Let’s be honest – market bulls had luck on their side throughout 2017. The Indian stock market was kind enough to reward investors with windfall gains last year. When leading indices such as Nifty 50, Nifty Midcap, and Nifty Smallcap make gains of almost 30-60% in a single year, it is not difficult to imagine how much one could have made in leading stocks, i.e. stocks with top-notch fundamentals and high growth rates in top industry groups.
Long-term investors who ideally wait for a stock to give multi-bagger returns in 5-10 years would have been shocked to see similar returns in a span of just one year. Instead of talking about how much a stock had advanced in terms of percentage, people got used to communicating in terms of how much a stock has multiplied. Well, that’s how 2017 was – a year when compounders took a back seat and quick multi-baggers took the lead.
As in the game of cricket, 2017 was akin to a powerplay. Fours and sixes were common, while dot balls were rare. But, powerplays are not forever and they always come to an end. The same seems to have happened with the Indian stock market in 2018. Key indices are down more than 8% from their yearly highs, while Midcap and Smallcap indices have corrected 14% and 18%, respectively.
We believe there are four key questions troubling investors in the current environment and with this letter, we aim to answer them.
Why Markets Corrected?
There are multiple reasons that have made investors nervy in recent times. There was a global market sell-off due to rising bond yields; locally, we had ballooning fiscal deficit concerns and PSU bank frauds hurting investor sentiment; and now there are fears of a global trade war after the U.S. levied tariffs on steel and aluminium imports.
But above all, the Indian market’s stupendous rise in 2017 had to come to an end and it all started with foreign institutional investors pulling out money from India in February. FIIs pulled out a massive Rs. 18,619 crore from the Indian market, the fourth-largest amount since January 2008.
How Smart Investors Handled the Recent Correction?
Many say timing the market is impossible; however, there are certain tell-tale signs that always come in handy when looking for trend reversals. Those are distribution day for stock market tops and follow-through day for stock market bottoms.
While a lot of investors would have felt that markets were overvalued from as early as July 2017, India’s key indices kept on scaling new highs in the following six months. Markets do not correct just because a valuation metric has reached the levels of 25. Markets correct when large financial institutions begin to reduce their exposure. And that shows in the form of distribution days at the exchanges.
A decline of 0.2% or more on higher volume than the prior session is known as a distribution day. Once you see five, six or more of those happen within a few weeks, you know institutional investors are backing away from stocks, and a top is possible.
At MarketSmith India, we alerted our users with a change in market direction to Uptrend Under Pressure on February 6, 2018. Since then, the markets have remained sloppy with many leading stocks declining hard and breaching their key support levels.
What To Do Now?
Tough times never last but tough people do.
This is that kind of a situation which is surely going to test your character as an investor. Well, that’s because you will have to take some tough decisions. Consider selling stocks and raising cash, cutting your weakest ones in the portfolio quickly and watching the best plays closely for key sell signals.
While you might get disheartened seeing some of your profits wiped off, the ongoing correction will be a blessing in disguise for serious investors. Many leading stocks will make new base patterns and provide investors with an opportunity to accumulate them as and when the market goes back in an uptrend. So, this is the best time to screen for growth stocks, read about their business models, build a watchlist of strong names and pounce on them as and when things fall back in your favour. Also, this is a good time to review your past few trades and conduct a thorough post-analysis of what went wrong and learn from your mistakes. This will certainly help you in improving your investing skills.
When Will Markets Do Well Again?
When will I become a millionaire? When will I die?
Everyone wants to know the answers to those questions, but the sad truth is nobody can answer them perfectly.
The ideal thing to do right now would be to prepare and not predict.
The most difficult task in the stock markets is to do the simple things again, and again. At MarketSmith India, we will keep things simple as always. We will look for a follow-through day that will signal a shift in market sentiment. A follow-through day occurs during a market correction when a major index closes 1.5% or higher on greater volume than the previous day.
Remember, no market uptrend has begun without providing an early signal in the form of a follow-though day. Until that happens, we are happy to play the waiting game.