Before I start, let me assure you this – you are not the only one who is thinking about a stock market correction.

In fact, my sense is that the number of investors waiting on sidelines or those who have built a portfolio to benefit from a stock market correction far exceeds long-term investors.

Thanks to technology and news even the most ignorant of all investors have become aware of the average long term price earnings multiple of the Nifty and where it currently stands.

And yet . . . . .

Those who found Nifty to be overvalued at 8000 jumped right back in when it hit 9000.  At 10000, things again looked overvalued and their story may well have repeated at 11000. Naturally, if you had stayed invested (or if you start today and stay invested), you will beat everyone who finds the market over or under-valued from time to time. I know what you are thinking, “you don’t want to overpay for stocks”, and hence you will stay away. More on this later.

I was 24 and fresh out of law school when I made my first stock purchase in ITC. Within days I sold what I had bought at a fairly good profit. Since then, I have bought the very same stock over and over again. It has compounded over 20% in the last 15 years. It took me a few cycles to realize that every bull market is different and so is every crash. I witnessed the 2008 crash and hoped that the next time something like this will happen, I will make the most of it. Unfortunately for me, 2008 did not happen again. I did however see a few minor stock market corrections of 10 – 15% since 2008 but these were way too small to witness any significant sector rotation.

Sentiment . . . 

Of course no one can predict when markets will crash or rally. I know top fund managers who were negative on the markets when Nifty was at 8000. Since then nothing has changed so dramatically so as for them to be so positive on the markets; other than the fact that the Nifty has hit 11000. The sentiment has been super bullish given the immense liquidity for the past 2 years.

Over the past 2 months however, sentiment is turning bearish again; but sentiment is sentiment, who knows what the government announces in an election year to get investors excited once again.

The truth is that sentiment can keep the markets bullish or bearish for a really long time. Sentiment can be used well to make very good returns, not by getting in and out of markets, but by staying invested. I will explain why . . .

When markets fall, they bounce back fast

What I have done with ITC since I started has made me realize one thing, If I had held on to my ITC shares, I would have made far higher return than I ever did by buying and selling. Not only is it difficult to predict when the market will correct, there is an ever crazier thing that happens when markets fall:

Look at every time the markets have fallen by over 20% and you will notice one thing in common – they bounce back close to their previous highs in a short span of time, even if they take much longer to rise beyond their previous highs. I wonder why this should be of any concern to someone looking to invest for a long term. Even if markets were to crash 20% tomorrow so long as they were going to bounce back by 20% over the next 1 year, how does it affect the life of an investor?

A word on sector rotation

While it is true that markets rise back to their previous highs after a crash, sectors that pull the market down HARDLY EVER pull the markets back up after a crash.

I vividly remember the 2008 crash when Sensex fell from 21000 to below 9000. From the bottom it bounced back to over 20000 level in less than 1 year. But here are some interesting things that happened:

BSE Reality Index that started above 7000 points at the beginning of the year 2008 never really recovered. In fact, even 10 years down, today it is still trading at 2200 (despite all the stock rotations made by the index management committee). Now imagine what would have happened to investors in stocks like DLF and Unitech back then. Just for fun, check price performance of these market leading counters back in those years.

BSE FMCG Index stood at ~ 2400 points at the beginning of the year 2008. Post the crash and subsequent recovery, BSE FMCG Index stood at 2900 points in January of 2010. That’s an average appreciation of 11% each year. This was a 24 month period where broader markets fell over 60% and bounced back ~ 55%. So while the markets remained where they were, those who invested in FMCG before the beginning of the biggest percentage crash, made 11% p.a. return. Today the BSE FMCG Index is at over 11000 points.

BSE Bank Index shot from 7454 points to 10,200 points from pre-correction level of January 2008 to post recovery level of January 2010. An average appreciation of over 18% each year. Today the BSE Bank Index is trading near 30000 points.

stock-market-correction-sector-indices

As a side note for those who remember 2008 well – No. There was no problem with the financial system in India back then. NPA’s were an abbreviation for something not many knew about.

You will find plenty of examples of sector wise corrections and appreciation in the markets whenever there is a crash. In fact, great money can be made by just making sure that (i) you always stay invested in stocks, and (ii) stay invested in the right sectors, where you see value preferably because of potential growth and not based on historic valuations.

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While 2008 kind of crash will not happen again, we will see many smaller corrections over the next 10 years. Every such correction will give an opportunity to earn higher than market return. However, what is of prime importance is to make sure that you are invested in the right stock/ sectors. Anyone investing and leaving money for long in these markets will be proud of what they will own in a few years, provided they are leaving money at the right place and have the right advisor looking after it.  Anyone selling and taking money away from these markets will feel silly after a few years.