How to Have a Perfectly Normal Day Even if Sensex Falls 2,000 Points

Mar 1, 2021

Rahul Shah, Editor, Profit Hunter

In Microcap Millionaires, one of stock recommendation services, I recently told my subscribers to sell stocks and increase exposure to cash.

We were 60% in stocks and 40% in cash before I published the report. Now, we are more than 60% in cash and only 40% in stocks.

It may look like a fabulous call in hindsight.

After all, just look at how shaky the stock market has been. Look how the BSE Sensex plunged close to 2,000 points on Friday.

However, I had no idea the Sensex would tank 2,000 points within a week of my asking my subscribers to reduce their exposure to stocks.

I was just working according to a pre-determined plan.

The plan calls for reviewing the allocation between stocks and cash periodically. I recommend switching from one to another, based on how cheap or how expensive the broader market is.

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Well, the market at the time was certainly quite expensive.

It still is. The Sensex is currently trading at a princely price to earnings ratio of around 34x.

Even if you account for the fact that the earnings are depressed due to the covid disruption to the economy, the PE ratio may only go down a tad to say 27x-28x.

Historically, the Sensex has traded at these high multiples only about 8%-10% of the time. Almost 90% of the time, it has traded at a multiple lower than 27x.

Thus, there was a strong possibility of a correction, reducing the PE ratio of the Sensex. That's why I recommended my subscribers to reduce the allocation to stocks and get into the safety of cash.

In what Warren Buffett calls one of his best speeches ever, Ben Graham said something back in 1963 that has left a deep impression on me.

  • In my nearly fifty years of experience in Wall Street I've found that I know less and less about what the stock market is going to do but I know more and more about what investors ought to do; and that's a pretty vital change in attitude.

I think you pretty much got the crux of what Graham is wanting to say. Instead of trying to predict the market's next move, it is always better to have a blueprint handy while investing.

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The blueprint should have clear rules or key action points if you will, based on how your portfolio and the broader market is moving.

Thus, if the market is going up and is beyond a certain threshold that you have set for yourself, you should lighten exposure to stocks and get into fixed deposits or bonds.

And if the market is going down and is below your threshold, you should increase exposure to stocks and reduce the same to bonds.

I have such a blueprint ready. It allowed me to view the 2,000 point decline in the Sensex late last week with equanimity.

I know that if the Sensex falls below my threshold, I will get an opportunity to deploy the excess cash and buy stocks at attractive valuations.

And if it doesn't and continues to go up instead, I can reduce my exposure to stocks further and move more into cash.

Isn't this a great approach to have?

It has three big advantages.

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One, it is extremely simple to implement.

Two, it allows you to do the right thing from a long term perspective i.e. sell when the markets are high and buy when the markets are low.

Last but not the least, it keeps you active and makes you take action after every significant move in the market.

I have been using this approach for many years now. Trust me, I've slept peacefully ever since.

I don't really worry about what the stock market will do. I'm more concerned about trying to stay the course.

I think you should too.

Good Investing,

Rahul Shah
Rahul Shah
Editor, Profit Hunter
Equitymaster Agora Research Private Limited (Research Analyst)

PS: Get access to Richa Agarwal's best small-cap stock recommendations in the ongoing revival in small-cap stocks. Details here.

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