“Markets are over heated”
“Stocks are running ahead of the fundamentals”
“Economy is struggling but stocks are rocketing. This is all managed”
“Book profits and wait for the correction”
“Market P/E is at historical highs and hence stocks are about to fall”
Does this sound familiar?…. I am sure it does !
Result – we all become jittery and wonder whether to book out and wait for the correction.
Our response is broadly classified in the following categories –
- Category 1 – Many of us book out, are proud of the profits that we made and tom-2 about them on the social media. Obviously we keep commenting about overheating and add to the frenzy. In the process, most of the times either market corrects marginally and then rebounds or keeps going up. After some time we become impatient, invest back and then the confusion starts again !
- Category 2 – Some don’t book out immediately but continue to have sleepless nights. They try to display their confusion on whatsapp and social media. After some time, they also book out and now behave like Category 1.
- Category 3 – Some active and informed investors don’t try to book out significantly and instead try to continuously juggle their portfolios based on their perception about over and under valuation across sectors and companies. However, as such they continue to be confused, jittery and concerned about the overall markets. This in turn starts impacting the overall decision making and consequently the performance.
- Category 4 – investors who are calmer and know that corrections are integral to stock market investing and they can never time them. They include active disciplined investors, professional fund managers and also buy and forget long term investors.
As you would have observed, most well known investors fall under category 4 !
Does it mean that one should not be wary about overheating and corrections?
Ideally Yes – especially if one wants to have long, happy, stress free innings in the stock market.
However, that’s easier said than done. Most of us are humans and don’t have the kind of wealth that well known investors have. They can afford to lose some of that and we can’t.
Maybe initially they were also like us – trying to time the corrections and were able to do it successfully !
So then what’s the issue?… Why does predicting and waiting for the corrections doesn’t work for me?…
Following are my observations:
1. We don’t actually know the meaning of ‘Correction’
Yes it’s true !
When we say market is due for correction, what does it mean? Will it correct by 5% or 10% or 15% or 20% or 50%?
I am sure no one can answer.
Problem is we confuse normal market fluctuations with deep sell offs and it’s important to differentiate between the two !
- Normal market fluctuations don’t have any significant triggers but deep sell offs do.
- The former are integral part of profit booking and rotation due to underlying valuations/ sentiments and can be very slow and frustrating. Latter are caused by sudden events, are sentiment/ panic driven and cannot be predicted e.g., India attacking Pakistan.
So what exactly are we expecting when we say market is due for correction?
Because then only we can look for the relevant triggers and figure out our own strategy.
Most of the times what we expect are deep sell off but what happens are normal market fluctuations.
2. We freeze when correction actually happens
Everything suddenly looks hazy and too uncertain. It seems that World is coming to an end !
- Covid fall
- Brexit sell-off
- Mortgage Crises
- Dotcom bust
- Asian financial crises
How many of us actually bought or if we did, how much capital did we deploy?
I am sure, you know the answer – very few and that too limited capital !
But we still keep on waiting for the so called corrections.
3. We assume market correction means stock correction
And that’s just not true !
Else every stock would have mirrored the returns of the indexes.
In normal fluctuations, stocks follow their own path and in case of deep sell offs, individual stock falls significantly more or less than the overall market depending upon it’s own underlying dynamics.
We should be bothered about our own stocks and not the overall markets. If our stock holdings continue to convey strength based on whatever strategy we follow (fundamental, technical, long term, short term) then how does it matter what overall indexes are doing ?… Think about it and you will agree !
4. We confuse short term outperformance to over heating
And that’s quite natural as short term is what we remember the most.
Current markets are a classic example. Have a look at nifty’s to date performance over various time periods –
- Over March lows +117% (annualised 74%)
- Over Pre Covid January’20 highs +31% (annualized 18%)
- 3 yrs CAGR +12%
However, what we always talk about is performance since March lows and not over other periods.
I am sure you got the idea.
5. We get lost too much in the past and fail to notice the emerging trends
Whether it was the 2002-2007 bull run or even the current markets – most of the times we live too much in the past and fail to observe emerging economic trends.
Yes the economy was doing badly in the previous years but are current markets trying to factor in any new emerging trends?
- Is technology becoming increasingly important and more so with work from home need during Covid
- Has pharma got a new boost post covid
- Has need for personal vehicle as well as own space provided necessary tailwind to the two core sectors – auto and real estate
Once we start factoring this, maybe markets may just start looking little more reasonable.
6. We underestimate the power of liquidity, trends and momentum
We believe that everything should be justifiable fundamentally.
It will never be – atleast in the short term. Sentiments and future discounting are a huge part of stock market investing.
Besides, if economic performance follows, the momentum becomes further strong.
One can handle it in three ways –
- Being part of the momentum;
- Completely staying out of it and strictly following the discipline of valuations and margin of safety; or
- Ignoring it and only focused on long term strong stocks investing.
Irrespective of the strategy that you may want to follow – atleast never fight with the trend/ momentum. No one can identify the top.
Markets can remain irrational longer than anyone can predict. Perfect example – US bull run since 2009 – 12 long years and still continuing. People have been calling the top since 2009 itself !
I hope to have provided sufficient material to think through. Hopefully it will help in correcting ourselves to manage the corrections !
Please do comment and your own experiences on the topic.
Let me conclude with the most famous quote on the topic –
Some other relevant topics –