How to Approach the Current Equity Market Decline?

Stay calm – goes the usual advice.

If I put a gun to your head and then say “Stay calm or I will shoot you”, do you think you will be more calm now?

First simple point – If you are anxious and worried, this is perfectly normal.

The last few weeks have been extremely volatile, and it is tough for all of us.

When it comes to investing, a significant chunk of our lifetime investment returns will be driven by the decisions we take on a select few days.

The next few weeks might include a few of those days. A few hasty decisions in panic can have long term repercussions on our future goals.

So while no doubt these are tough times, all of us need to have a plan to approach the current markets.

While I have no clue on how long this will prolong or how deep the correction would be, here is my approach to handle the current scenario.

This framework is called the B.U.R.R.P framework.

1. BELIEF in Equities

Despite all this Corona Virus, Oil crash, US market volatility etc my mom who is a real estate and gold investor has absolutely no worries whatsoever on what will happen to her assets because of this.

Her only worry is about corona virus impacting one of us.

Reason – Belief.

Her belief is that in the long run Real Estate and Gold will do well.

If you are an equity investor wanting to have a good long term experience, fundamentally it has to start with this. Belief.

Belief in Entrepreneurship, Resilience, Innovation and Ingenuity of humans.

Belief that Indian equities will do well over the long run (provided you are not entering at insane valuations)

Soon enough, you will find enough data points to scare you such as – what happened to equity markets in Japan etc

While I can bore you with data, if you are not convinced intuitively on the future of entrepreneurship, then you should not be in this asset class.

Once you agree on this basic belief, that Indian equities will do well over the long run, let us translate this into something more concrete.

Sensex @ 1 lakh by the year 2028 to 2030

While I don’t predict, I will obviously have to build some reasonable long term expectations (based on history) without which I won’t have the conviction to invest and stick to equities.

You can find a detailed explanation of the thought process here

Let us move on to the second requirement..

2.UNPREDICTABLE – ‘No one Knows’

If you go back two months and look at Yearly Outlook reports provided by various investment firms, nowhere do you find the mention of Corona Virus.

Here is the google search trend for Corona virus

Simple truth – ‘the world is a complex place’. There are too many ‘unknown unknowns’.

As seen above, it is impossible to predict the markets in the short run, as they are driven by literally hundreds of variables and these variables keep changing every now and then.

Even if you end up predicting these variables right, you will also need to predict how millions of investors with different perspectives, goals, risk appetite and time frames react.

The more you think about it, you realize the humble fact that no one can predict the stock markets in the short term.

However, in the long run stock market returns mirror earnings growth (provided you haven’t entered at insane valuations) and hence it is better to build long term expectations instead.

If you are not convinced by the ‘no one knows’ argument, then you will end up listening to some expert out there who will take an extreme market crash view.

You will move out only to realize it is unbelievably difficult to get back in as

  1. Bear markets have several false upsides and the recovery phase has several false downsides constantly keeping you confused
  2. The best and worst days occur very close to each other
  3. The recovery phase is extremely fast – first 1-3 months captures a significant chunk of the recovery

So this is the time, where you need to take a stance on both ‘Belief in Equities’ and ‘No one can predict’ argument.

If you don’t buy this, then you can skip this article right away.

But if you think the above two makes logical sense to you, here is an approach that is a result of the above thinking.

Since we can’t predict a precise outcome (which we will only know in hindsight), we need to start preparing for a range of outcomes.

How do we do this?

3.RISK vs RETURN

There are three types of risks you don’t want to get caught into, in a bear market

  1. Valuation Risk
  2. Business/Earnings Risk
  3. Balance Sheet Risk/Leverage Risk

As our belief in long term equities holds, we need to ensure the valuations aren’t exorbitant. A 20% correction from a very expensive market will still make it move only from ‘outrageously expensive’ to ‘expensive’.

So let us check the valuations..

Valuations post the 20-25% decline has become very attractive (they weren’t extremely expensive to begin with as per my framework) –
MCAP to GDP < 60%, TTM PE ratio at 19.4 times, Price to book at 2.4 times. PAT/GDP at multiyear lows again indicating we are close to the bottom of earnings cycle.

Any decently managed well diversified fund with an experienced fund manager can solve for the remaining two issues.

So overall, the current valuations are set up for providing above average future returns from these levels. We need to invest more in equities at these levels.

4.REGRET Minimization

Now that we have our Belief in Long Term Equities and Reasonable Valuations coming together, how do we address the issue that no one knows the answer to – how much deeper can this fall extend and how much longer.

This where we take the approach of ‘regret minimization’

We know that from today’s levels our odds of a good return over the next 3-5 years is significantly high.

But if we deploy the entire amount (earmarked from new money or debt portion to make use of this opportunity), what happens if markets fall further. We are then left with the regret of having bought too early.

If we don’t invest and wait for a further fall, then if the markets suddenly rally, we are left with the regret of not buying at lower levels.

So the idea is to take a measured approach and incrementally deploy as markets fall. In this way, if the markets suddenly rally, at least we have some portion deployed, and if markets fall further we have cash to deploy.

Overall, the idea is to manage for our ‘regrets’ rather than trying to predict a precise outcome.

5.PLAN – ‘Triple W Plan’

The biggest issue during a market fall is that each and every day there is some news flow (either positive or negative) and market moves are usually significant. If unprepared, then every day, every hour, every minute might seem like there needs to be a decision made.

By now, given the current market volatility you must have realized this..

Deciding when to decide is often as important as deciding how to decide.

So personally I have reduced the no of decisions to make and have pre-loaded a ‘If-Then’ decision plan which includes ‘when’ to decide.

This plan addresses three important questions (Triple W Plan)

W – When to decide

W – What % to allocate to Equities (from extra cash or debt allocation)

W – Where to invest (fund choice)

Before you think it’s a very complex plan, this is all it takes

  1. If markets fall 20% then I will:
  2. If markets fall 30% then I will:
  3. If markets fall 40% then I will:
  4. If markets fall 50% then I will:

You can customize the levels and actions based on your preferences. The key is not to get bogged down by ‘precision’ but to have an approximate decent plan that you can stick to.

For those interested you can check the detailed thought process here:

  • What if things go wrong plan – Link
  • Three ways to make sure this stock market correction is not wasted – Link

Parting Thoughts

Let me be clear. I ain’t a market veteran and don’t have everything figured out.

The idea of putting a framework is to bring the focus back into things I can ‘control’.

Also eventually after the market recovers, I can go back to the framework and evolve it based on the outcome.

I still have to invest for around 50-60 years. And I expect to see several such declines in my lifetime.

If things work out as per plan (historically it has worked out great), then I can use the same approach to handle other declines. If not, then I can find out where I went wrong, improve this further, and be better prepared for the next one.

I would love to hear your feedback at rarun86@gmail.com – critical or nice ones – both are welcome:)

Hope this thought process was of some help.

As always, Happy Investing Folks!

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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.

8 thoughts on “How to Approach the Current Equity Market Decline?

  1. Hi Arun!

    Thanx for the nice post! Affirms my belief in equity market. Ups and downs are part of life.

    One suggestion: I noticed I’m getting your entire post in my email. It’s good that I can read your fresh post in mail but it also means that ‘I do not have to visit your website!’

    You may consider making necessary changes in your WP Dashboard>Reading settings. Just a click and your post snapshot will be delivered to your subscribers, and they’ll have to click in the given link to come to your website, and they might read more articles!

    That’s all.

    Like

  2. Absolutely right analysis of the current pandemic and it’s economic fallout.
    No need to worry.
    Someone asked me what to do with Yes Bank shares (on the day, it touched some sub-six rupees a piece). I said whatever has happened, has already happened. You can’t undo the past.
    So the question is “what next”.
    You have given a very right framework of working, analyzing, understanding and taking a future oriented decision with the core philosophy of having belief that equities give superior return over long run.

    Like

  3. The belief is where people falter the most IMHO. We expect real estate and gold to be long term asset classes, while look at equity as a quick buck opportunity. While there is quick money opportunities, the risk is also tremendous; learned it the hard way in the 2008 crash and 2015 downtrend. This time not shorting, not trading. Just keep adding to the portfolio directly or through MFs is the plan. Thanks for this!

    Next step is to understand the art of identifying valuation. That should be top on my reading list

    Like

  4. Great post Arun ! Completely agree.

    My cent (no more ‘two cent’ view..my portfolio is cut in half) on this subject that may add to your sound framework.Its more of a behavioral POV…these are behavioral times.

    ‘Belief’ is the third step.First step is ‘Hope’.Keep the hope floating (if shit can float..so can hope..pardon my language) that we will emerge with minimal life & financial loss from virus earthquake which will be followed by economic tsunami.

    Before we take the third step unto concrete ‘Belief’,we have to take the courageous next step unto the second.. ‘Faith’… as you rightly pointed out..faith in human ingenuity and resilience.

    To 8000+ readers..keep your heads above water..stay safe..TC

    Like

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