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Share Market Has Been Down For a Few Months. What’s the Smartest Move?

07 Aug 2019

After touching its peak of ~38,900-levels in the last week of August, the BSE benchmark index Sensex has lost nearly 5,000 points up until the second week of October. There are individual stocks that have lost 40-50% in valuations. We are not even talking about companies with dubious track records and governance issues. We are talking about quality, blue-chip companies that have corrected in sympathy with short-term fears.

In these conditions, how does one invest in the share markets? How does one make the best of their trading account and trading app to capitalize on this correction? You obviously cannot rely on stock market tips and specific stock tips for this. Here is a strategy sheet…

When in Doubt, Shift to Quality

There are quite a few stocks in the market that have shown consistent growth over the years due to their very mature and robust business model. In the last 20 years, stocks like HDFC Bank, Hero Moto, Reliance Industries, and Eicher Motors have all been classic examples of value growth. These stocks have grown at a consistent pace through good and not-so-good times only because these companies focused on the top-line and the bottom-line as well as maintaining the quality of their business.

Take the case of Eicher or Kotak Bank or even Maruti. Some of the froth is out and the correction is sharper than the Nifty and the Sensex. However, their business models are less vulnerable by default. When the model is sound, stocks of such companies will recover faster than other stocks.

You must use the opportunity of a falling index to move your portfolio towards quality and to this extent, restructure aggressively.

Rebalance Away From Stars That Triggered This Downtrend

Just sit back and evaluate the sectors that triggered this downtrend in the first place. There are the NBFCs and the oil companies that were key triggers behind it. FMCG was a sector that had added heft to the drop on the back of weakened consumer sentiment. Successive rallies are rarely driven by the same set of stocks and vice versa.

So, take some money off of such stocks on every bounce and then take a measured call on the sectors for the future. This rebalancing is a key decision as it will decide how well your portfolio performs in the future. The message is to book losses in losers (if required) in a bid to reallocate to future stars.

Your Shopping Basket Needs Liquidity at Lower Levels

An interesting question is whether one must remain in equities or shift to debt altogether. You could then use the liquidity of debt to buy stocks at lower levels. This is an extreme asset allocation approach and is neither recommended nor feasible.

What one should actually do is increase the allocation to debt and reduce the allocation to equity. The reason investors lose out on buying stocks at attractive prices is because they do not have the requisite liquidity when stock prices are down. We are still left holding the fancy stocks that we purchased at fancy valuations.

A greater allocation to debt and liquids at this time will ensure that you have the required liquidity to enter stocks at lower levels.

Sharp Corrections Rarely Reverse in V-Shaped Fashion

(Data Source: NSE)

The above chart shows the Nifty and the VIX (Volatility/Fear Index) since August on a scale of 100. The sharp fall in the Nifty is accompanied by a sharp rise in the VIX. That is a typical correction accompanied by volatility. Such corrections rarely show a V-shaped recovery.

Such markets will recover after meandering at lower levels for some time after the VIX has again come back to lower levels. This means that you need not be in a hurry to bottom fish immediately; instead, you can wait for the right opportunities to buy stocks.

Don’t Upset Your Asset Allocation for the Sake of the Correction

You must still stick to your rule-based approach to asset allocation. After all, asset allocation is about discipline and the advantage of this discipline is that your allocation automatically moves contrary to the market valuations.

For example, if stocks move up and the equity allocation goes up beyond the threshold, then you are automatically pushed towards debt. Similarly, if debt portfolio has appreciated due to a fall in interest rates, then automatically more money gets allocated to equities at relatively lower levels.

The good old asset allocation model may look quite mundane but it is your best bet in such markets.

Falling markets have two dimensions to them. In the words of Warren Buffet, the stock sage of Omaha, the finest investors make money by being greedy when others are fearful. However, your asset allocation has to be tweaked smartly and liquidity management should be much better and the rest will follow!

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Share Market Has Been Down For a Few Months. What’s the Smartest Move?

07 Aug 2019

After touching its peak of ~38,900-levels in the last week of August, the BSE benchmark index Sensex has lost nearly 5,000 points up until the second week of October. There are individual stocks that have lost 40-50% in valuations. We are not even talking about companies with dubious track records and governance issues. We are talking about quality, blue-chip companies that have corrected in sympathy with short-term fears.

In these conditions, how does one invest in the share markets? How does one make the best of their trading account and trading app to capitalize on this correction? You obviously cannot rely on stock market tips and specific stock tips for this. Here is a strategy sheet…

When in Doubt, Shift to Quality

There are quite a few stocks in the market that have shown consistent growth over the years due to their very mature and robust business model. In the last 20 years, stocks like HDFC Bank, Hero Moto, Reliance Industries, and Eicher Motors have all been classic examples of value growth. These stocks have grown at a consistent pace through good and not-so-good times only because these companies focused on the top-line and the bottom-line as well as maintaining the quality of their business.

Take the case of Eicher or Kotak Bank or even Maruti. Some of the froth is out and the correction is sharper than the Nifty and the Sensex. However, their business models are less vulnerable by default. When the model is sound, stocks of such companies will recover faster than other stocks.

You must use the opportunity of a falling index to move your portfolio towards quality and to this extent, restructure aggressively.

Rebalance Away From Stars That Triggered This Downtrend

Just sit back and evaluate the sectors that triggered this downtrend in the first place. There are the NBFCs and the oil companies that were key triggers behind it. FMCG was a sector that had added heft to the drop on the back of weakened consumer sentiment. Successive rallies are rarely driven by the same set of stocks and vice versa.

So, take some money off of such stocks on every bounce and then take a measured call on the sectors for the future. This rebalancing is a key decision as it will decide how well your portfolio performs in the future. The message is to book losses in losers (if required) in a bid to reallocate to future stars.

Your Shopping Basket Needs Liquidity at Lower Levels

An interesting question is whether one must remain in equities or shift to debt altogether. You could then use the liquidity of debt to buy stocks at lower levels. This is an extreme asset allocation approach and is neither recommended nor feasible.

What one should actually do is increase the allocation to debt and reduce the allocation to equity. The reason investors lose out on buying stocks at attractive prices is because they do not have the requisite liquidity when stock prices are down. We are still left holding the fancy stocks that we purchased at fancy valuations.

A greater allocation to debt and liquids at this time will ensure that you have the required liquidity to enter stocks at lower levels.

Sharp Corrections Rarely Reverse in V-Shaped Fashion

(Data Source: NSE)

The above chart shows the Nifty and the VIX (Volatility/Fear Index) since August on a scale of 100. The sharp fall in the Nifty is accompanied by a sharp rise in the VIX. That is a typical correction accompanied by volatility. Such corrections rarely show a V-shaped recovery.

Such markets will recover after meandering at lower levels for some time after the VIX has again come back to lower levels. This means that you need not be in a hurry to bottom fish immediately; instead, you can wait for the right opportunities to buy stocks.

Don’t Upset Your Asset Allocation for the Sake of the Correction

You must still stick to your rule-based approach to asset allocation. After all, asset allocation is about discipline and the advantage of this discipline is that your allocation automatically moves contrary to the market valuations.

For example, if stocks move up and the equity allocation goes up beyond the threshold, then you are automatically pushed towards debt. Similarly, if debt portfolio has appreciated due to a fall in interest rates, then automatically more money gets allocated to equities at relatively lower levels.

The good old asset allocation model may look quite mundane but it is your best bet in such markets.

Falling markets have two dimensions to them. In the words of Warren Buffet, the stock sage of Omaha, the finest investors make money by being greedy when others are fearful. However, your asset allocation has to be tweaked smartly and liquidity management should be much better and the rest will follow!