IL&FS fiasco: Stock markets are bleeding; what should a retail investor do now to ensure longevity in bear phase?

Back in 1986 when I cut my teeth in the financial markets, veterans told rookies to take the Churchgate–Virar evening locals to learn from the 'chatter' of fellow commuters and get a grip on the prevalent sentiments of the markets. Thanks to social media, one doesn’t need to go through that rigmarole anymore.

The second noteworthy aspect of the veterans’ training process was they advocated that a rookies training wasn’t complete till he lived through at least one (if not two) bear markets. It was believed, and rightly so, that your investing/trading acumen would display it’s strengths and weaknesses promptly in a bear phase. To that extent, understanding, anticipating and planning ahead for an impeding bearish phase is a crucial aspect of the investing/trading game.

Don Cassidy in his 1994 book, Its when you sell that counts elaborates upon the virtue of selling out at the right time, in order to ensure one’s own longevity in the financial markets.

Monitoring the social media 'chatter' however, gives me a feeling that the average retail player is not yet geared up for any decline in the markets. That makes the market a little more vulnerable as 'surprised' traders will react in a knee-jerk manner at a later date and create volatility clusters due to emotional selling, leading to what is known as a 'sell climax'.

To be able to understand what lies ahead, one needs to understand the cause that may trigger the decline to be able to gauge the effect, in a mathematical and scientific manner. In the budget of 2018, the government sent out three crucial signals to the financial markets – a) Long-term capital gains (LTCG), b) Rising interest rates and c) Raising tax exempt threshold on bank deposit interest income from Rs 10,000 per financial year to Rs 50,000 per financial year. Admittedly, this raising of the threshold five-fold applied only to assesses who were senior citizens, but again, it is this very age group which contributes a majority of bank deposits.

 IL&FS fiasco: Stock markets are bleeding; what should a retail investor do now to ensure longevity in bear phase?

Representative image. Reuters

The seeds of the next decline were sowed by making fixed income more lucrative and taxing equity investments even on long-term gains. This is likely to have a logical fallout on the asset allocation (rather, re-allocation) wherein the emphasis on fixed income will rise and equities will decline.

The raising of interest/yield on PPF, KVP and Sukanya Samriddhi Accounts will make fixed income (there are also tax benefits associated) even more attractive. Should there be further rate hikes by the Reserve Bank of India (quite likely), the asset allocation mix will get further recalibrated. This is an aspect that the average retail trader seems to be almost completely ignorant about.

Constant inflows are needed in equity markets to propel stock prices higher, combating gravity and selling pressure are additional counter forces. If you slow down the inflows into equities, the combined forces of gravity and sellers will cause a decline in financial asset values. Then people will get 'surprised'. This happens all the time.

What should you expect if and when markets decline?

Some erosion in your equity portfolio will be an immediate observation. The more high beta (volatile) stocks in your portfolio, the more vulnerable you are. Quality stocks suffer less on drawdowns in the markets

  1. Erosion in your mutual fund NAVs, especially the equity schemes. Your money is invested by the fund into stocks. Stocks decline, NAV declines. It should be a no-brainer.
  2. Your ULIP products will witness erosion in valuation too.
  3. In the 2008 downturn, investors realised to their horror that the MIPs (monthly income plans) were not guaranteed to provide monthly income. Some schemes reneged on their monthly payouts. We do not know for sure how much the markets will correct but prepare for the probability of some reduction in the payout quantum.
  4. With bond yields firming up, bond prices have fallen marginally; therefore, there will be mark-to-market notional (paper) losses to your debt funds as well. This is a natural fallout in the cyclical nature of interest rate cycles.
  5. Empirical evidence exists of a correlation between equity market declines and real estate prices softening by varying degrees.
  6. The rising interest rates will raise EMIs of borrowers, which means less disposable income in the hands of the borrower, who now will have to cut back on his investment options (direct investments, SIPs etc)

The above is merely a generic checklist. Humans evolve, behavior changes and so do market textures during and after each decline. Change is a constant in the financial markets. From sectoral rotation to the time tenure of the decline, no two falls are exactly the same. The investor/ trader must be constantly learning lessons from the markets. So should you be intimidated by any future decline in asset prices? Far from it, accept it as a matter of routine, plan ahead and take preemptive steps to safeguard yourself. There is no point in blaming the markets, the economy or any other factor. Markets rise, they fall. That is the nature of this beast. The player who adapts himself to these rhythmic movements comes up ahead of the overall herd.

Pulling out completely from the markets doesn’t make sense. Remember, ships are safest in the harbor but that’s not what they are built for. The key to your success in the investing game is asset allocation. Shuffle your money when it is time to change the investment mix. It pays to think mathematically rather than emotionally. Emotions might just freeze your responses like a deer in a car's headlights on a highway. Don Cassidy cautions us against such a pitfall in his book. Lesson learnt. Have a profitable day.

(The writer heads Bhambwani Securities Pvt Ltd and is the author of 'A Traders Guide to Indian Commodity Markets')

Updated Date: Sep 26, 2018 11:47:41 IST