What History and Psychology Teach Us About the Current Market

20 March 2025

Market Bottoms — Why We Struggle to See Them

Market bottoms are often hard to recognize because of our psychological biases. Recency bias makes investors focus on recent losses, fearing further declines. Loss aversion causes people to avoid investing, even when stocks seem attractively priced. Confirmation bias leads to accepting negative news while ignoring positive signals, making recoveries appear uncertain until they are well-established. These biases create hesitation, delaying participation in market rebounds. It's tough to know if we're at the market's bottom until it's behind us. Large-cap stocks seem reasonably priced for careful, gradual buying, but small and mid-caps might still be overvalued. Instead of trying to time the perfect bottom, it's better to stay patient, avoid emotional decisions, and build investments slowly. True bottoms often appear when most people have lost hope — something clearer only in hindsight.

India's Market Cap to GDP ratio, a classic measure of market valuation. Historically, the average stands at 71%, serving as a baseline for fair market value. Peaks like 141% in 2008 and 150% in 2022 signify market exuberance, often preceding significant corrections. Conversely, troughs like 53% in 2009 and 56% in 2020 reflect market pessimism, presenting potential long-term buying opportunities. With the current level at 116%, the market remains above its historical average, suggesting a potential overvaluation but not yet at an extreme level.

India's stock market is valued compared to other emerging markets. Usually, India's market has been valued about 1.5 times higher than its peers. At certain times, like in 2004 and 2022, it was much higher, indicating strong optimism about India's growth. Recently, the premium has come down to its long-term average, suggesting that the excitement has settled, and India's market is now more in line with global expectations. This could mean a more balanced view of India's growth potential compared to other emerging markets.

The relationship between the revenue growth (top-line growth) and profit margins (PAT margins) of the BSE 500 companies over the years

From 2010 to 2016, both revenue growth and profit margins declined, suggesting tough business conditions and possibly rising costs.
Around 2018, profit margins fell sharply, indicating pressure on profits, even though revenue growth saw some fluctuations.
The period 2020 witnessed a spike in both revenue and profit margins — likely due to the post-pandemic recovery, cost controls, and demand surge. Recently, profit margins have stabilized while revenue growth has slowed, suggesting businesses might be finding it challenging to maintain high growth

Nifty 50's Price-to-Earnings (P/E) ratio, which is currently below 20, indicating that the market may be relatively cheaper compared to its long-term average. However, the average has shifted upwards due to strong market performance in the past decade. The red line shows the overvalued zone, while the green line shows the undervalued zone. If the P/E ratio nears the red line, the market could face a correction, while nearing the green line might present a buying opportunity. This helps investors gauge whether the market is expensive or affordable.

Nifty 50 Total Returns Index (TRI) with the NSE VIX, which measures market volatility. Despite the Nifty 50 falling over 16% from its peak, the VIX has stayed low, indicating limited fear or panic in the market. Usually, a significant market drop leads to a spike in VIX, reflecting increased uncertainty. The shaded areas highlight periods of high market stress when both Nifty fell sharply, and VIX spiked. The current low VIX despite the market drop suggests that investors might expect stability ahead

The unemployment rate in India has shown notable fluctuations over the past decade. It peaked at 8.4% in 2023, reflecting post-pandemic economic challenges, but improved to 6.7% in 2024. Historically, unemployment rates below 6% indicate economic stability, which aligns with pre-pandemic years. High unemployment can lead to reduced consumer spending, impacting market demand and corporate earnings. As the rate stabilizes, it may boost market sentiment, signaling a potential recovery phase. Investors should watch employment data closely, as sustained improvement could support economic growth and market performance

India's GDP annual growth rate and the NIFTY 50 index from 2015 to 2024. During the pre-pandemic period (2015-2019), India's GDP growth rate remained relatively stable, ranging between 4% to 8%, while the NIFTY 50 exhibited cyclical movements with market corrections that generally aligned with minor GDP slowdowns. However, the pandemic in 2020 led to a sharp contraction in GDP, marking a significant economic downturn. Simultaneously, the NIFTY 50 experienced extreme volatility, capturing the market's initial panic followed by a rapid recovery driven by stimulus measures and investor optimism. In the post-pandemic recovery phase from 2021 to 2024, GDP growth rebounded sharply but later stabilized around 5% to 6%, while the NIFTY 50 continued to display volatility, reflecting ongoing market uncertainties, inflationary pressures, and global economic challenges. The strong correlation between GDP growth and NIFTY 50 movements highlights the influence of economic health on market performance. Notably, the pandemic created a unique divergence where market optimism outpaced the immediate economic recovery, likely fueled by liquidity injections and global market trends. In recent years, the stability in GDP growth alongside persistent NIFTY volatility suggests that market sentiment remains sensitive to external factors like global inflation, interest rate changes, and geopolitical tensions. Market bottoms are challenging to identify due to psychological biases like recency bias, loss aversion, and confirmation bias, which make investors hesitant to re-enter the market. Historically, India's Market Cap to GDP ratio averages 71%, with peaks signaling market exuberance and troughs indicating potential buying opportunities. Currently, it stands at 116%, suggesting possible overvaluation. India's market premium over other emerging markets has normalized, reflecting more balanced growth expectations. The BSE 500 has seen fluctuating revenue growth and profit margins, stabilizing recently. Nifty 50's P/E ratio, currently below 20, hints at a relatively cheaper market, while the low NSE VIX signals limited fear despite a market drop. The unemployment rate has improved from its 2023 peak, suggesting recovery. India's GDP growth and NIFTY 50 movements show a strong correlation, with post-pandemic stability tempered by market volatility. Investors should focus on long-term strategies, avoiding emotional decisions, and monitoring economic indicators for informed decisions.

Source : DSP