With the sharp fall in the markets in last few days, once again stock markets are talk of the town. Investors are discussing the reasons for fall and trying to find answers of two questions. First, what was the exact cause of this sharp fall in the stock market? And second is how much will markets fall further from here?
Let me tell you that both these questions cannot be actually answered ; reason is very simple, answer of both these questions depend upon different global and National Macro economic factors and their correlation with each other and it is difficult or I would say impossible to predict functioning of these factors with preciseness. Let us discuss this first and then we will discuss what strategy should be adopted by a rational smart investor?
Global & National Macro Economic Factors and their Correlation: Macro Economics is the branch of Economics which studies Economics at larger level, i.e. at country level and at global level. And Macro Economic Factors are factors affecting larger economy, economy at country level and global level. Few examples are inflation, currency fluctuations, interest rates, commodity prices (oil, gold etc) etc. There are large number of such macroeconomic factors which are affecting economy as a whole. So, when we try to analyze the exact cause of such Sharpe falls in Equity market, we actually try to analyze functioning of these Macro Economic Factors and their effect on economy. Like if you observe in this current fall we are trying to analyze what are the exact reasons for this fall. Some experts are saying that this fall is due to fall in global markets and Chinese markets, some are saying that this is due to Dollar appreciating against rupees, some are saying that it is due to crash in crude oil prices. But actually it is result of all different macro economic factors which are functioning together and we cannot exactly and precisely understand which factor affected how much? When I listen to different economic experts or fund managers on this topic, everyone has some different view on this. Some consider Dollar Strengthening a primary reason, some consider fall in the Chinese markets as primary reason. So we are actually wasting our time and energy on analyzing something which actually cannot be done precisely.
Can we predict where will markets go from here?
Now, when we know we cannot analyze why markets have fallen? The question is Why we try to find exact reasons for the same? The answer is we want to predict how much markets will fall exactly ? so that we can find the bottom of the market and invest in that bottom. So first of all every investor should understand that as it is not possible to predict markets and find the bottom of markets or top of the markets. Trying to predict the markets and then investing according to market predictions is primarily trying to time the markets. Timing the markets is not possible so please don’t waste your time and energy on the same.
What should you do now?
Now, What should investors do in this type of falling markets where there is lots of uncertainty in global economy? To get the exact answer first please understand following points.
Fall in the Market doesn’t mean fall in Real Economy or Economic Activity : Always remember that fall in the markets does not necessarily mean fall in the real economic activity of the country. For example on 24th August Indian equity markets had fallen by around 6% so my question is whether economic activity of the country and profits of the Indian companies went down by 6% on One single day? Or in 2008-09 equity markets fall by around 60% so was economic activity in India down by around 60% or profits of Indian Company went down by 60%? Similarly in 2007, markets had gone up by around 60% so Was Economic activity in the country or profits of Indian companies up by 60%? The answer is No. Over a short term markets fall due to news, views and sentimental reactions of investors to events.
The father of value investing, Benjamin Graham, explained this concept by saying that in the short run, the market is like a voting machine–tallying up which companies are popular and unpopular. But in the long run, the market is like a weighing machine–assessing the substance of a company. The message is clear: when sentiments are good most of market participants start buying without understanding fundamental and markets go up over short term because of their buying vice versa when news and sentiments are not good most of the participant start selling so markets fall sharply but this has nothing to do over long term fundamental of economy. What matters in the long run is a economy’s actual underlying business performance and not the investing public’s fickle opinion about its prospects in the short run
Don’t be Fear full or Greedy: Get out of emotions of fear and greed and start thinking rationally. In above paragraph we saw that if markets have fallen by 60%, real economy has not fallen by 60% and if markets had gone up by 60% in a year, real economy had not gone up by 60% in a year so don’t be fearful or greedy be rational. Most of the wrong decisions are taken when you are fearful or greedy.
Focus on Asset Allocation & Strategic Management: Rather than focusing on news, views and market predictions, Investors should put their focus on their own Asset allocation. They should see what is their own asset allocation? And, what should be their strategy for re balancing their asset allocation? to understand asset allocation in detail you can read one of my articles on Asset Allocation & Re balancing Click here to read. If you have decided to keep 50% equity allocation and that has fallen significantly then you should see what was your portfolio re balancing strategy? Whether you were to re balance on a regular frequency or do a trigger based re balancing? Whatever strategy is being adopted, investor’s should stick to it and with every sharp fall follow that strategy and not news, views or market predictions.
Don’t Jump to Buy Equities at one go: One point that every investor should always remember is don’t jump at one stroke to buy the equities because markets have fallen significantly and someone is saying they have bottomed out. Just follow your asset allocation because markets can fall sharply from here also and in that condition you will find it difficult to invest further. So don’t think that markets are bottomed out and let me invest everything in equities now. Always live with a thought that markets may fall from here or go up from here but you should be prepared for all kind of market movements psychologically & strategically.
To conclude with rather than getting confused I would recommend to follow your own asset allocation and re balancing strategy and don’t take any actions in hurry.