Last few weeks haven’t been easy.
And unless you are a perfect timer, chances are that your portfolio would be down.
By how much? The cut would be less for those who decided to leave the party early and comparatively bigger for those who either came in late or were being way too adventurous.
In times like these when the equity markets are volatile and surprise you daily, you will come across conflicting views. Optimists will try and influence you to buy more as prices drop. Pessimists will, as usual, ask you to take away what you can and run. But it’s not that easy to take either side. We are common people who are realists and lie between the optimists and the pessimists. We use the money to achieve our financial goals and not just worry about beating or not beating the markets.
Volatility in markets is painful. No doubt.
But Markets aren’t Fixed Deposits and hence, rise and fall all the time. It’s normal.
The year 2017 was a great one for most of us.
The journey was smooth and straight and almost one-way, i.e. Up. It made successful investing look extremely easy.
Just one look at the YTD returns in 2017 for large caps, mid caps and small caps in below graph and you will agree that there was very little chance that someone would have not made money:
In fact, if I remember correctly, it was one of the least volatile years in recent memory.
But 2018 came and… things changed.
And we have just completed three quarters of this year.
The story has changed and how…
At the time of writing (early Oct-2018), the large-cap index Nifty50 has given up all its returns for the year and is mostly flat. In fact, it is down -2% for the year.
But the real price correction has happened in mid- and small-cap indices. One look at the red and blue line in the graph above and you will realize. These are year-to-date figures. Cuts are bad, if not horrible.
And this is just about the indices. Individual companies have fallen much more. Many big names have come down by more than 40-50% and I am not taking any names here.
The divergence between large and non-large caps is quite large and as of date, there has been a massive outperformance of large-cap indices against the non-large cap space.
A couple of months back, I came across an interesting data point that supports this conclusion. Sourced from Stalwart website (link), here is an eye-popping data about the 1584 stocks listed on BSE with a market cap >= INR 100 crore (as on 25th June 2018):
- Fall of 60% or more from 52-week highs – 106 stocks
- Fall of 50 to 59% from 52w highs – 175 stocks
- Fall of 40 to 49% from 52w highs – 289 stocks
- Fall of 30 to 39% from 52w highs – 359 stocks
- Fall of 20 to 29% from 52w highs – 336 stocks
The dataset is slightly old (June-end) but I am sure the numbers have deteriorated further. Clearly, the large-cap indices of Nifty50 and Sensex are not reflecting the reality of on-going deep correction in the broader markets.
Even if you were to analyze Mutual Fund Portfolios, the divergence between the returns delivered in the last few months by large-cap funds and non-large cap funds would be clearly evident.
Sadly, the investors who believed that the stellar performance of Mid & Small caps during last year will be repeated this year have been disappointed.
Trees don’t grow to the sky. And neither does the market.
If investors continue to disregard the risk in order to enhance returns, sooner or later they will be caught off guard. In a way, this is exactly what is happening right now.
Mean reversion is a law of markets and cannot be avoided. It happens every now and then. And past experience tells that it can be ferocious in the short term. Many who were small-cap heavy in last 2-3 months would agree with that now.
If you already know me, you will agree that high valuations make me uncomfortable. 🙂 I am not a Growth-At-Any-Price kind of investor. Rather, I am a valuation conscious common man who gives cognizance to the real risks.
Since last year or so, there was absolutely no doubt that valuations were stretched (check this and this). And if mean reversion does work (and I believe it does), then sooner or later this kind of correction was expected.
I know we cannot perfectly time the markets. But valuations do act as a guide. And we need to respect it.
Please don’t think that I am trying to portray myself as someone who got the timing of this correction right. Using the State of Markets Tracker, I have been highlighting the risk of the on-going increase in valuations for some time now. So to be fair, this road bump in returns was bound to come sooner or later.
Nevertheless… what next?
I don’t know.
Even after the recent fall in small/mid-cap space, the valuations are still not cheap. Large caps still seem to be overvalued from a historical perspective. But not as overvalued as they were maybe at the start of the year. But having said that, it must also be acknowledged that there are several moving parts right now – like the mood of the population as elections approach, crude oil, geopolitical stuff, sector-specific issues, valuation itself, etc. I am not trying to paint a bleak picture here and I don’t think that this is the repeat of 2008 crisis. But the reality is that no one knows how the current situation will further evolve. And if the panic does take over due to any reason whatsoever, then the stress will increase across the board.
Although as long-term investors, we should not react to the short-term movements in the market, we nevertheless need to remain awake and have adequate situational awareness and link it to historical trends.
If you believe in goal-based investing and are investing for your long-term goals, then you should remain focused. You are already investing in line with your suggested asset allocation and hence, you should stick to it. If you are a SIP investor in mutual funds and your goals are still several years away, you should continue your regular investments as the strategy is good enough and works only if you continue to invest in falling markets too. Unfortunately, if your financial goal is more immediate and you were still heavily in equity, then you had it coming. Your allocation was wrong to begin with as for short-term goals, large % of equity should be avoided for most investors.
If you already hold a large-ish portfolio, then you should respect your strategic asset allocation (assuming you were wise enough to have thought about it earlier) and act accordingly. Ideally, rebalancing should have begun much earlier. Now it’s the market that is rebalancing the portfolios by force.
If you have surplus money to invest, don’t be too excited and try to do anything adventurous. You are excited and we all know that. Let the dust settle a bit more. Being in cash is also a decision. And cash has immense power in such markets.
Every now and then when high valuations and other factors line up in some combination, the markets will have their corrections. In theory, everyone knows how they should react to market falls. But in reality, we can’t be very sure of our actions as our real tolerance for market falls may not be what we think it is.
But corrections are normal and healthy and we should pray for them.
In fact, panic weeks and months are common if you increase the time scale under consideration. And once you do that, the earlier corrections or even the ongoing correction will seem like a blip in the returns that disciplined long-term investors eventually reap. So do not be afraid of this one. Even this will pass away.
It would still not be a bad idea to remain cautious for some more time. It is easy to be carried away by the panic selling. There is a time to be bold and there is also a time to not be bold. Depending on who you are and what goals you are saving for, you need to decide what you will be doing.