What the biggest fall in six years means for Indian stock markets

So this happened this week…

The Calm Investor | Aug 2015 Nifty

A single day fall of almost 6% and an 8.3% fall for the week before a partial recovery.

So what does the biggest fall in six years mean for Indian stock markets?

TCI is no economist and apart from a word-cloud of “China” “commodities” “yuan devaluation”, I wouldn’t know to explain the sharp fall in global markets last week. Hence a look at more erudite opinions was called for and directly from this Vox article helpfully titled ‘The global stock market crash, explained‘, here are three (unquestioned) reasons for the Aug 24th fall in stock markets:

  1. U.S. markets have risen for six straight years and a correction was / is due
  2. China’s export-led economic model is running out of steam
  3. Western economies, especially in Europe, are still fragile

The question that comes to my mind whenever I read such analysis explaining stock market movements is: “None of the three reasons above were overnight factors, so why did the world’s investors wake up and decide to factor them into their decisions on this day?” I’m still to arrive at a satisfactory answer to this question so don’t mind me.

I’ve found it more useful to use hindsight in a different way, that is to see what history says about such movements, to get some inkling of what might be in store.

1. Such sharp falls do not happen often

The Calm Investor | Nifty One Day Returns Histogram

Chart shows 16 years of 1-day returns plotted by how often they happened. So out of 4,155 days of NIFTY performance, on 2,448 days, the NIFTY ended between -1% to 1% of where it started the day. That’s about 59% of the time. Similarly, it ended down by 2% on 491 days, 3% on 173 days, 4% on 68 days.

In the 16 years since Jan 1999, this was only the 28th time that the NIFTY ended down more than 5% in a single day

2. This was the 14th biggest fall in the NIFTY in one day

The Calm Investor | Nifty Worst Days

The NIFTY has fallen more than on 24th Aug 2015, in a single day only 13 times in the last 16 years

The last such fall was over six years ago on 24th Oct 2008 with financial markets around the world falling like dominoes in the face of the sub-prime crisis. On a related note, 2008 appears 6 times on that list, just something to keep at the back of our minds. Markets can be punishing at times.

3. Down days might (not) be a precursor to great returns

The Calm Investor | Nifty Returns after down days

“Buy low, Sell High” right? So, if one were to buy immediately after some of these big down days, how would we be doing from then on.

Turns out, median returns after days when the market fell 3% or more, is 16% with positive returns 2/3rd of the time and negative returns 1/3rd of the time   

The Calm Investor | NIFTY crash in Aug 2015

Top half of the graphic above shows the current Price-Earnings ratio of the Nifty which inspite of the fall, stands at 22.2, significantly higher than the median of 18.6. Superimpose that on the bottom half which shows histrorical returns from various P/E levels and we’re still in the range where returns are not too optimistic.

In summary, while the drop last week was significant, it doesn’t provide a reliable indication of what’s to come. We could have many more of those like in 2008, especially if corporate earnings do not rise to match expectations. Or then again, this might be a pause before a slew of favourable factors like low inflation, stable currency and strengthening corporate performance boost market.

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