Since the start of 2017, the stock markets have broadly moved upward. The BSE Sensex, the prime index of the broad markets, rose from 26,447 in January 2017 to a high of 38,989 in August 2018 (an increase of 47%). Since reaching this peak, the markets have seen a significant amount of correction over the past 2 months and are currently experiencing a mild upward movement. The Sensex closed at 34,981 on 22 November 2018.
India SENSEX Stock Market Index
Most investors are worried; but is this correction really a reason to worry? Let’s review a few factors on market corrections that will help us find answers.
Corrections are commonplace
The economy goes through cycles. It expands for a few years, then contracts and again expands. If we look historically, different sectors tend to perform during different stages of an economic cycle. So, if a sector is being shunned right now, do not think that investment in those sectors is a no-no. Sector rotation and the economic cycle is a very common trend in growing economies. Clearly, markets go through cycles and tend to correct during each cycle.
Corrections can’t be predicted
One can confidently state that no market guru can accurately determine when a market correction will occur. The key is to hold on, and better still, increase your holdings during corrections to eventually earn multi-bagger returns. According to an analysis, if an investor were to have held a Nifty index fund between January 1, 1995 and December 31, 2014, they'd have earned a cumulative return of 705%, or 37% a year. Mind you, this includes holding during the period of Harshad Mehta, Ketan Parekh and the Satyam scams and events-based market crashes like the Bombay bomb blasts followed by the 1993 riots or the 9/11 World Trade Centre terrorist attack.
The extent of corrections too can’t be predicted
History shows that one can neither predict when a correction will occur nor can one accurately estimate the extent of correction. Over the past 25 years, only 5 major corrections in the Sensex have officially hit bear market territory (i.e., a 20% decline.) On average, investors will endure a bear market about once a decade.
Why the correction?
Here is another surprising fact – you will find out the real reason for the correction only after it has occurred. While the market is correcting, most reasons put forth by so-called market experts are usually simply hearsay.
Corrections don’t last long
Most corrections are short-lived. Considering the previous 21 short-medium term corrections in the Sensex over the last 25 years, 14 of them lasted only for a few months. Comparatively, just 5 persisted for longer than a year. Clearly, all you need to do is sit tight and wait it out. Eventually, the rise is inevitable.
Corrections indicate sentiment
Corrections are usually the result of emotions (panic being the key emotion). One will also see that there is a significant increase in volatility during periods of correction as against a relatively one-way upward movement during market rises.
Margin trading must be avoided
Corrections are usually sudden and swift. Investors who buy on margins are usually impacted the most due to lack of time to close their trades. During corrections, margin traders holding a long position face large losses. Margin investing is a strict no-no in order to avoid losing during a sudden and steep fall.
Corrections impact traders
Short-term market moves usually impact traders and not long term investors. A commitment to an investment for the long term (10 years and above) implies short term movements to be irrelevant.
Time to review
A market correction offers a good time to review your portfolio. You have fundamentally strong stocks available at very reasonable prices. Investing in such stocks gives you a very high margin of safety and a strong possibility of multi-bagger returns.
Time in the market usually brings great gains
For investors, the longer their holding period, the greater the returns; at the same time, lower the risks of losses. Despite 21 short-medium and 5 major corrections in the Sensex and Nifty Index, they all were completely erased by a bull market rally.
Remember ‘time’ is an investor’s best friend in the stock markets. It helps increase potential returns while reducing possibility of losses. Like investment guru Warren Buffett says, “Our favourite holding period is forever.”