The stock market has seen considerable volatility over the last one month or so. In our last post, What should you do in falling stock market: Part 1, we discussed how easy monetary policy (low interest rate regime) globally, fueled huge rally in stock prices for the last 5 years. Now as the US Federal Reserve looks to tighten interest rates more aggressively than what the market was anticipating, stock markets have turned nervous and volatile. As nervousness increases in the market, global investors shift funds from equity to safe assets like US Government bonds causing stock prices to fall. The interest rate related volatility in the market may last for some time. Finally, as always, the volatility will subside and the market will react to fundamentals like GDP and corporate earnings growth.
Long term investors among untouched online readers will have seen many cycles of stock market volatility in the past and at the end they see market making new highs. However, we do realize that volatility, as long as it lasts, can be stressful for some investors. It is not easy to see, investments made with your hard earned money falling in value – sometimes fear causes investors to make wrong investment decisions. Investors can also make wrong decisions due to over-excitement.
In this blog post, we will discuss how a systematic approach to investing can help you navigate through volatile markets.
How long will the market correction last?
Some investors may be wondering how long with this volatility continue or for how long will the market fall. It is not possible to predict what the stock market will do in the near term, but historical data shows that, corrections or even bear markets do not last for very long. Historically, a 10 – 15% correction usually lasted for about 3 to 4 months – the market then bottoms out and up trend resumes. The Nifty-50 has fallen about 7% from its all time high in the last month or so. The market can fall a few more percentage points, but as long as the correction is within 10 -15%, investors can expect the market to start recovering within a few months. In times of high volatility, even 3 – 4 months can seem like a long time, but patience is the key in such times to ride out the volatility.
When the market falls more than 20%, the correction is termed as bear market. A bear market is more severe than a bear market. A bear market usually takes a year to bottom out and start recovery. In the last 10 years, the market fell more than 20% in 2008, 2011 and 2015 / early 2016. Each of these corrections lasted for 12 months or less, even the crash of 2008, when the market fell more than 50%. However, considerable price damage may be done to some stocks in a bear market and these stocks may take much longer to recover if at all. In bear markets, we often get text messages or emails from stock analysts saying that, so and so stocks have fallen 50% and are now very attractive. Be very careful.
Volatility, corrections and bear market all look the same at the beginning. If the market is down 6 – 7%, how do you know if it will fall 10% (correction) or 20% (bear market)? You do not. You have to work with the information you have. If the market has fallen 7%, then you should prepare yourself mentally for a 10% correction – the preparation entails only a bit of patience. If the market falls 15%, you should prepare yourself for a bear market. Liquidity can become a problem for investors in bear market and therefore, proper asset allocation (mix of equity, debt and money market) is important in bear markets.
Have realistic expectations
You should have realistic expectations in volatile markets or market corrections. If market has corrected 10%, expect your equity portfolio to be down by 10%. If your equity portfolio is aggressive, high allocation in mid and small cap stocks / funds, then expect your portfolio to be down more than the market. If the market has corrected 10% and your mutual fund portfolio is down by only 5%, it is great for you; your asset allocation or fund selection protected you from the market downside. However, if your portfolio has fallen more than the market, do not feel depressed because the underperformance might be due to the beta of your portfolio. The same beta would have helped your portfolio outperform in bull markets. You should be concerned about underperformance, when your mutual funds underperform both in bull market and bear market.
Do not panic
If your portfolio is down 15%, do not panic that you will lose all your money and call your financial advisor to redeem your investments. Even if your portfolio has fallen 15 or 20%, 80 to 85% of your money in the portfolio is still there. Bull markets follow bear markets, and bear markets will follow bull markets – markets go up and down, it is inevitable. The problem is not with market, but with our own expectations. Investors tend to think that, whatever the current environment, bull market or bear market, it will go on forever. Your emotions in volatile markets, unless kept in check, can not only cause stress, it can also lead to very bad decisions. Patience is one of the most important qualities in emotional intelligence and leads to investment success in the long term.
Turn off the TV
This may sound like a funny advice, but I have found it useful in many stock market corrections or bear markets. During bear markets, it is not uncommon to see the Sensex falling four or five hundred points within minutes of opening. The panicked anchors proclaiming that the market is crashing will only aggravate your fragile nerves and cause doubts in your mind about your investments. Sometimes investors want to understand what is happening in the market from experts on TV. You should understand that events in stock markets can be explained only in hindsight; when an event is unfolding, all views are mere conjectures. In falling markets, instead of worrying about your investments, you should focus on your other work and wait for this market phase to pass.
Meet with your financial advisor
If you are feeling nervous about the market and your investments, you should meet with your financial advisor and review your financial goals and investment plans. Some of you may be new to stock markets, but your financial advisor may have advised investors through multiple bear market cycles. A bear market tests the temperament of an investor. A good financial advisor is empathetic to investor’s needs, helps them remain calm and focused on their investment.
You can also approach us directly by call or submission entry if feeling pathless.