Many investors are feeling restless these days. They are trying to find answer to just one question. Will the markets bounce back from the recent crash? Or will they go down further?
Now ‘Crash’ is a strong word used generally for declines of severe magnitude. A word like ‘Crash’ reminds me of 2008-09. And we are still a long way from that kind of a fall. Probably, ‘Correction’ would have been a better word. 🙂
Interestingly, since 15th August this year, the Indian markets seem to have found their freedom from the Bulls. Here is a snapshot of what has happened since 1st August in Indian Markets:
Our markets are already down by more than 10% in last one month. And if we were to consider the highs of 30,000+, then we are down much more – by more than 16%.
Now I have absolutely no doubt that the valuations of broader indices like Sensex were quite stretched. We had hit a PE of 24. That is not cheap by any standards. And if anyone at such high levels had claimed that we were bound for a correction like this, then we couldn’t have blamed him. On the contrary, he would have actually got it right. 🙂
But important point to note here is that even after this fall, it is not necessary that markets might start going up again. It is also not necessary that markets might fall lower.
But let me be honest here.
A 16% correction does offer opportunities to buy shares of some good quality companies. And if buying individual shares seems tough, one can even look at making lumpsum investments in mutual funds.
Is 10% Fall Rare?
This is another big question. Is a 10% cut really big one? I mean that if we were only concerned about the broader markets and not individual stocks, then is a 10% cut in a month, something rare?
I crunched last 20 years data to arrive at following interesting piece of information:
In last 20 years, a 10% monthly cut has just happened 14 times, i.e. 5.6% of the times. That’s not as common as many of us might make it sound like. 🙂 Please note that I have not used rolling monthly returns. I have just used monthly-closing figures for Sensex.
Technically, August gave a return of -6.69%. But between 3rd August and 4thSeptember (which was the last trading day before I wrote this post), the returns have been -10.4%
I know… the thought that “a 10% cut is a good point to start deploying additional cash” has already crossed your mind. But hold on… I have another interesting set of data for you.
I did another round of number crunching. But this time, instead of monthly returns, I took quarterly returns.
Now we have already completed 2 months in the July – September Quarter. But we already have a 10% cut, since the July closing of 28,114 for Sensex.
Lets have a look at how Sensex has moved historically, on a quarterly basis:
In last 82 quarter since Jan 1995, Sensex has only had 11 quarters that saw a fall of more than 10% – i.e. about 13% of the time. Out of these, 6 resulted in a fall of more than 15%.
But whether the market falls lower or whether this will result in the Crash of 2016, is something that nobody can tell. People do feel that volatility will remain high for next few months. But I am telling you. Nobody knows anything. Everybody is guessing out there.
Even you and me are trying to guess whether it makes sense to buy additional shares and mutual funds now or not. 🙂
So best of luck to us, with our guessing(s).
What I have done during this 10% – 15% fall?
I have already said that when markets correct by 10% to 15%, its natural for us to feel and think about how we can benefit from it.
Carl Richards of Behaviour Gap has written beautifully about the current situation in a post (link):
“When the markets get scary, there’s an overwhelming temptation to do something, anything really, with our portfolios… …and the data confirms that successfully timing the market is, at the very least, highly unlikely. Yet it feels crazy to just sit in front of what feels like an oncoming train.”
So what should one do here?
I can tell you what I do and what I have done during the last 10% fall:
I keep a Market Crash Fund – a fund that I use when either the broader markets have crashed, or there are some special bargain situations available in individual stocks.
Generally, this fund holds cash (or equivalent) positions that can range between 5% and 15% of my overall portfolio. The idea of keeping a Market Crash Fund is to have some financial ammunition to use, in case of buying opportunities arising out of sudden market falls.
I have already written extensively about this idea in a post titled Cash + Courage + Crisis = Huge Profits.
So for all practical purposes, I am never fully invested in equities. I always keep some cash buffers – as a minimum, I always have 5% cash that is ready to be deployed for next (atleast) 5 years.
And in last 15 days, I have purchased a few stocks and used a part of my Market Crash Fund. Not surprisingly, I ended up buying more of what I already owned. 🙂
But I don’t suggest this approach for everybody. I have even analyzed how using a Market Crash Fund might not be very useful for someone who invests in SIPs regularly. You can read more about it in this detailed case study.
So did I invest all my surplus in last few days?
The answer is no. If markets fall further, I will invest more from my surplus. If it falls even after I have used up my surplus, then probably I will borrow some surplus from my value investor wife. 🙂
The point to understand here is that this market fall of 10% might not be much. But if you have the cash to spare for next few years, then you could or still can use it to buy shares of good businesses. Markets may still go down lower. And you cannot control that. But what you can do is to keep investing slowly and steadily, but only in good and stable businesses.
Now everyone might have their own thoughts about deploying their surplus funds in a falling market. But I came across a really interesting approach suggested by Morgan Housel here. What he suggests is that if you have Rs 1,00,000 (Rs 1 lac) set aside to invest, then you can deploy it using the below logic:
He also mentions that these rules apply to the portion of portfolio that invests in index funds, since opportunities in specific companies and sectors vary in unpredictable ways during each crash.
His reasoning is simple and quite sensible:
“I assume the larger the market drop, the bigger the opportunity to invest. I wanted to deploy enough money to take advantage of the “decent” opportunities while still having enough around for the “big” opportunities. The amount of cash deployed peaks when the market falls by 20% because that’s both a large decline and a historically frequent decline. The market falling 50% represents the greatest opportunity, but it occurs infrequently enough that I don’t want to earmark a ton of cash waiting for it to happen.”
Now this is a rough guide and even Morgan says that it does not take into account things like market valuations. So a 10% drop can and should be ignored in an overvalued market like that of 2008.
Though I still don’t agree completely with this framework, I will still say that it will make a lot of sense for many common investors. Having something like this as a reference, forces one to think about big market drops as opportunities and not just crashes.