Will the 2020 meltdown mimic 2008? Possible, but there is a caveat

Many are drawing parallels with the 2008 financial crisis which wiped out more than 50 percent of the benchmark value in a matter of months. The meltdown which we are witnessing in 2020 is a ‘health crisis’ which could well turn into a financial crisis as economies across the globe are virtually shut down.

The 2008 crash lasted around 300 days and the Nifty50 fell a total of 60 percent. But, the fall was not unidirectional, and the market fell in three steps. After each fall, the market saw a small (sharp) rebound only to fall lower in the next crash (refer chart).

The current crash, as such, has seen only the first step of the crash, though the correction has been much sharper. Experts feel that another down move is possible; however, there is a caveat and that is if we develop a vaccine for COVID-19, it could fuel a risk-on sentiment in equity markets across the globe.

“The Nifty50 fell 38 percent from peak to bottom over a period of 66 days. Historically, most bear markets last for at least 3 months. As a result, depending on the extent of the lockdown in India and the rate of spread of COVID-19 across the world, the market may see further correction in the coming months,” IDFC MF said in a report.

“A big caveat to the above postulation is the discovery of a medical breakthrough in the treatment of coronaVirus leading to a dramatic fall in morbidity rate (currently at 5 percent). Then markets may have a significant, sharp relief rally and probably create a base which may not be breached,” it said.

The major differentiator between the current bear market and the past bear markets is the fact that economic activity is universally on a shutdown mode unlike in the past when bear markets were triggered due to the financial crisis.

“I would concur with the fact that every crash has multiple legs and it generally does not end after the first leg of massive hammering. But, it would be very difficult to compare the current situation with the previous ones,” Sameet Chavan Chief Technical Analyst, Angel Broking told Moneycontrol.

Chavan draws a few scenarios as to how markets could pan out in the near future:

a)If the actual impact of the coronavirus is in line with expectations, 7500 remains to be a bottom and the recovery would be slightly slower in nature.

b) If things do not turn that bad as the market already anticipated, we may see faster recovery.

c) Lastly (hoping for it not to happen), whatever market has already reacted, in reality, if things become worse than this, then we are likely to see another leg of the fall and historically, the last leg is more brutal than the previous one; because prices literally sink to a different level in this phase.

History suggests that there could be a possibility of a further fall in the markets which could be even more severe compared to the one which we have seen in March.

The Nifty50 has bounced back about 20 percent from the lows but as we approach higher levels there is a bit of resistance which suggests that it would not be an easy ride for the bulls on the way up.

There is some similarity between 2008 & 2020 fall but the cause of the falls is different, say experts. Similar to 2008 we are heading for a recession and longer bear phase.

Before the 2008 fall, there was a steep rise in global markets and valuations had gone to 2 Standard Deviation from its 10-year average. This time, at the peak, the Nifty-50 was at 1 standard deviation above its 10-year average.

“In terms of impact on business and earnings, the current lockdown and its uncertainty of recovery will cause more disturbances than what we witnessed in the 2008-09 phase. During the financial crisis business activity was functioning but this time it has come to a standstill,” Rusmik Oza, Executive Vice President, Head of Fundamental Research at Kotak Securities Ltd told Moneycontrol.

“To this extent, the forthcoming impact on revenues and earnings will be far more harmful than that of the 2008 crisis. Based on this reading, we could see somewhat replication of what happened in 2008 and there could be internment down phases still to come. In a longer bear phase it is usual to see interim rallies of ~20% followed by steeper falls,” he said.

History suggests that major bear markets have led to wealth destruction of 50-60 percent. In 2020 we have just corrected by about 30 percent at the index level since January 20, when the index hit a record high of 12,430.

Hence, investors should be more focused on individual stocks because volatility is likely to remain in benchmark indices.

“Major bear markets in India witnessed wealth destruction of 50-60 percent from their respective bull market peaks. Hence, if we go by that fact then mechanically we should arrive at a bear market target of something around 6,200 levels if we are going to see wealth destruction of 50% from the top of 12400,” Mazhar Mohammad, Chief Strategist – Technical Research & Trading Advisory, Chartviewindia.in told Moneycontrol.

“But, considering the fact that wealth destruction in financial markets is happening since January 2018 in the broader markets, at least in Indian markets, we might have reached a saturation point in terms of pessimism at least in the broader markets. Hence, for the next 12 – 18 months it can remain as a stock picker markets till normalcy catches up with economic activity,” he said.