There are a large number of sceptics waiting for a market correction. The market is obliging them once in a while with some pause, sideways consolidation and correction for a few days. In the last one year, we have been seeing a very healthy sectoral rotation, which has prevented any linear rise in any sector or a particular stock. The exception had been the
group stocks, which have also had their share of fall recently. Yet, as many as 64% of stocks are still below January 2018 highs created by a booming midcap & smallcap rally.
Looking at the sectors that are rallying will give you a sense of the market. Commodity cyclicals like sugar, steel and cement have been on the forefront of this rally. But other more ‘secular growth sectors’ like IT, pharma, specialty chemicals have also participated in it in the last one year.
In such a market, two completely divergent thought processes run on the minds of investors. The first is the fear-of-missing-out or FOMO. We want to be in the hot stock or the hot sector and ride the rally. We do not want to miss out on the rally that is happening, which seems to be making money for everyone else. The opposite fear is that market valuations are very high and that make us hesitate to deploy our capital fully. We are pulled in two opposite directions at the same time and do not know what to do.
In a bull rally, the first casualty becomes the quality of a portfolio. Usually, quality companies rarely run spectacularly. They tend to be, what I call, ‘peaceful compounders’. Companies that are a few notches below in the quality curve run the fastest. And people with FOMO gravitate towards that. As any market veteran will tell you, they end up with a clutch of poor stocks in the portfolio when the bear market comes.
So, the first and perhaps the most important thing to remember is to not dilute the portfolio quality. Does that mean you miss out the rally and resign yourself to a more flaccid investment performance? Of course not. You can definitely participate in a sectoral rally, but ensure that you are buying into the top one or two companies in that sector. And make sure you position size conservatively. Always, think of the downside first.
Every bull market brings with it some narrative on why a particular cyclical industry has turned the corner and will henceforth be a secular growth story. Don’t fall for that. You should be able to understand both the bull and bear cases before you invest.
The second part of hesitancy in investment can be avoided with two simple rules. This bull phase may end tomorrow, and it may go on for the next five years for all we know. It is important to have a well-thought-out ‘systematic’ strategy before we invest in a market like this. The first rule of investing in a market like this is to invest slowly, in tranches over time. Take a few months to deploy your capital. Keep nibbling at the stocks you have shortlisted and accumulate them. The second is to have an exit strategy ready. You need to know when and how much you will sell and where you will put the cash. You also have to plan for when and how to get back into the market subsequently. If all that seems very complex and difficult, just buy good quality businesses and try and ignore the short-term market gyrations.
