the peak in 2008 was 64 per cent and it lasted more than 10 months.

The decline in 2000, following the the dotcom bubble, made the Sensex lose 46 per cent from the peak, and lasted around 18 months.

Market valuation

The valuation of the Sensex was quite pricey when the decline began in January 2020, trading at a price earning multiple of 25.2 times its trailing 12 months earnings. The valuation had been marked up due to two factors. One, large institutional investors converging on large-cap stocks formed the Sensex basket, thus increasing their stock price.

Two, the earnings growth of most companies had been impacted by slowing demand and other cyclical factors. Following the correction, Sensex PE has moved lower to 21.8 times.

The valuation of the Sensex in December 2007 was also quite elevated, at 22 times its trailing earnings. But the sharp decline in stock prices in a small time-span had made the Sensex’ PE decline to 11 times by December 2008.

In 2000, the Sensex PE declined from 20 times in December 2000 to 13 times by September 2001 as the decline accelerated.

In other words, though Sensex valuation has corrected slightly, it can even halve from these levels, if the fall accelerates. That will of course, be a buying opportunity from a long-term perspective.

Earnings growth

According to Bloomberg, earnings growth for the Sensex in 2020 is expected to be 9 per cent over its 2019 earnings. In other words, earnings expectations for the Sensex components have been considerably tempered given the liquidity challenges, problems facing consumer-oriented sectors, commodity companies being impacted by global price correction and regulatory issues in other segments.

In contrast, the earnings growth in 2007 was very strong, at 38 per cent, as many companies had begun expanding capacities with demand being robust and private capex cycle at its peak.

The most striking similarity between the two previous bear markets and the ongoing decline is that the trigger has been a global event that had a considerable impact on global growth. The increase in global risk-aversion caused foreign portfolio investors to pull money out of India in 2008 as well, thus exacerbating the decline.

Takeaways for investors

Given that the impact of the Covid-19 on global growth is not yet known, it is not possible to gauge the extent of the current decline. If the contagion is contained soon and normalcy is restored, it is possible that we could get away with a far shallower correction compared to 2008 or 2001, perhaps 20-30 per cent.

But a deeper fall is also likely, if risk aversion continues. In that event, valuations can move to mouth-watering levels as seen in the previous declines. Best to be ready for such an eventuality.