Why is the equity market falling and what should investors do

The equity market has been volatile over the past few weeks. From its all-time high of 18,600 in mid-October 2021, the Nifty has corrected by more than 1,600 points closing November 2021 below the psychological 17,000 mark. The broader market also saw deep cuts. Nifty Midcap 150 index fell by 9% from its all-time high, while the Nifty Small Cap 250 index by 8%. Volatility can be stressful, especially for new investors.

In this blog post, we will discuss what you should do in volatile markets. In our view, informed investors are always better positioned to make better investment decisions. If you understand what is going on and why it is happening, you will be better prepared to deal with the risks and capitalize on opportunities as and when they arise.

Why is the market falling?

There are several reasons why the market is showing nervousness. These reasons are also somewhat interrelated:-

• Rising COVID infections and hospitalizations in some regions of the world is making markets nervous. The situation in some parts of the United States is a cause of concern. The highly infectious COVID strain Omicron, which may partly resistant to the existing vaccines is a major risk factor for the market.
  
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• High global commodity process is also a cause of concern. Central banks around the world, including the RBI are still keeping interest rates low, but the market fears that persistently high inflation may force the central banks’ hands. Though several diplomatic efforts have been made to persuade OPEC countries to increase crude production, the effort have not yet borne fruit and crude prices continue to be high.


• Given concerns about inflation and future COVID waves, the market is also worried about how the US Federal Reserve’s tapering of bond purchase program will play out. The market has discounted a gradual and orderly taper by the Fed. However, if the Fed ends its stimulus too early before the US economy recovers, it will be a negative for the equity market.


• The Nifty had rallied 55% in the 12 months preceding this recent correction. Valuations became stretched as the rally in stock prices outpaced earnings growth. Given the high valuations, a 9 – 10% correction seems to be normal and not necessarily, a precursor to a bear market.

What should investors expect?

You should understand that the recent correction is primarily due to uncertainty caused by the above factors. The market will be closely following the information provided by scientists on the Omicron strain. The US President has said that it will take at least 2 weeks to get definitive data on the Omicron. It may take a few more weeks to get further clarity on the virus strain and its potential impact.

People do not like uncertainty. In uncertain situations, Foreign Institutional Investors (FIIs) may shift their asset allocation from emerging market equities to safe assets like US Treasury Bonds. So investors should be prepared for volatility. Once the market has more clarity on what to expect going forward, it will take a definitive direction.

Related read: What should you do when the stock market is at high level?

Short term versus long term outlook

In the short term, the market will try to assess the economic impact of another COVID wave. The market will react to information as it comes; there is no need to read too much in short term market movements, either move up or move down. You should expect the market to be volatile with downward bias because when risk aversion sets in the market, risk factors often get exaggerated in prices. With the holiday season approaching, market should be trading will thinner volumes in the last two weeks of December. You should be patient during this time and not make hasty decisions.

The long term outlook is positive. Our economy is a domestic demand driven economy. After a difficult FY 2020-21, the Indian economy is showing clear signs of recovery. The Q2 (July to September 2021) GDP growth was 8.4% (source: Ministry of Statistics & Programme Implementation), compared to 7.4% contraction over the same period in the last fiscal year. The earnings growth outlook is also positive. The festive season sales were very encouraging. With the reopening of services sector after the COVID related restrictions, we may see good sales in the holiday season. The recent correction along with higher earnings growth in coming quarters will provide a good platform for Indian equities from a medium to long term perspective.

What should you do?

• Do not panic if the market falls: Most investors do not like to see losses, but you should understand that equity, as an asset class is volatile. We have seen 10 – 20% corrections even in strong bull markets e.g. 2004 – 2008. A deep correction, like the one we saw in March 2020, may be an opportune time for tactical investments in equity. However, you need to have long horizons for investments made in deep corrections.


• Do not listen to rumours: Rumours abound in uncertain times. Do not believe in rumours, even if you have heard a rumour from multiple sources. Get your information from credible sources like the Government, RBI, WHO, ICMR, reputed media agencies etc. Social media has invaded our lives, but you must not make investment decisions based on what you read on social media. You should attempt to verify any information before acting on it.


• Do not give in to herd instincts: Herd mentality is typical in behavioural finance. We feel comfortable following what our colleagues, friends and relatives are doing. But just because many of your acquaintances have done something, it may not be the right thing to do. On the contrary, herd mentality may cause a lot of harm to your financial interest.Being patient in uncertain and volatile markets is one of the best investment virtues.


• Do not try bottom fishing: Some adventurous investors try bottom fishing in corrections. You may get tips that such and such stocks are trading at rock bottom prices and will give multi-bagger returns. Avoid such tips, unless you have sufficient knowledge about stocks. These can be very risky investments. Stick to mutual funds, which invest in a diversified portfolio of stocks, which are well researched by a professional fund manager.


• Stick to your financial plan: This is perhaps the most important advice in volatile markets. If you are a long term investor, do you remember the last time when the market fell 10 – 20%? What was the impact on your portfolio? Markets may move up or down, but your long term financial goals will not change. You need to be disciplined and invest for your long term goals irrespective of market movements.
  
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• Be disciplined in your SIPs: Stopping SIPs in volatile market is an emotional reaction and will ultimately harm your financial interest. Continuing your SIPs will not only keep you on track of your financial goals; you will also benefit from market volatility through Rupee Cost Averaging.


• Focus on asset allocation: You should not wait for corrections to look at asset allocation, but corrections provide an opportunity to look at your asset allocation. Asset rebalancing is an important part of asset allocation. You should rebalance your portfolio from time to time to bring it back to your target asset allocation. By rebalancing your asset allocation on a regular basis you can reduce downside risk and improve risk adjusted returns.
  
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• Engage with your financial advisor: In bull markets everything seems hunky dory but you may need some hand-holding in uncertain situations. Your financial advisor can be of help in such situations. Do not expect your financial advisor to have answers to all your questions, but your advisor may have dealt with similar situations in the past. Engaging with your financial advisor, may help you keep disciplined and better informed in volatile markets.

Conclusion

We have been through many uncertainties over the past two years or so, since the outbreak of COVID-19 pandemic. At present, the equity market is going through another period of uncertainty and only time will tell, in which direction we are headed after this in the short term. But your long term goals, as well as the long term prospects of Indian equities remain unchanged.

In this blog post, we have discussed what is causing volatility in the equity market and what to expect. We also discussed what you should in such situations based on our experience with volatile markets in the past. Patience and discipline will be your best friend in such markets. Also, as mentioned in this post, engaging with your financial advisor may help you tide over this volatile market and work towards your long term financial well-being.