Thursday, February 10, 2011

5 Reasons to start buying now and 5 Reasons to wait

With the BSE Sensex and Nifty 50 indices dropping like bricks and shattering likely support levels, small investors are naturally anxious and bewildered by the quick turn of events. Both indices were near their all–time peaks just three months back. But a deadly cocktail of corruption and scams, generously mixed with untamed inflation and rising interest rates have left investors punch-drunk and chased FIIs to the exit doors.

In an earlier post, I had given 4 definitions of a bear market. So far, only definition number 2 has been satisfied, and definition 4 – the ‘death cross’ – may be satisfied soon. That will confirm a bear market. So what should investors do now? Use the correction to start buying, or wait for the correction to end?

Those are tough questions to answer – mainly because there are no simple answers that will satisfy all investors. Given below are 5 reasons why investors should start buying now, and 5 reasons why investors should wait. The idea is not to confuse, but to provide alternative arguments that investors can evaluate and then decide their own courses of action.

5 Reasons to buy now

1. The BSE Sensex and Nifty 50 indices touched their Oct ‘09 peaks. Since previous tops tend to provide support, a bounce up from current levels is a possibility. The technical indicators are looking oversold – also hinting at an upward bounce.

2. If you missed the rally from Mar ‘09 and had waited for a correction to enter, well you’ve got it. The indices are down 18% from their Nov ‘10 peak, and the downside seems limited. It is very difficult to time the market perfectly, so this is a good time to start accumulating.

3. You should invest when you have the money. It doesn’t matter if you have the cash to invest because you missed the rally, or because you were one of the smart ones who have been regularly booking profits. Many stocks are at or near their 52 week lows – even some good companies can be found in that group.

4. Inflation rate has shown the first signs of reducing. Whether it is the base effect or the effect of monetary tightening is some thing the economists can debate about. But a positive fall out for the stock markets could be that RBI may hold off on raising interest rates further.

5. The FIIs are selling, but not at the rate they did in 2008. It is more of profit booking in emerging markets and redeploying in developed markets because of valuation differences. With each passing day, Indian indices are falling and US and European indices are rising – progressively reducing the valuation gap. The Indian growth story is in tact. At some point, the FIIs will be back.

5 Reasons to wait

1. Volumes have been higher on down days than on up days. That means selling pressure hasn’t abated, and the up days have mostly been due to short covering rather than investment buying. That points to further selling.

2. If you missed the rally since Mar ‘09 because you waited for a correction, why not wait a little longer? No point trying to catch a falling knife. Let the selling subside. Once the indices start to turn around, that would be a better time to enter.

3. One of the four bear market definitions (mentioned above) have already been satisfied. If  the ‘death cross’ happens, a bear market will get confirmed. Any subsequent upward bounces will be sold into, and the indices may drop much lower. How much lower? Check this post. Remember the old saying: The early bird catches the worm? Guess what happens to the early worm – it gets caught! Many small investors bought during May ‘08 during a bear market rally. They were badly ‘caught’ in the crash that followed.

4. The government is trying to show that it can also act against scams and corruption. But so far it has been too little – too late. Investor sentiments have gone for a toss, and no one wants to step up and buy. FIIs continue to sell. This isn’t the time to be brave.

5. FIIs have lots of choices about where to invest. China has been growing faster than India. But the Shanghai Composite index has been in a bear market for more than 3 years. There is no reason to believe that FIIs will pour in money like they did in 2009-10. India’s GDP growth rate is beginning to slow down. Investors may be better off by taking advantage of the higher interest rates and safer option of bank fixed deposits till the correction plays out and the bull rally resumes.

What would you like to do, dear reader? Are you in the ‘buy now’ camp or ‘let us wait out the correction’ camp and why? Your opinion may help other readers to decide.


Dilip Raju Lillaney said...

I would wait. Remember Seth Klarman saying once that the thing he fears most is being early while buying. He explained that in 1929 Dow was around 100 and in 1930 at 70, so it seemed that an investor was getting a 30% bargain, but the markets continued to fall and were at 20 in 1934. Buying at 70 did not seem like a wise decision, did it? The fall from 100 to 20 was almost as painful as the fall from 70 to 20.

Harry said...

I can not predict the trading side as you can not predict the FII rationales. You know what they are doing only after it happens.

However, the sure shot way for India to get out of the dependence on FIIs is to execute way better than expectations and other countries. If we (the companies and the government) execute ... rather than be corrupt, there's nothing the FIIs can do.

Harry said...

I also wanted to point out America's situation where they lost all industries and are now heavily dependent on financial services.

As traders / investors, if we invest in productive value creating companies rather than the alert of yesterday, I think this has a 2 fold benefit of creating value as well as reducing volatility.

RAVIN said...

I would like to invest in small quantities in good companies in SIP way in every dip.

Karan Kamdar said...

I think you should start accumulating good value companies which are quoting at 52 week lows and they some have even fallen below their book values. These are huge bargain buys and the maximum downside is very limited. as you rightly said it is very difficult to time the markets so one should start accumulating because you cannot always buy at the lowest possible price.

Smartlead said...

Great Blog Sir!

I think the market is headed downwards in the short term and may see another 15% correction before serious buying emerges. A little wait appears prudent if you are low on reserves and missed booking profits at the peak.

Anyways no one can predict the bottom so it is a good idea to start accumulating in small quantities right now as we are 20% corrected already. I have started buying ever since sensex moved below 20000. I am not worried about the market moving further down as my focus is two years from now and I do find current buy attractive from that perspective. I am holding some cash for the bottom however.

Amit said...

New Scams are emerging every day..latest one S-Band inflation has off-course come down but it is still in double-digit..more heads are going to roll in 2G scam...powerful maharashtra politician name is coming( no prize for guessing who he is)....become tortoise...go to ur shell!!!!

United We Grow said...

Wait - wait - wait !!! First six months of 2011 - just wait and watch !!!

Subhankar said...

Thanks every one for your comments and participation.

@Dilip: One of the best ways to make money in the stock market is to buy good stocks at fair prices, and then wait for them to grow.

But waiting for Sensex levels to go lower may not always be a great idea. Some individual stocks have fallen to attractive, if not mouthwatering, levels.

@Harry: FII dependence is not going away any time soon. India Inc's floating stock - particularly in mid and small caps - is low compared with other markets. Even trading a few thousand shares can cause wild price swings.

If India Inc keeps performing and the government takes believable action against the corrupt ministers and officials, the floodgates of overseas funds will really open.

@RAVIN: What if this correction turns into a bear market and the Sensex falls to 9000? Will you continue to buy the dips all the way down?

Buying the dips works well in bull markets, when the trend is clearly up. In bear markets, you make money by selling the rises. If you wish to continue with regular SIPs, do so in an index fund or a balanced fund or a debt fund - not in an equity fund or in individual stocks. Having an asset allocation helps in taking such decisions.

@Karan: All stocks that have fallen below book values or to their 52 week lows may not be investment worthy. No one knows for sure if the down side is limited or not. Make sure you set adequate stop-losses to protect against a crash.

@Smartlead: After the bust in 2000, stock markets remained in a bear market for 3 years. I'm not saying it will happen again, but never make assumptions that the market will only fall 10% or 20%.

@Amit: Why be a tortoise when you can be a python or a crocodile? Those two reptiles don't eat very often, but when they do, they eat big. They wait and wait for the opportune moment, and then strike. It is an 'active' waiting - always being ready for the big opportunity.

@UWG: Why 6 months? Why not 1 or 3 or 9? Be prepared, and be flexible. Opportunities may arrive unexpectedly.

I would like to re-iterate that all investors need to have an asset allocation plan. Without such a plan, when to buy and when to wait (and when to sell) becomes guesswork.