Mark Twain didn’t have much to do with stock markets. But market participants during times of crashes and recovery frequently resort to his famous quote: ‘History never repeats itself, but it does often rhyme.’
Well, Sensex of 2006-07 and Nifty of 2020-21 do seem to rhyme. The fact that Nifty in February/March 2020 was around the same 12,000 levels at which Sensex was in April/May 2006 is just the starting point of this similarity.
By May 2006, Sensex had had the run of its life. From a post dotcom bust bear market low of around 2,600 in September 2001, the index had given CAGR returns of 37 per cent to reach an all-time high of 12,671 by May 2006. What followed was a stunning reversal starting May 18 triggered by US inflation data/rate increase and sudden fall in metal prices. In a little over a month, the benchmark index had corrected by 30 per cent.
Sounds a bit familiar, doesn’t it? The Nifty index, after reaching record high of 12,430 in January 2020 (similar to Sensex highs in 2006) and hovering above 12,000 till mid-February 2020, had as stunning a crash over the next month as fears of a Covid-driven economic crisis engulfed the world.
What transpired in both the indices following the short bearish phase was a marathon rally lasting 18 months. While the Nifty of today is up 131 per cent in the 18 months from its March 2020 lows, the Sensex then was up a near matching 125 per cent from its June 2006 lows in 18 months.
However, the underlying factors behind the rally at both times are a study in contrast. The years leading to FY07 were a period of accelerating economic growth for India while in FY21 recession stared at us, with GDP contracting 7.3 per cent.
The global economy, too, witnessed one of its best phases of economic expansion since the Second World War (WW2) between 2003 and 2007 and saw the worst recession since WW2 in 2020.
Concerns that the economy could overheat led to central banks increasing interest rates then. In contrast, heading into the slump of March 2020, the global economy was dealing with a decade of low economic growth, low inflation and declining interest rates. Quantitative easing (QE) was only a theoretical concept in 2006-07, while the massive QE driven monetary stimulus by global central banks is the factor driving markets today.
Corporate earnings were booming then with Sensex earnings CAGR at around 25 per cent in the five years into 2007.
The Nifty earnings CAGR in the five years into 2021 were a paltry 5 per cent. The Sensex trailing PE was at 21 times then versus the Nifty trailing PE of around 30 times now.
The index leadership then was from Power/Infra and Real Estate stocks with blue chip IT services companies underperforming and giving negative absolute returns in 2007 due to worries from the impact of the significant rupee appreciation that year.
In contrast, IT services companies have been leaders in the current bull run although ironically their revenue/earnings growth now is much lower than in 2007.
There were, however, a few similarities, the most interesting being the boom in US housing prices during both these times. The record number of IPOs and the frenzy around it as well as the bull run in commodities is another similarity.
Probably what has panned out so far is just a coincidence. However, if the rhyme of history continues, then a significant correction is likely. Remember 2008?
That said, when it comes to markets, one can only deal in terms of probabilities and not certainties.
All-time high valuations and the fact that the global economy is today dependent on monetary and fiscal stimulus that may not continue forever, do imply that there are risks to the current rally.