How low can the Sensex go?

That must be the question on the lips of every investor.

Inflation is going up, so are interest rates for borrowings. Pretty soon banks will be forced to raise interests for fixed deposits. Oil prices are at an all time high. The political situation is in turmoil with the Congress and the Left fighting harder than the bulls and bears!

So the fundamentals – at least in the near term – are looking bleak. That tells you the Sensex will go down further – but can’t tell you how far. Score one more point for the technical analysts over the fundamentalists.

Enter Fibonacci retracement levels. For some strange reason better known to smarter investors than me, the Sensex tends to reverse direction at levels of 38.2%, 50% and 61.8% of its previous move (up or down). Of these, the 61.8% appears to be the most significant.

If we take the entire 5 years bull run from 2900 in 2003 to 21200 in 2008, we had a total up move of (21200 – 2900 =) 18300 points. The respective Fibonacci retracements are:

(a) 38.2% of 18300 = 7000 points

(b) 50% of 18300 = 9150 points

(c) 61.8% of 18300 = 11300 points

So the retracement levels are:

(a) 21200 – 7000 = 14200

(b) 21200 – 9150 = 12050

(c) 21200 – 11300 = 9900

The 14000 level has been violated already. So the next stop is at 12000. If there is no retracement at 12000, then the Sensex can drop to 10000. (Now you know why these numbers are being talked about in the media!)

If the 10000 mark is violated also, then the Sensex may retrace the entire up move. This is a possibility but highly unlikely considering the current growth path of the Indian economy.

Let us, therefore, concentrate on the 12000 and 10000 levels. We seem to be in the grip of an 8 years time cycle. In 1992 and 2000 we had bear markets where the Sensex retraced between 50-60% of the up moves. As we are in the middle of a bear market again in 2008, my guess is that history will tend to repeat itself. (In 2004 and 2006 we had bull market corrections – but the long term up trend line was not broken; it has been broken conclusively in 2008.)

Chances are that the Sensex bottom will be somewhere between the 11000 and 12000 levels, and there will be some consolidation at that level before the market begins to turn back up again.

If you are a pessimist, wait for clear market up trend signals before entering. You may have to wait till the end of the year to do so. If you are an optimist, start nibbling at fundamentally strong ‘A’ group stocks once the 13000 level is broken.