Why we fear equity market corrections -

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Asset bubbles have been around for centuries. Although we humans have grown in leaps and bounds in areas of science and technology, when it comes to stock market behavior our instincts are as primitive as ever. As always the ongoing correction and volatility have started sending blood pressures soaring. Investors want to know, to what level will the market correct? How long will the trend last? , will FII dump stocks like they did in the 2008 meltdown? Unfortunately I don’t have the answers .Neither do the gaggle of fundamental and technical analysts offering you their expert views on various market channels .

Corrections are only a mechanism to purge the market of all imperfections and excesses. It is a friend of the value picker and long term investor. Then why do we fear market corrections?

1) We are not sure of the real ‘value ‘of the equity we hold. Let take a little example here. Let’s say you and your friend found two beautiful teak wood tables at 'Chor Bazaar' for Rs.10000. You both realize that this solid wood table is a steal at the quoted price, and that you can easily sell the tables at Rs.30000. You buy one each. You friend unfortunately realizes that he needs the money for an urgent errand and due to his urgent need agrees to sell at Rs.8000. What do you do at this stage?
    1. Panic and put your table on sale too
    2. Offer to buy his table and plan to sell both at Rs.30000
    3. Do nothing , but look to selling your table at Rs.30000
While most of us would choose option b and c, in stock markets we rush to do ‘a’ i.e. sell in panic .Its probably because many investors aren’t sure about the true ‘value’ of their investments. A price quoted on the ticker is not necessarily the right price of your equity and unless in distress there is no reason for you to sell or panic about portfolio losses.

2) We have no asset allocation plan – We can’t time markets peaks and lows. In the absence of an asset allocation plan it is unlikely that you will sell when prices are high. Consequently when the cycle reverses you find yourself unable to buy low because you may be fully invested with little cash available to buy afresh.

3) We were speculating – Sadly many investors may not even believe that they are speculating. Speculation is not only about short term trading, F &O or day trading. Not doing your due diligence before buying a stock and relying entirely on a friend/dealer’s tip even if you intend to keep it for the long haul, is speculating.

5) We Over-expect Returns and Underestimate TIME – Returns from equity do not follow a linear pattern in the short term. If your portfolio grows at 15% to 18 % CAGR over reasonable periods of time (5 years plus) you are on your way to great wealth. You cannot earn 100 % every year, nor can you save your portfolio from losing 20 %-30 % in some years. . If you make ‘reasonable returns in reasonable time ‘your mantra, then market movements will stop bothering you.

So here’s the bottom-line - switch off the market news channel , get an asset allocation plan, reassess the portfolio (take the help of a equity advisor if you must), sell the stocks you bought for speculation and use the correction to switch into quality companies backed by improving fundamentals. For keeping things simple, a SIP with a good mutual fund/stock is never a bad idea. And stop looking at your equity portfolio daily. It never helps  

Comments

  1. CFAstudentFebruary 8, 2011 at 1:40 PM

    the article is good and informative - but let me add - value investing is for fund managers, they cannot afford to speculate so they have to look at the reality about earnings, growth and value and price and aim for a 20 percent return pa.- and not for the trader who trades for a living because there are a lot of players and buying and selling is possible at any price level using charts - for the day or even a trader who seeks a good return for any time horizon. it is a game of many versus the one trader placing an order - rather than the fundamentals unfortunately the market mechanics have changed drastically - institutions use automated algorithms to place buy and sell orders and have expertise and information the ordinary investor does not have - so he would better be a good chart reader first and buy only that which gives him a return - better if he knows fundamentals and better if he still has insider information - while he is competing with institutions that have analysts and automated programs and lower costs that buy and sell without any human intervention.

    risk is inherent - either for a fundamental or a technical investor - especially in an FII dominated condition, people should rely on charts and the FII sentiment more than fundamentals - if they stop buying for a few weeks due to some reason - nifty will be at 2000 or 2500 at most - and all notions of value will become redundant if they never buy - indian will never trade among themselves paying higher and higher price - so it is the market mechanics that matter - timing matters as much as timing them in the right stocks that have a presence in futures etc because of the negative bias that a retail investor is subject to even as he invests or trades.

    ReplyDelete
  2. Kavitha Menon, CFPFebruary 9, 2011 at 2:39 AM

    Dear Vijay .. my articile is meant for the value investor and not for traders . The dynamics for a trader are totally different . AS value investors FII buying is not a criteria for picking stocks .. rather long term fundamentals are .. If history is any indicator then in the long run , prices catch up with value and risk is a short term phenomenon.

    ReplyDelete

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