Is the equity market overheated? Analysts and market experts say valuations are stretched, but the main indices and even the broader benchmarks continue their ride upwards.
But, over the last two months, the advance-decline ratio of stocks has slipped below 1 for the month of August. This means more stocks fell than those that rose. Though you could put it down to company specific factors, the three recent Initial Public Offerings (IPOs) in August have had a negative closing on listing day.
All this doesn’t mean equities will necessarily fall. But, it is possible. Another possibility is that prices might move sideways for a long time rather than correcting or moving up sharply.
This equity rally has lasted 17 months, so it’s easy to forget what a sharp correction looks like. When such corrections do happen, we panic and react, which can be detrimental to our long-term investment portfolio. If markets correct, then here are five things which you must do.
Do not exit equities. This is easier said than done. If you own a portfolio of stocks, within a few days you may see prices correction 20-50 percent. When markets corrected in March 2020, even a 10-year mutual fund SIP showed negative returns for a few schemes. Panic sets in.
But as a recent IDFC mutual fund study showed, investors who continued their systematic investment plans (SIP) after the COVID-19 crash are now winners. The 10-year SIP returns today present a much prettier picture.
Only redeem if you need the money
You may take money off the table if you think you would need it in the next six to 12 months. This will ensure that your immediate needs are unaffected by market events.
For instance, you would have been saving up to send your children abroad for their education. If your savings are tied up in equity markets and if stocks start to fall, that can dent your corpus. Redeem the required amounts when you see markets fall. The equity market may not recover as quickly as it falls.
Invest more in equities
Be opportunistic. When markets correct, it is the best time to enter. When you invest at lower prices, you are securing potentially better returns for the future. Buying low is the best opportunity to accumulate for to your long-term portfolio. Top up your investments, whenever possible, in a market correction. You must ideally not wait till markets hit the rock bottom, because you can never really predict when the lowest levels would be touched. The best way to approach this is staggering your top-ups over a period of 4-6 months.
Do not change your asset allocation
Keep a close watch on your asset allocation. If, as per your risk tolerance, you should invest, say, Rs 70 in equities out of Rs 100, then that is what you should continue to have in equities.
If markets correct and this ratio gets altered, then restore it. Keep in mind that this change of allocation is happening as your overall portfolio value is falling. Ideally, the shift out of equity should have happened when the portfolio value was rising. Keep these safeguards in mind before fixing your asset allocation.
Sell bad stocks
One thing that a correction allows you to do is to separate the bad apples and exit them. You may exit at a loss, but if it’s a laggard stock, chances are that its price will not recover even in a subsequent rally. It’s best to book losses, which can then be set off against capital gains from other sources.