There is a lot going on in the world – crude oil price volatility, Fed rate hikes, global inflation concerns, surge in commodity prices, Covid outbreak in China etc.
And we have entered week five of the Russia-Ukraine conflict.
Simply put, the news is bad.
Now it’s intuitive to think that the best option is to exit or postpone our equity investments (as it feels like markets may fall) and enter back later at lower levels when the situation improves (and feels like markets will recover).
However, there is a small problem with this approach…
It’s not as easy as it sounds!
In fact, in the 400+ years of stock market history, no one has been able to develop a strategy or model that can consistently exit equities at the market peak and re-enter the bottom.
But the key question for us is…
Why is it difficult to exit at higher levels and enter later at lower levels?
Simple. To get this right, you actually need two decisions to go your way
- You have to sell at the right time (before a market fall)
- You have to re-enter at the right time (before the market recovers)
Even if you somehow manage to exit before a market fall, getting back into equities at lower levels is incredibly hard.
This is because stock market recoveries do not always wait until things get better.
More often than not, the recovery begins in anticipation that the situation will improve!
This makes it extremely difficult to predict when the market recovery will start.
Let us try to understand this with the help of the 2020 Coronavirus crash. Here’s how the pandemic played out in case you had forgotten.
31-Jan-20: India records its first case of Covid-19
11-Mar-20: WHO declares Covid-19 a pandemic
12-Mar-20: India records first Covid death
25-Mar-20: India under lockdown
Apr-20 to May-20: Coronavirus tally races ahead…
Jun-20: Heightened tensions between India and China
Sep-20 to Dec-20: Cases surge in India and around the world
Mar-21: After a few months of decline, Covid cases spike again…
Apr-21 to Jun-21: India grapples with a brutal second wave
Jul-21: The delta variant leaves a devastating impact…
Jan-22: The third wave had lower impact thanks to vaccinations
Now that we have reviewed the timeline, let’s see when the market bottomed.
Here comes the shocker – Sensex declined 38% during the Covid induced sell-off and started to recover from 23-March-2020.
To put this into perspective, the equity market began its recovery even before the country went into a full lockdown (the lockdown began on 25-Mar-2020)!
The recovery and the subsequent rally continued even when the country was reeling under the pandemic.
During the brutal second wave (Mar-21 to Jun-21), the Sensex recorded a maximum decline of just 9%.
Here comes the paradox.
Even if you had every information on how the Covid pandemic would have unfolded, there is no way you could have predicted the sharp fall and recovery/rally.
We can be certain of market bottoms only in hindsight. It is fairly easy to attach logic and a neat narrative to past market bottoms when looking back but it is almost impossible to predict them in real-time.
Takeaway 1: Equity markets usually recover much ahead of the actual economic recovery and in the middle of bad news
Okay, but what if you ignore the news and instead try to enter back only after the markets start rising?
This again is difficult because markets rarely move in a linear manner.
There can be several false upsides during a market correction. For instance, during the Covid crash, there were three instances of market recovery which in hindsight turned out to be short-lived.
The same is true for market recoveries – multiple false downsides can happen during a recovery. Any of the four intermittent declines seen during the market recovery would have looked like the start of another huge crash.
Again, all these are known only in hindsight!
Takeaway 2: There can be several false recoveries during a fall and several false declines during a rally
Further, the market recovery when it happens can be really sharp. For instance, in a matter of just 1 month from the market bottom (23-Mar-20), the Sensex gained a whopping 23%!
Takeaway 3: Recoveries can sometimes be extremely fast. A small delay in entering back and you run the risk of missing a large part of the recovery – which can prove to be costly.
Would the experts be able to predict and help us time the markets?
Let us take a look at some of the market predictions.
These are knowledgeable experts with access to great talent, sophisticated softwares, extensive data and tools to analyze market movements. All of them had a logical rationale to back their predictions.
However, their predictions could not have been more wrong.
This is yet another humble reminder that predicting and timing the markets is almost close to impossible.
So, when you hear market experts making doomsday predictions, the best thing is to follow legendary fund manager Peter Lynch’s advice:
“When it comes to predicting the market, the important skill here is not listening.
Takeaway 4: Even the experts can’t predict!
Summing it up
Exiting equities and re-entering at the market bottom is easier said than done as
- Equity markets usually recover much ahead of the actual economic recovery and in the middle of bad news
- There can be several false recoveries during a fall and several false declines during a rally
- Recoveries can sometimes be extremely fast. A small delay in entering back and you run the risk of missing a large part of the recovery – which can prove to be costly.
- Even the Experts can’t predict!
The better approach for volatile markets would be to keep it simple
- Stay invested as per your original asset allocation – rebalance if equity allocation deviates more than +/-5%
- Continue your SIPs/STPs to take advantage of lower prices
- Activate your Crisis Plan – if market corrects more than 20%