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  4. 4 things to avoid in the market correction

4 things to avoid in the market correction

February 27, 2022

Russia’s attack on Ukraine has added fuel to simmering commodity prices and stoked fears about Fed rate hikes. Therefore, Indian stock markets seem to be correcting in the right earnest. The bellwether Nifty 50 has corrected about 12% from its January 17 high to its February 24 low. Non-index stocks suffered much more comprehensive damage. Here’s a break-down of losses in NSE-listed stocks.

In situations such as this, friends, colleagues and social media gurus can bewilder you with conflicting advice. Some will warn you that this is just the beginning of the end and that worse is yet to come. Others will remind you of the March 2020 rebound and urge you to buy the dip.

At PrimeInvestor, we don’t believe in our superior ability to forecast what markets will do. While we did expect a market correction to take shape this year in our Equity Outlook we certainly did not foresee events like the Russia-Ukraine standoff. 

Therefore, though the market correction has begun, we don’t know how far stock prices can fall or how long the fall will last. But having lived through the past three big bear phases in Indian markets (in 2000, 2008-09 and March 2020), we do know that if you’re a long-term investor with a 5-year plus horizon, phases such as this market correction, present a great opportunity to build a strong portfolio positioned for wealth creation. Here are our practical tips to navigating the rough road ahead and what not to do during a market correction.

market correction, 4 things to avoid in the market correction

Don’t sell

For the last five years at least, global gurus who specialize in spotting bubbles have been warning that the easy money policies of central banks have created an epic bubble and that a big crash will soon follow. You can read some of their forecasts here and here.

Now that global events have triggered a market correction, these gurus and their followers love to tell us that they were right all along and this is the beginning of the ‘mother of all bear markets.’ Subscribing to such views can tempt you to get out of all your stock and equity fund positions right now, in the hope of saving your portfolio from the cataclysm ahead.  

Applying an 18 PE to this number throws up a Nifty 50 level of about 15,400. A 15 PE will take it to about 12,800. Fundamentals therefore suggest that the downside to Nifty 50 from here is of the order of 5% to 20%.

But we urge you not to take any drastic action on selling your equity positions now, for three reasons.  

  1. The time to reduce your equity allocations or aggressively sell stocks is when everyone is gung-ho about equities and painting a blue-sky scenario. Today, fear is the more pervasive mood in the markets. The India VIX which traded in the 20-25 range for the past year has shot up to 31.98 on February 24 (the March 2020 peak was at 70), showing that investors are today jittery. By selling into a fearful market, you’d be needlessly converting paper losses on your portfolio into real losses.  
  2. When deciding if it’s the right time to sell stocks, it is better to be guided by valuations rather than absolute index levels. With the Nifty50 companies delivering strong profit growth recently, Nifty50 valuations have corrected a lot from 34 times (trailing consolidated earnings) in April 2021 to 20.8 times now. In our earlier Equity Outlook, we noted that Indian markets have historically traded at a trailing PE of about 18 times, while bottoming out at 14-15 times. The current trailing PE of 20.8 on the Nifty50 is not that expensive and is only a little higher than the average 18 times. 
  3. Market moves in the short run are often dictated by liquidity and emotions, but in the long run they are dictated only by earnings. On this score, Indian companies have managed a strong profit show in the last three quarters of FY22 and are likely to continue this over FY23, as demand recovers from the pandemic. 

When we wrote our January outlook, the Street was expecting Nifty 50 consolidated earnings at Rs 736 for FY22 and Rs 877 for FY23. But since then, a majority of Nifty 50 companies have beaten Street estimates. The Nifty 50 earnings on a trailing 12-month basis now stands at Rs 778. These earnings, we believe, should cushion Indian markets from plunging too far in the current market correction.

Assuming even a 10% earnings growth, Nifty 50 earnings may come in at Rs 856 for FY23. Applying an 18 PE to this number throws up a Nifty 50 level of about 15,400. A 15 PE will take it to about 12,800. Fundamentals therefore suggest that the downside to Nifty 50 from here is of the order of 5% to 20%. 

We’ve also seen in past bear markets like October 2008, March 2009 and March 2020 that when fear is at its peak and the market makes a panic bottom, events can happen lightning fast. Such flash strikes tend to leave you with very little time to exit and rebuild large portfolio positions. If you listen to doomsayers and liquidate a sizeable portion of your stock/fund portfolio today, reinvesting all that money in the midst of full-scale panic will be extremely difficult.

Don’t go all in

If selling into a fearful market is a bad move, throwing all caution to the winds and jumping all in is equally risky. Folks who remember the quick rebound of March 2020 may be tempted to bunch up their buys right now on FOMO. But do pause to recognize that not all bear phases in Indian markets have proved as short-lived as the March 2020 market correction. Past bear markets have taken 18-24 months to play out. When markets see a structural reversal after a long bull phase lasting 7-8 years (as we are now), bear phases can prolong too.  

In our previous point, we’ve indicated the rational levels at which markets should find their bottom. But when panic takes over, rationality takes a back seat. Should there be a true capitulation phase like we saw in October 2008 or March 2009, stock valuations can fall to irrationally low levels. Investors buying into the first dip can see further erosion of 20-30% in a matter of a few weeks/days. 

No one can tell you if the market is bottoming out while we’re still living through it (bottoms are crystal-clear only in hindsight). So, a phased deployment strategy is your best bet right now. We suggest using the recent market correction to deploy 1/3rd or 1/4th of your cash positions. Bide your time and watch for the above Nifty levels, to deploy the rest.

Don’t chase tactical opportunities

When a market correction catches you by surprise and you’d like to capitalize on the opportunity, knowing what to buy can be a challenge. 

So after an event-led market correction like this one, many investors get tempted by tactical opportunities to make quick gains. So, if you’re getting tips to bet on edible oil stocks because the Ukraine war will disrupt sunflower oil imports, or on oil drillers because crude oil is at $100, remind yourself that your short-term bet may or may not work.

The cash you use on such bets can be more usefully deployed in stocks that can make a difference to your long-term wealth. Unless you are a Berkshire Hathaway, you’re likely to have limited money to deploy in a market correction and it is important to use this money judiciously. 

If you’re a fundamental investor, your only guide to looking for buys should be business prospects and valuations. Avoid looking for stocks at their 52-week lows or stocks that have crashed by 50%, as there’s nothing that prevents an over-hyped stock from losing 90% from its current low. Use the market correction to accumulate quality stocks that you’ve always dreamt of owning in your long-term portfolio. If you don’t have such a wish-list, Prime Stocks’ buy recommendations offer a readymade shopping list.

Be wary of past winners

When a bull market that has run on for many years gives way to a bear phase, the stocks and sectors that lead the next bull market can be completely different. This is particularly true now, because of the two big macro changes that are driving this corrective phase. 

The bull market over the last 7-8 years was propelled by the easy money and low rate policies of central banks, which are now likely to be withdrawn. The stocks and sectors that do well in a high inflation, rising rate, pro-growth environment are likely to be very different from those that do well in a low inflation, easy money and low growth environment. To add to the disruption, Covid has permanently changed both consumer and business behaviour in many ways.

The so-called ‘defensive’ stocks from FMCG, healthcare, insurance and pharma sectors that were rerated during Covid times for being able to capitalize on pandemic needs, may see both an earnings slowdown and a valuation derating. Narratives such as China Plus One may need a relook too.  This argues for not blindly buying into the multibaggers of the past 5 or 10 years. Look afresh into sectoral prospects and recent earnings trends to identify your buy candidates.   

Having written reams about what you shouldn’t be doing in this market correction, what should your equity strategy be?  

  • If your equity allocation is below your comfort levels, buy equities to take it up gradually. But don’t make drastic shifts in your asset allocation.  
  • Deploy your cash in phases and not all at once. Ideally, use 1/3rd or 1/4th of your cash to capitalize on this market correction. Bide your time to deploy the rest. Watch out for the ballpark Nifty levels (based on fundamentals) indicated above (about 12,800 to 15,400) to deploy more cash.
  • Buy quality companies you’ve always wanted to own, after ensuring their business case hasn’t changed post-Covid.  
  • Be market-cap agnostic in your stock selection as market cap has nothing to do the quality of a business. Mid and small-caps may offer better buying opportunities than large-caps right now as they’ve corrected more.
  • If you don’t have ready cash, selling the less desirable stocks or funds from your existing portfolio can free up cash. Switch from low quality or low conviction stocks or funds in your portfolio to high quality, high conviction ones. (Use PrimeInvestor’s MF Review and Stock Rankings tool to weed out the duds).

If you can’t find the time to do your homework on sectors or stocks during lightning market moves, simply invest in index funds or ETFs. This will help you capitalize on any bounce without FOMO. You can do your homework on individual stocks to buy later and redeploy the money at leisure.

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