How am I Approaching the Correction in Small Caps?

Aug 25, 2021

Rahul Shah, Editor, Profit Hunter

Back in February this year, I did something that was considered quite contrarian at the time.

I recommended subscribers of my Microcap Millionaires service to switch from a 60:40 allocation between stocks and bonds to 40:60 i.e. to switch from being 60% in stocks to 40%.

My argument was simple. The Sensex had almost doubled in less than a year. Thus, there was a strong chance of a meaningful correction.

Even the broader stock market valuations were supportive of my argument.

Therefore, it was only logical to lighten up on stocks and move some of the corpus into bonds or fixed deposits.

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And this is exactly what I did.

I recommended a SELL on few of the stocks and recommended an allocation to fixed deposits to the tune of 60%.

A case can be made that if I was so confident of a correction, why not go into FDs or bonds to the tune of 100%? Why not exit stocks completely?

Well, I view investing as a game of probabilities and not certainties. I thought there is a strong possibility of a correction over the next few months but in no way felt that a correction was guaranteed.

And it's this principle that came to my rescue.

You see, a meaningful correction never came. After falling a bit in the following months, the Sensex resumed its upward journey and for the first time in its history, crossed the 56k mark. The BSE Small Cap index did even better, going up an impressive 36% during the same period.

As we were into stocks to the tune of 40%, the overall Microcap Millionaires corpus went up by around 22%.

Thus, taking a probabilistic approach allowed my subscribers to partially cash in on the bull-run since February 2021.

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In fact here are the guiding principles of the strategy we use in Microcap Millionaires.

  • The markets can remain greedy for longer than you can remain patient. Thus, you should be at least 25% into stocks at all times no matter how big the stock market bubble.
  • There is always a possibility of a big crash in the stock market. Therefore, you should be ready in thought and action for it. This is why one should always have at least 25% in fixed deposits or cash at all times.

What about the remaining 50%? Well, you can toggle between stocks and bonds with this remaining 50% based on the broader stock market valuation.

For example, right now, we are still 60% in fixed deposits and 40% in stocks in Microcap Millionaires.

This is not to say this is a perfect ratio. You can certainly be the reverse or even take a maximum 75% exposure to stocks.

It's just that if there is a big crash in a few months, I will have an edge because I will have a lot more cash to put to work.

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On the other hand, if the bull run continues, I will underperform and you will outperform because you have more in stocks.

Over the long term though, both approaches are likely to give you good returns as long as you stick to your process.

My approach has multiplied subscriber's money by 4x since inception in February 2014 versus the 2.7x gains returned by the Sensex.

Now, to go back to the question of how I am approaching the current correction in smallcaps, I am waiting for these stocks to fall more.

If there is a meaningful correction from here on, I may ask subscribers to deploy more money into stocks. On the contrary, if this turns out to be a temporary pullback and the bull-run resumes its northbound journey, the stock portion of the corpus is likely to participate in the rally.

Thus, as we saw, thinking about investing probabilistically allows you to think calmly about bull-markets and corrections and not get too greedy or too fearful.

I think this is as close as one can get to the holy grail of investing.

Warm regards,

Rahul Shah
Rahul Shah
Editor and Research Analyst, Profit Hunter

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1 Responses to "How am I Approaching the Correction in Small Caps?"

Dinesh Hegde

Aug 25, 2021

Looks like you are interested only in troubling your customer and sucking money from them and pure marketing. Your analysts are totally stopped reading. Otherwise you would have not missed big time bull in Speciality chemicals and Sugar. Just see McKency report from early 2020 on Indian speciality chemicals, you understand what I mean.

Comparing your performance with Indiex is a biggest fraud you do, instead of that compare with wipro or infosys and see where you stand.

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