Investors will have to suffer downsides if they want to see returns
Investing in bear markets requires three traits. The first trait in order of rank is to bear downside risk. The second trait is to think ahead and the third trait is conviction. Investors having two out of three of these traits can also invest in bear markets, but of that bearing downside risk is of primary importance.
Bearing downside risk
Downside risk is the risk of your investments losing money due to depreciation in value. In bear markets investing in equities will have downside risk. The risk varies with the security. The index (Nifty or Sensex) will have the least risk followed by large cap stocks, mid cap stocks and small cap stocks. The levels of equities in bear markets may look good in terms of many factors including valuations, however every level will be tested by the market. For example Nifty may have looked good at 5500, 5300,5000 and 4700. Investors buying into the Nifty at 5500 with a long term point of view will hesitate to buy the Nifty at 4700 as they have already seen depreciation of 15% on their investments. The 15% depreciation is the downside risk the investor is taking when investing in the Nifty at 5500.
Investors unfortunately do not see it that way. The look at it as instead of making money they have lost money and that prevents them from staying invested or investing further sums of money at lower levels. It is a common investor trait and has no rational attached to it. No investment will make money from day one. Markets by nature are volatile and there will be upsides and downsides. In bear markets, investors will have to suffer downside risk when they buy and in bull markets investors will have to suffer upside risk when they sell. Hence investing in today’s markets with the Nifty at 4800 levels and the Sensex at 16,000 levels with return expectations of over 25% will come with downside risk in the form of the Nifty and the Sensex going down further by 10%.
Investors will have to judge the downside risk they can bear. If they can tolerate higher downside risk they should look at individual stocks but if they can only tolerate lower downside risk they should stick to the index. Bear market investments will always lose money first before giving higher than average returns.
Investors buying in bear markets will have to have a vision of the future and that vision should look bright. If the vision does not look bright then there is no reason to buy stocks in bear markets, as the investment will definitely turn sour before becoming sweet. The sentiment is bear markets are bad and everywhere one looks there will be negative news. Investors will have to filter out negative news to look at the positives, if any, and then take investment decisions.
Today’s news is all about sovereign debt crisis, fall in rupee, scams, corporate debt burden etc. In all this, sovereign’s are pledging to cut deficit, RBI and government is acting against in inflation, corporates are cutting costs and looking to prune debt and become productive and investors are becoming more risk averse. All these are positives out of the negatives as it will strengthen economies and corporates down the line while investors will demand their price for investing.
Bear markets will test one’s conviction. Everyday news will be bad, investments will depreciate in value at the blink of an eye and there will be more reasons to sell rather than buy. Bear markets by definition are markets where prices continuously fall and usually one knows one is in a bear market when prices have fallen sharply bringing down sentiments along with it. Investing in such markets require a lot of conviction of how the future will pan out.
The Nifty and Sensex are in the fourth year of a bear market and are at least 20% below levels seen in late 2007 and early 2008. Many stocks have lost more than 75% of their value in the last four years. Investors will need to have conviction that this bear market will not last for another four year before investing in such markets.
Bear market turnaround happens without one realising it. Prices will first stagnate at lower levels before trending higher. Oversold markets will see sharp rises from lows at first before stabilising and then again trend up as more investors realise value in stocks. These are actually the first signs of a bull market and investors will have to have conviction to catch this initial bull phase of the market.
Bull markets too behave the same way as bear markets. Investors require to stomach loss in profits to sell in bull markets. Investors would have to think ahead of potential risks on sustained rise in prices of assets. Conviction to sell will have to be there to exit bull markets. Thinking back if investors had these traits when the market was peaking out in 2007 a lot of money would have been saved.