A bear market will eventually come..
In a world of uncertainty, there is one thing you can be reasonably certain –
a bear market will eventually arrive.
The next obvious question..
I don’t know.
You must be thinking this is outrageously irresponsible.
Assuming you think I am an expert (by now you must have changed your view) or I have access to a lot of other experts, I should have an answer right?
Am I hiding something..
The experts should know..
Some of the largest AMCs (Asset Management Companies) in India make profits upwards of INR 500 cr every year.
Think about it.
With that kind of money, they can hire the best talent, access the best sell side brokerages, best reports, databases, market analytics tools, softwares etc.
In fact a lot of CIOs (Chief Investment Officers), fund managers and analysts have more than 20-25 years of stock market experience.
Take a pause. 20-25 years is a very long time.
If there was a holy grail to market timing, despite all their resources and incentives why haven’t they figured it out yet?
Ok. Maybe Indian investor’s haven’t figured it out.
But the global investors must know.
Let us check that too..
Recently, Michael Cembalest, the chairman of market and investment strategy for J.P. Morgan Asset Management did something very interesting.
He put together the comments made by well known investors warning about bear markets since 2010. In fact a few of them had hero status as they had anticipated the prior bear market and recession.
While this provides enough evidence on how even the best of the best got their calls dramatically wrong, Michael went one step ahead and also calculated the performance impact of shifting $1 from the S&P 500 to the Barclays Aggregate Bond Index, measured from the week of the comment to November 8, 2019.
To be fair, eventually their predictions will come right at some point in time, but however the opportunity cost of being too early as seen above can be significant.
In fact a bear market with ~35% to 45% declines from peak levels would be needed to reverse many of the opportunity losses!
You can read the entire paper here
Now you have a rough idea on what would have happened to your investments, if you had followed the advice of some of the best brains in the world.
All this points to a simple lesson:
Timing market crashes is unbelievably difficult.
Imagine having to do this consistently over your lifetime.
Even if you think you are far smarter than the global investors or Indian fund managers, your problems don’t end in timing the crash and moving out.
You need to get back in.
This means you need to get two calls right. Getting out and getting in. And you need to do it consistently.
Now I will go back to my original answer to how to time markets?
I don’t know.
The difference this time being, now you also know the reason behind the answer.
If someone is pitching you that they have a special model to time the markets, it is time to wear your running shoes.
Eventually as the bull market progresses, you will find that everyday there is a new headline about someone who predicted the last crisis predicting that the next crisis is around the corner
Relax. You know what happened to people who listened to them.
Nobody knows exactly when the next crisis will arrive. And as long as you don’t forget that, you will be fine!
Does this mean you just buy and hold irrespective of whatever happens?
This to be honest might be a great strategy in the long run, but behaviorally this will be extremely challenging for most of us.
So while there are enough evidence on why timing is too difficult, the compromise considering we are all human is to sin a little.
Sin a Little – Call it Risk Management
Since the Indian equity market in my view is a structurally positive one (read as – in the longer run it will be directionally up) and the fact that timing a market crash is very difficult, it is better to be positive on equities majority of times.
Hence the condition to go underweight on equities (if at all you decide to do) must be very stringent.
I will personally become negative only in extreme market scenarios.
The key word here is extreme.
Now comes the million dollar question – What is an extreme overheated market scenario?
I will only go underweight when all the below four parameters fall in place
- Valuations becomes ultra-expensive
- Earnings growth over the last 5-7 years is extremely high
- Sentiment cycle – Very High FII & DII Flows, abundant speculative IPOs, new theme collecting significant money in MFs etc
- Momentum becomes negative
There are few other factors that I consider. You can also refer to the detailed framework here.
Now despite all this I maybe wrong and far too early. Hence instead of the all-in-or-all-out approach I will take the mid path solution.
If my framework indicates, going negative
- 50% of Equities will be moved to Dynamic Asset Allocation Funds – I have used DAAF instead of pure debt so that even if I panic and freeze during the expected decline, my money will automatically move back into equity markets
- Humble approach – Remaining 50% of Equity – Hold
View: Overvalued markets can continue to get overvalued, often for a long time
But as with most irrational markets it may continue to go up.
- For every 10% up move from there move additional 20% of equity allocation to DAAF
- So by the next 50% upside, entire remaining equity would have moved into DAAF
If in case the decline starts,
- 20% fall – Move 20% of Debt allocation to Equities
- 30% fall – Move 30% of Debt allocation to Equities
- 40% fall – Move 40% of Debt allocation to Equities + 50% of DAAF allocation back into equities
- 50% fall – Move 10% of Debt allocation to Equities + 50% of DAAF allocation back into equities
Eventually bring it back to original asset allocation (Equity + Debt split) as and when the valuations become expensive (irrespective of other indicators – sentiment, momentum or earnings growth)
The whole idea behind putting a framework is to ensure that even if I get lured by greed or fear (I am a human after all), sticking to these rules will help me handle the whole market cycle in a much better way especially during the bubble and bear phases.
Preferably I would suggest that you don’t do it alone. Take the help of an advisor and tell him/her that it’s their responsibility to ensure you stick to the plan come what may.
As with everything in personal finance there is nothing sacrosanct about this plan, and you along with your advisor can build your own personalized plan.
Hope you found this useful. Before you forget this post, take some time out, put together a plan, sin a little and make sure to keep it in writing.
If you need any help, mail to firstname.lastname@example.org
And as always happy investing 🙂
If you loved this post, share it with your friends and don’t forget to subscribe to the blog (1 article per week) or Twitter along with the 8000+ awesome people. Look out for some fresh, super interesting investment insights delivered straight to your inbox.
You can also check out my other articles here
Disclaimer: All blog posts are my personal views and do not reflect the views of my organization. I do not provide any investment advisory service via this blog. No content on this blog should be construed to be investment advice. You should consult a qualified financial advisor prior to making any actual investment or trading decisions. All information is a point of view, and is for educational and informational use only. The author accepts no liability for any interpretation of articles or comments on this blog being used for actual investments.