Indian Stock Market: Is the Worst Over?

As I was getting ready for office last Friday, I got a call from my sister.

'Rahul, the market has corrected a fair bit. Should I add to your midcap recommendations, especially the ones that have fallen a good deal?', she enquired.

I smiled and felt proud of her. In fact, this is something that the entire industry must be lauded for.

A lot of investors, including my sister, have now been conditioned to believe that stock market corrections are an opportunity to buy more of your favourite stocks and not sell in panic.

I don't think this was the case with majority of the investors few years back. Market corrections used to turn them into deers caught in the headlights. They used to get all nervous and often head for the exits.

Hence, showing the right behaviour and looking upon a market correction as an opportunity, is indeed a welcome change.

Coming back to my sister's inquiry, I told her not to add to any of my midcap recommendations just yet and wait for a communication to my subscribers on the right course of action.

I'm sure most of you are facing this dilemma as well. You must be wondering about the next course of action.

Should one take more exposure to stocks right now or wait for the markets to correct further? Moreover, was Friday's recovery a dead cat bounce or is the worse behind us and the market may make a new high in the coming months?

Well, my one-line reply would be what Ben Graham had so beautifully summed up in a speech he gave back in 1963.

• 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 can't help but completely agree with Graham here. There's no point wasting your time in trying to figure out what the market is going to do next.

It is an impossible thing to do, and no one gets it right 10 times out of 10. In fact, no one gets it right even 5 times out of 10 I reckon.

The easier thing to do is to prepare a plan well in advance and then try and execute it with total discipline.

So, here's the plan that I propose.

You see, the one common feature or the one quality of the stock market that's never going to change is that the markets will never cease to fluctuate.

Take the Sensex for example. Its 52-weeek low is 57,085 and its 52-week high is 67,927. That's a close to 20% fluctuation right there. Besides, its current value is 63,726, once again a fluctuation from its lows as well as highs.

Now, one of your jobs as an investor is to take advantage of these fluctuations. Not just in the broader market but also among individual stocks. In other words, you need to buy low and sell high.

Hence, given this nature of both the broader market as well as individual stocks, this is what I suggest.

If you have Rs 100 to invest, put Rs 25 each into a portfolio of 20 stocks and into a fixed deposit or a bond.

For the remaining Rs 50, you can decide the split depending on whether the stock market is up or down a good deal from its highs.

So, say if you are 50:50 in stocks as well as bonds and if the stock portion goes up and the ratio now becomes 60:40, you can sell some of your stocks and bring the ratio back to 50:50.

On the other hand, if the stock portion goes down and ratio becomes 40:60 in favour of bonds, you sell some of the bonds and invest in stocks and bring the ratio back to 50:50.

You can also do this on a yearly basis where once in 12 months you look at the ratio and then rebalance to 50:50, depending on which portion has become higher and which one has gone lower.

This approach may look simple but it has one huge advantage. It lets you capitalise on the fluctuating nature of the stock market, and also individual stocks the right way.

It lets you buy low and sell high instead of the usual tendency of most investors of buying high and selling low.

So effectively, you are reducing exposure to stocks at lifetime highs and increasing them after the market has suffered a brutal correction. And this is exactly how it should be.

Does this strategy also help you beat the market over the long term?

Well, I can't guarantee that. In fact, no strategy can guarantee a market beating performance.

However, the good thing is that although you may or may not outperform the broader market over the long term, your overall returns may still look good.

In other words, this strategy may limit your downside risks even though it can't guarantee outperformance.

Last but not the least, what kind of stocks one should buy under this strategy?

Well, if your goal is to outperform then I would recommend small and microcaps as you have a better chance of outperforming with these stocks than large and midcaps.

However, within small and microcaps, you need to pay attention to both business quality as well as underlying valuations. Loss making stocks with dubious financials or highly leverage companies are a strict no-no.

I would prefer companies with good track records and strong balance sheets.

So, going back to the question at the start of this piece: Was the Friday's recovery a dead cat bounce or is the worst really behind us?

Well, as I said, worry less about what the market is going to do and more about you ought to do.

If you don't want to outperform the market and are happy with market like returns then keep doing your SIPs.

However, if you want to outperform but at the same time do not want to underperform by a big margin then you should certainly give the strategy I suggested a try.

Allocate equally between stocks and bonds or keep it 60:40 in favour of stocks and then rebalance periodically based on whether stock market has gone up or down.

Also, within stocks, focus more on small and microcaps but the ones with good track record and reasonable valuations.

Keep doing this and there's a strong chance you won't get a bad result from your investments.

Whether you get outstanding results depends on your skills in picking the right stocks and the amount of fluctuations that the market goes through over the next few years.

The more the fluctuations, the better it will be for this strategy.

Happy investing.

Warm regards,


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