"As volatile as the stock market" is a popular expression in the English language. Historically, stock markets have been the most volatile among financial markets but since April 2020, except for some mild volatility in January 2021, markets globally have been surprisingly stable. What explains this stability? How long will it last? Is a major correction imminent? How should investors prepare for it?
The ongoing bull run, which has taken the Nifty from below 7,600 at the end of March 2020 to above 17,400 in September 2021, is similar to the one in 2003-07. It took the Sensex from around 3,000 in May 2003 to above 20,000 in December 2007 but the market went through many sharp corrections during the period.
If we take the period from 2006 to 2020, markets have corrected by more than 10 percent on 17 occasions, which is more than one correction of above 10 percent on an average a year. Such sharp corrections are typical of markets.
It is coming
This bull run, too, will experience sharp corrections. It is difficult, almost impossible, to predict the timing of market movements. But some probabilities can be anticipated.
Without doubt, markets are richly valued and cannot go on accelerating like a vehicle in a one-way street. So, what are the likely triggers for a sharp correction?
Foreign portfolio investor (FPI), unlike retail investment, is “smart money”. FPIs who have been net sellers in the cash market since July appear sceptical about the market valuations. Even though individual investors account for around 45 percent of cash market turnover on the exchanges now against 11 percent for FPIs, the latter holds 27.4 percent of Indian stocks against 8.1 percent held by individual investors and 7.9 percent held by DIIs.
The exuberance and domination of retail investors has played an important role in the ongoing rally. But the experience of 2000 and 2008 tells us that this can change.
There is a high probability of FPIs turning big sellers when the market mood turns negative. This negative turn for the market may emerge when the Fed announces tapering this year-end or if inflation in the US spikes sharply, pushing the bond yields up. A big shift of capital from equity to bonds is inevitable, particularly since stocks are overvalued.
When FPIs sell, initially retail investors may again jump in to buy as they have been doing since last April. But when the selling persists and becomes larger, corrections can be swift and sharp. There is a likelihood of retail investors panicking and leaving the market as they did in 2000 and 2008. Mutual fund redemptions that happen in such phases can add to the distress.
Do the prep
This is one probability. The actual trigger for a correction may come from a presently unknown factor. Whatever might be the trigger, investors should be prepared for a correction, even while remaining invested in this ferocious bull market.
Sticking to quality large-caps, occasional partial profit booking and moving some money to fixed income should be the essential ingredients of a balanced investment strategy now.
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