Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it.”—Warren Buffett
Warren Buffett’s golden words are true when the markets are falling. The prolonged Bear market appears once in every decade. The last was the financial crisis of 2007-08 when Nifty fell over 50 per cent. Ever since Covid-19 hit, markets have loomed under fear as uncertainty prevails. Companies have scaled back its operations, layoffs have multiplied and employee compensations have been affected resulting in negligible growth in the last couple of months. India VIX, the volatility index, was highest around Mid-March at 83.61 which indicates 2020 to be a bear market. India VIX is the index indicating the Indian market’s volatility from the investor’s perception.
Your equity portfolio would be all red and the fear of wealth depletion will compel you to sell your stocks in this falling market. But the stock market in the history has time and again proved that bad news is your friend and that dips in the stock markets provide the investor with an opportunity to enter the market at low points and earn a higher return in the long run. It provides entry at a lower price point and participates in India’s Future.
But then the question that arises is which stocks to buy and when to buy?
Well, diversification benefits your investments in such a market. Diversification is devised in a way to protect you from risks at such times. If one industry is not performing well and your portfolio has stocks that are less correlated with that industry, your losses can be covered. (Correlation measures the degree to which two securities move in relation to each other). Eg- Sectors like IT and Consumer staples have a lower correlation of 0.27. Also, you can be diversified into other investment vehicles to protect your losses coming from the entire equity market. Eg- Equity market and commodities or gold. The lower betas and uncorrelated nature of the diversified portfolio is the very core diversification is built on. Stocks with a lower beta tend to fall less than the overall market during a downturn. (Beta measures stock volatility in relation to the overall market). A diversified portfolio will bring down the overall standard deviation of your portfolio, thus immunizing it from concentrated risks in a particular sector due to lockdowns.
Since this pandemic is more of a health hazard than the previous crisis which had been more of a liquidity crisis, the uncertainty and fear this time is different than the rest and is bound to create a change in consumer behaviour. Hence, past performances of few companies may not truly aid to predict the future. Majority of the stocks are down but only a few companies can manage to come out of this crisis strong. Picking up companies which have higher free cash flows to sales, higher Return to capital employed, sufficient reserves, low debt and a dominant industry position are safer bets. The idea is to believe in a company’s long-term potential so you can ride out the storm until the market finally turns around.
But in this process don’t blindly get into undervalued companies (mid- and small-caps) just because they are available at cheap valuations. Filter the quality and stronger men from the countless boys. These very men will turn out to be winners in the long run. Hence, cherry-pick the fundamentally strong players as these companies will be setting record profits 5-10 years down the line.
Now addressing when to start buying. You must have heard that a good time to enter the market is at such lows when the prices of most of the companies have fallen down. It is during this time that you get good companies at a relatively cheaper valuation. But a risk-taking investor can start picking up stocks in a SIP Format. Such an incremental investing approach in smaller amounts yet building up a diversified portfolio will enable you to create positions that accelerate your returns. Don’t wait to predict bottoms instead when you believe in a company’s future start buying at lower valuations so you don’t miss the rally when markets turnaround.
But this is better said than done. As the majority of investors tend to overreact and go on a selling spree when they witness a stock market crash. Selling these stocks or funds would mean booking losses. However, if you remain invested, you can recover the value of your investments over the next few months or years. Unless in dreadful need of money, selling in a bear market would be the worst strategy as what goes down usually comes up. And markets have proved it time and again. Profiting from investing in bear markets requires patience, discipline and enough wealth to be able to make opportunistic purchases. Benefiting from such a market is a long term game. Hence, diversification should be the sole motto but yes diversify ‘smartly’ to reap the best risk-adjusted returns.
Write-up by: Preet Shah
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