Q2 earnings may bring relief on Street

If there is anything certain about stock markets, then it has to be the eternal optimism of the investors. Such optimism lies at the heart of all major moves in the stocks; both bottoms and tops are its handiwork. Bottoms are formed when such optimism gets the better of fears and when fear gets the upper hand, crashes ensue. If we were to quantify optimism and fear, then picking bottoms and tops would be just mathematics.

In other words, the stock market equation would be like this: next bottom = forward optimism – present fear.

Technical analysts use the fear and greed indicator to get close to solving this equation. The closest that we can get to quantifying fear is by measuring risk. However, that is very much an onerous job in itself, but it is easier to understand that fear. In stock markets, volatility is a good judge of how the risk-taking investors embrace fear.

Let us look at the extent of fear prevailing in the equity markets presently. At Monday's low, Nifty had fallen over 13% from the record peak. The fall is pretty steep, as record peak was seen just a month ago in August. But small and mid-cap stocks have fallen much more sharply and the decline has been persistent through the year, with small-cap registering a YTD (year-to-date) loss of 35% and mid caps registering a loss of over 22%. This suggests that fear has been floating for a longer time, and got to the front line stocks only recently.

September was historically a tough month for equities, but this time, the falls got exacerbated by coincidences like trade war tensions, record low rupee, rising oil as well as issues surrounding IL&FS and YES Bank etc. The abruptness and steepness of the recent fall and the measures taken along the aforementioned factors, suggests that they do not hold a surprise to the investor anymore. This is reflected in VIX, a measure of volatility, which, at 21.62 is approaching record peak.

Higher the volatility, higher the chances of seeing a reversal, which suggests that it may not be long before the 50-share Nifty sees a break from the present downtrend. The sustainability of such a move is unsure but the investor expectations are certainly at a tipping point, and second-quarter earnings season provides a welcome distraction.

The writer is chief market strategist, Geojit Financial Services