What goes wrong when you exit equities hoping to reenter later at lower levels?

July 28, 2022 . Arun Kumar

This article was originally published in LiveMint. Click here to read it.

Indian equity markets have declined in the last few months led by several concerns – high inflation across the world, global central banks and RBI increasing interest rates, Russia-Ukraine crisis, high crude oil prices, China lockdowns, supply chain constraints, high FII outflows from Indian Equities etc. 

Given the recent market fall and several uncertainties, it is natural for a lot of us to extrapolate the current fall and worry that the fall may continue. There is a strong natural temptation to exit equities now with the intent of entering back later at lower levels. 

While this approach seems logical, unfortunately, there are some counterintuitive patterns (read as traps) that occur in a market fall which make entering back into the markets extremely difficult once you have sold out. 

Here are the five counterintuitive patterns to watch out for. 

Counter-Intuitive Pattern 1: Equity market recoveries usually happen in the middle of bad news

Timing the entry back is difficult because history shows us that stock markets typically hit their bottom before the worst news arrives. The recent Covid 2020 crash was a classic case where the Indian markets rallied by 40% before the actual covid cases peaked in the first wave. This is a pattern seen across most bear market recoveries both in India and around the world.

Counter-Intuitive Pattern 2: Market decline has several false upside rallies and the actual recovery also has several false declines

There are a lot of false upside rallies in the middle of a market fall. Once you experience several false upside rallies in the middle of a market fall and add to it the continuing bad news, there is a high likelihood that you may dismiss the actual recovery as yet another false upside rally. To make things more confusing, even the actual recovery has a lot of false intermittent declines. As a result, it is very difficult to distinguish between the real recovery and the false upside rally.

Counter-Intuitive Pattern 3: Recovery is usually extremely fast – the first few months capture most of the rally.

Waiting for a few months (say 6 months) to confirm a recovery (vs a false upside) also does not work well as most of the times the initial recovery rally is extremely fast. Sample this – Sensex gained 85% in 3 months during the 2009 recovery.

Counter-Intuitive Pattern 4: We get psychologically anchored to the bottom levels

Once you miss the market bottom, you generally get psychologically anchored to the bottom levels and it’s behaviorally challenging to enter back at higher levels.

Counter-Intuitive Pattern 5: No one can predict the markets in the short run

Even the best market experts can’t exactly predict the timing of a market recovery on a consistent basis. There are several evolving factors that impact the markets in the short run and it’s difficult to predict how millions of investors are going to react to that. If you plan to wait for your favorite market expert to let you know when to enter back, this may not be a great idea. 

Overall, while it’s easy to move out, these 5 counterintuitive patterns along with the fact that it’s difficult to predict short term market movements consistently make it extremely difficult to time your entry back if you exit now. 

A temporary fall while no doubt painful, is the emotional fees that equity investors need to pay for long term superior returns. As we mature, our approach to market falls becomes one of acceptance rather than denial. 

The best course of action will be to stick to your original plan i.e your asset allocation between equity, debt and gold. If the market fall continues keep rebalancing back to your original asset allocation (i.e increase equity and reduce debt/gold) at regular predetermined intervals.

The boring but proven mindset necessary for successful investing remain the same – stay patient (at least 7 year time horizon), be humble (do not try to time the market), be prepared (to endure temporary market falls) and remain optimistic for the long term (faith in human ingenuity). 

1 thought on “What goes wrong when you exit equities hoping to reenter later at lower levels?

  1. Well written & convincing article. What if my fund has been underperforming compared to peers for the last 6 months or so – even though it was a 5 star rated fund when the SIPs started. Now SIPs have been stopped since the fund has been rated 3 star. Is it better to redeem the accumulation & reinvest in a liquid fund & use that for re-entering the equity funds through systematic transfer plan? Or, should I have faith on the once 5 star rated plan & hold the investment till market recovers? Or, keep the SIPs going to take advantage of cost averaging during the market downturn.

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