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Thursday, November 10, 2011

What if the stock market remains in a down trend for another year?

The Sensex and Nifty indices had touched their peaks one year back. Since then, both indices have been in down trends – neither falling a lot, nor rising much during counter-trend rallies. A gradual drift downwards that has all but sapped the bullish energy of small investors.

Several rounds of interest rate hikes by the RBI have failed to restrain rising inflation, but has started affecting economic growth. The high interest rates have led to postponing or cancelling of capital expenditure by companies, which in turn has affected the order books of capital goods makers, and engineering and construction companies.

The RBI had indicated the possibility of pausing the rate hikes if inflation begins to moderate. If the situation doesn’t improve within the next month or so, the RBI may be forced to hike the interest rate again.

Even if there is a pause in the rate hike, the already high rates are unlikely to be reduced immediately. Market sentiments do not turn bullish when interest rates are high and the GDP growth is slipping. It is quite possible that the Sensex and the Nifty may continue to trend downwards for another year.

However unlikely or pessimistic the above may sound, the path to success in stock market investing is to assess the surrounding environment at all times, and have strategies and plans in place. So, what can small investors do to prepare for another year of down trend in the stock indices?

The most important – and I can’t emphasise this more – is to have a financial plan, and based on it, an asset allocation plan. The queries I receive from small investors are mostly of these two types: “This stock is going up in a bear market – should I buy now or wait” or, “That stock has fallen a lot – should I wait longer or buy now”.

Hardly anyone asks me: “How do I make a financial plan” or, “How do I work out an asset allocation plan”. Without a plan, random buying and selling of stocks will lead to an unwieldy portfolio and very little returns.

Once plans are in place, a portfolio to suit the plans and the risk tolerance level of an individual can be built. A stock market in a down trend is the best time to build portfolios, because many good stocks are available at bargain prices.

What if you are one of those enlightened investors who already has plans and a well thought-out portfolio in place? Allow your portfolio to grow and prosper. How do you do that in a down trend? Mostly by not being overly aggressive. Within an overall down trend, individual stocks may perform better or worse. Use opportunities to book part profits or add to fundamentally strong stocks that have been beaten down.

Needless to say, whether to buy, sell or hold should be determined not by market fluctuations or gut feel, but by your asset allocation plan. When you book part profits, try to control the impulse of buying some thing right away. The high interest regime has its benefits in the form of higher bank fixed deposit rates and good returns from debt funds. Invest in them – as per your asset allocation plan.

Use the stock dividends that you receive at this time of the year to reinvest in your portfolio companies. Dividend reinvestment is like adding fertiliser to your plants. It helps them to grow better and faster.

Continue with your regular savings and systematic investment plans. There is a tendency of many small investors to stop investing when the markets are down. If you haven’t developed the skills to time the market (very few investors do), stick to your regular investments. Again, follow your asset allocation plan in a disciplined manner.

That is all there is to it. No magic formula will produce phenomenal returns in a down trending market. Just a boring, disciplined approach to planning, saving and investing for building wealth over the long term.


Jasi said...

A gem of a post! Answers so many questions most of us ask in very simple language.
Great job!

Nishit Vadhavkar said...

Best post of the Year

Anonymous said...

Hello Sir,

About market can I add 1 more reason "decision paralysis of govt.", because of several scams govt. is in defensive mode and do not want to push forward the policies which are good for market or economy, but if govt. want to win election in2014 they have to do something good to fill up there report card so may be early 2013 we will see some progress in policy making and may be that will reflect in share market.

But Sir, I want to ask you one thing, is it really market anticipate things 6 month before they happen?


ujjwal said...

dada tumi god...pronam nio...

Subhankar said...

@Jasi: Thanks - you are always generous with your compliments.

@NV: Appreciate the comment - more so because it comes from a veteran investor.

@Titu: The failure of the government to take tough decisions is one of the major reasons for the downward drift in the economy and the stock markets.

Markets appear to 'discount' good and bad news in advance, because there are always two groups - bulls and bears - that are speculating. If the bulls are dominant, the market moves up slowly and then suddenly spurts higher when the bears also turn into bulls. Vice versa when the markets are in a down trend, and the bulls turn into bears. So it appears that the market 'knew' in advance about the sudden rise or fall.

@ujjwal: Unfortunately, I haven't quite achieved the elite status you have bestowed on me. Otherwise, I would really know in advance about what is going to happen in the market - and become a lot richer!