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Stock markets on fire: what should you do?

Manvi Agarwal
·5-min read

Sensex and Nifty have hit a record high in recent days. Spurred by the liquidity injection across the world at first, the markets have now leapt owing to various reasons:

Successful vaccine announcements: In the past few weeks some of the top pharma companies like Pfizer and Moderna have announced successful vaccine trails, with some even declaring a tentative date for releasing their vaccines.

Results of the US election - the leadership change has aroused expectations of further liquidity injection into the economy.

An economic turnaround, ahead of expectations - the Reserve Bank of India (RBI) now expects the GDP of the country to shrink by 7.5% instead of 9.5% earlier. The RBI also emphasised on the use of relevant instruments for ample liquidity to support growth.

How long can this rally sustain? A few months ago, when the Sensex was hovering around 40,000, I had written about how this rally can continue on the back of concrete vaccine announcements and liquidity injections. But now, with the index at this level, it is difficult to tell.

Valuations at present, suggest it should not. Unless there are substantial changes at the ground level, in demand and corporate profitability, the prevailing valuations don't justify the rally.

Nevertheless, this rally has everyone thinking we are in a bull market.

People often presume that making money in a bull market is easy. And while there are several success stories, there are plenty of failures as well. Now, there is no sure shot formula to ensure your success, but there are certain steps you can avoid in a bull market frenzy.

Trying to time the markets: Trying to time the markets is a futile exercise. Many have tried and failed only to realise that it is impossible to time the markets correctly, at all times.

Crashes come out of nowhere, making stock market movements hard to predict. It happened in 2008 and now again in 2020. So a wager on things staying the same for too long can only set you up for disappointment, in case the markets turn turbulent or move sharply in the opposite direction. “We wish we had perfect market timing (as well as the ability to fly). The reality is that no one does or ever will.’’ - Seth Klarman

A better and proven strategy is to stick to your investment plans. Something, every investor must follow.

Don't allow market movements to decide your plan of action. Instead, every time the markets get volatile, ask yourself:

  • What should I make of all the news about the stock market?

  • Can this market volatility be helpful? How can I take advantage of the situation?

  • Do these near term swings affect my long-term financial goals?

It will guide and help you define your plan of action.

Justifying overvalued investments and ignoring fundamentals: Positive sentiments in a bull market phase can make fundamentally weak, over-leveraged companies look like the next multi-bagger.

As the stock markets rise, investors hunt for a bargain. Desperately on the lookout for stocks trading at low valuations, you try to justify your inferior purchase. Throwing all logic out of the window, you assign those companies a higher future value only to regret later.

But a wise investor is always wary of bull markets. They avoid these bad companies masking as multi-baggers by judging them not just on valuations but also on the quality of business, earnings and management.

So in such times, go back to Mr Buffett's and Mr Munger's advice: 'It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.'

Allowing market scenarios to define your portfolio allocation

Asset allocation is the process of choosing the right asset mix of bonds, equities or gold that reflects the investor's financial goals. Its primary objective is to lower investment risk by reducing over-reliance on a single asset class. But a bull run can lure some of the most seasoned investors into forgetting this golden rule of investing.

Ignoring your financial goals and willingly increasing your allocation to the riskier asset class, equities, is dangerous.

Even though bonds lag in a stock bull cycle, they play a significant role as the return stabiliser.

So, don't allow any short-term returns in a particular asset class to define your asset mix. Let it remain a function of your long-term financial goals and your risk appetite, to avoid wreaking havoc on your long-term portfolio returns.

Premature exits: Failing to exit in a bull market can sometimes be as bad as selling prematurely.

So, for instance, if your choice of stock has touched it's all-time high price, do some background research. Analyse any news items and ask yourself:

  • Has there been any fundamental change in the business?

  • Do the fundamental reasons I bought the stock initially, still hold?

  • Is there more scope for growth? Is this level of growth sustainable?

  • Has there been any dramatic change in its line of business?

The key is to identify the reasons behind the high valuation, so you can decide whether the stock is worth holding or not.

A falling or a rising market must not influence your decision to buy or sell a stock. It does not matter whether you are at the beginning of a bull run or towards the tail end, because there is no way of knowing.

So, if you feel that your choice of investment has had its day in the sun, exiting might be a good call. But understand the pros and cons and make a conscious decision based on the fundamentals of the business, not the market movements.

Movements of excess volatility in the markets can be worrying and often distracting. And while you cannot control the market movements, you can most certainly control your reaction to them.

Cut through the noise and let your investment strategy alone define any portfolio changes. It will ensure that you are on track to achieving your long-term financial goals.