6 investing lessons the markets taught us

Markets are a cycle, no rocket science there! But somehow we tend to believe that the market is uni-directional – irrespective of whether is it a bull run or a bear trend! When the markets were at 21000 levels D street was full of positive news that markets in a short term will touch 25000 levels, so much optimism turned to complete pessimism in less than a year when in Oct ’08 markets hit a low of 7.6k. But markets, they never grow tired of throwing surprises, which makes even the best of market pundits sit up and watch!

1.    Stay  cautious when markets turn euphoric

Date	Sensex	% Fall
Feb-00	6,150.69
Apr-03	2,904.44	-52.78%
Dec-03	5,920.76
May-04	4,227.50	-28.60%
May-06	12,671.11
Jun-06	8,799.01	-30.56%
Jan-08	21,206.77
Oct-08	7,697.39	-63.70%

Although the force of gravity is something that would apply pre-dominantly to physics, this holds true for equity markets as well. What goes up, comes down – if there is a steep run-up and valuations get expensive, then it is bound to make a turnaround and come down to moderate levels. Hence, it becomes important to stay cautious when the markets turn euphoric.

Since, October 2008, markets have not looked back; we scaled all the way up to 18k levels by July – 2010, it’s been a choppy ride over the past 21 months, with an upward bias. The P/E (price / earnings) which is a key indicator of whether the underlying instrument is overvalued or undervalued, was at 12 levels when the markets went all the way to 7.6k levels after it hit an all time peak at 21.2K levels in Jan-2008 when the P/E stood at 25.5 levels and markets were grossly overvalued. 

At current levels, Indian economy is definitely healthy, however, at the rate the market is scaling new heights despite very moderate fundamental change, it definitely requires us to be cautious of a possible correction.

2.    Avoid herd mentality

‘Buy low, sell high’, now how hard could that get! While we were young, we always wanted to have what the other person had. When it is the time to book some handsome profits and sit tight on cash, we end up entering the markets precisely then!

Source – AMFI, BSE India

This graph tells us how many times we have gone wrong and the best part is that we have never bothered to learn anything from the past. The past few months seem to have an inverse correlation where the markets have scaled up, possibly due to factors like change in regulations and thus may not be truly reflective of the state of affairs. Only time will tell if we have walked wiser from the experience we had during the 2008 fall.

3.    Systematic Profit booking at market high

‘Just a little more and I promise to get out of the stock’, this approach really does not work – you will never get the peak or trough right! It is always advisable to exit from market in phases; a certain percentage of portfolio should be sold when markets breach a certain level. This not only helps to reduce the risk but also provides an opportunity if the markets move on further. In the whole bargain of ‘just a bit more’ we often see the returns completely erode and sometimes get into red! This infact is a dangerous preposition and hence, would make sense to fix the target and stick to it at all costs.

4.    Get rid of penny stocks

Certain stocks see phenomenal rise may be more than 30%, however this rise is purely on rumours and such companies could be lacking sound fundamentals. Every time you will notice that the penny stock which was a hot pick in a bull run will be nowhere when the markets tank – they are the first ones to go down, infact they may even shut their businesses, so one should always get rid of such investments.

5.    Fear and greed steal the show

When the markets were at 21k there was a sense of déjà vu, everybody was sure that the markets had formed a unidirectional pattern and it would simply keep moving northwards, however, the turnaround happened when least expected and when the markets did turn sharply, panic selling occurred which pulled down the markets sharply.

Fear and greed always have an upper hand in markets, during bull run markets are driven 70% by greed and 30% by fear whereas the same is reverse in case of bear phase. A contrarian strategy always helps, when people are fearful that the markets will come down be greedy to grab the stocks at a particular price, when people are greedy that the markets will climb further be fearful and start exiting from the markets.

6. Heady mix of debt & equity

Amidst all this hoopla, there is one thing that comes to rescue – Diversification. Too much into equities or too little – both are situations that you do not want be caught in. Statistics have proved that equity is one of the best asset class to invest in, global averages indicate that in the long term horizon it gives a return of atleast 15% p.a - however it is a game of patience and strategy which requires commitment from a medium to longer term frame. Also, it is important to de-risk your portfolio at regular intervals; this can happen only if we are stringently booking profits at relevant levels of the market.

It is probably the right time to evaluate your asset allocation and look at derisking your portfolio.  For investors who are getting into the markets one needs to be cautious especially if one is making lumpsum investments.  Systematic investments could be a better option at this time.
Since we are all euphoric about markets scaling new heights, this author may be accused of playing spoil sport, but all I want to say is ‘Tread with care!’