CORRECTIONS – APPROXIMATELY RIGHT BUT PRECISELY WRONG

After the sharp run up in the indices in the last 3 months most investors have cashed out and are waiting for a correction to get back into the market. What constitutes a ‘correction’? This is very tricky since in the past I know of many investors who exited in the year 2008 at an index level very near the top and then got so bearish that they never got back in. The general classification of a bull market is a 30 % rise after 50 calendar days or a 13 % rise after 155 calendar days. So we are effectively in a bull market (at last, just in case any one still has any doubts)!!!  When all the experts and forecasts suggest that we are due for a correction you can be sure that is the least likely outcome!!

In a bull market what should be considered as a normal or meaningful correction? There is no unanimity on this and each investor will have to decide his specific level of entry and exit, depending on his comfort levels. When most investors talk of a correction and I ask them to quantify that in terms of % or index values, I find that they have no such defined values and they are getting carried away with the media b******t . Investors should remember that markets tend to correct much more often than they crash. Are investors waiting for a correction or a crash? In my opinion a correction would occur if the markets changes direction to the extent of 10 % in a relatively short period of time (say a month), a crash would be if the same happens in a day or two and is followed up by further declines. I find that investors have been waiting for a correction from December 2013 (after the Delhi Election results). Most investors who have been waiting for a correction since then, are still waiting.  The reason for this is that in India, unfortunately, equity is not sold as an asset class but as a ‘matka‘ or lottery and the media is directly responsible for this. The media blitzkrieg  and the glamour attached to index ‘levels’ effectively ensures that equity is not considered to be an asset class by most. When a person buys stocks he is not investing but ‘playing’ (khel raha hai). With that perspective I think the current index levels are not conducive for anyone who is trying to ‘play with the stock market’. In any case any such person is not investing but is speculating. For all such speculators (why should I even call them investors?), all the best. If you are going to part with hard-earned money on the basis of ‘tips, targets and time frames‘ then very clearly and undoubtedly there are better investment avenues than the stock market. The financial regulator and the media, unfortunately, do not see the difference between investors and speculators.

There are many financial pundits and forecasters calling for a correction on the basis of the index levels.  I think that investors are making a mistake looking at the index and levels which the media articulates incessantly. When the market closed on Friday I had an investor asking me the next resistance level, and honestly,  I do not have an answer since we are in uncharted territory, but you still have Fibonacci numbers and all kinds of mumbo-jumbo with the usual disclaimers (which mean nothing). For investors who are convinced about equity as an asset class and are still circumspect about the market my advice would be to commit a small amount initially and build on it when the inevitable correction does occur. Investors have a fear of heights and as the index trends higher the fear increases exponentially. This fear can be tackled by adopting a two-pronged strategy, (a) start a systematic and graded index investing plan through an ETF which will ensure that one does not have to invest too much at one shot and (b) invest selectively in to individual stocks (on the basis of sound advice) since these move independent of the index. If investors keep watching the index and are waiting for a crash there is a risk that they may be left out altogether.  Alternatively, what investors who buy ETF’s can do is to buy stocks which are not part of the ETF composition (to avoid an overlap). What investors have to do is to increase allocation towards equities. Saying that stocks will go down is easy, but when,  nobody knows and the perma-bears will be shouting ‘I told you so’ when it eventually happens. Investors would be well advised to analyze the index at the time of the so-called bear calls and the time when it eventually happens. I can say with a very high degree of certitude that timing corrections with any degree of precision is practically impossible. What has happened in the past can be indicative but not certain because each cycle is different. Just to put matters in the right perspective, the U.S. markets have gone up for the last 31 months without a 10 % correction. The CNX NIFTY is only mirroring 50 stocks and watching the index tells you nothing. What investors are doing is that they are basing their buy and sell decisions on the index value which has soared. Effectively they are being left out of the market. What the index values can tell you is the mood of the stock market and a rising index signifies an upbeat or bullish demeanor and vice-versa. What happens in reality is that waiting for corrections and crashes leads investors to be left out of the market completely. In other words the opportunity cost of trying to time corrections is very high. Stocks will go down sooner or later, but waiting for the next big crash to hit is a huge opportunity cost investors should avoid. Are we nearing a phase of “Irrational Exuberance”, I personally do not think so, not as yet, at least.

The following table shows the % correction required from Friday’s Nifty closing of  7583.40 to reach the index levels on the dates mentioned.

In any market there are only four possibilities and they are BIG UPSIDE, SMALL UPSIDE, BIG DOWNSIDE and SMALL DOWNSIDE. If investors feel that there is a BIG DOWNSIDE then they are justified in staying away from investing in stocks. In case of the other three possibilities there is no reason to stay out of the market (especially if you have a long-term perspective) since the opportunity cost of timing can turn out to be very high. In all bull markets corrections are quite common, they are driven by sentiment and not by fundamentals. I think investors have to take a long-term call on equity investing.  No one can predict when the markets will correct , maybe they will or maybe they will not. There is no law saying how long the markets can go in one direction without a correction. If markets hit all time highs and consolidate there is nothing to suggest that they will go down first before they go up. For the long-term investors ,tune out the noise, it does not matter. If you are convinced that the long-term outlook appears bright don’t wait for corrections since nothing goes up or down in a straight line forever. To conclude, as far as timing corrections is concerned I would like to remind the readers of a quote by the great economist John Maynard Keynes who has said  “I’d prefer to be approximately right than precisely wrong”.