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Should Investors Resist Temptation To Exit Equities Now, Reenter Later?

Indian equity markets have declined in the last few months, led by several concerns—high inflation across the world, global central banks (including the Reserve Bank of India) raising interest rates, the war between Russia and Ukraine, high crude oil prices, lockdowns in China due to rising covid cases, global supply chain constraints, and huge foreign institutional investor (FII) fund outflows from Indian equities, etc.

Given the recent decline in the markets and several uncertainties, it is natural for a lot of us to extrapolate the current situation, and worry that the fall may continue. There is a strong natural temptation to exit equities now with the intent of entering back later at lower levels. While this approach seems logical, unfortunately, there are some counter-intuitive patterns (read traps) that occur in a market fall which make a reentry into the markets extremely difficult once you have sold out.

Here are the five counter-intuitive patterns to watch out for.

Pattern 1: Equity market recoveries usually happen in the middle of bad news.

Timing your entry back is difficult because history shows us that stock markets typically hit their bottom before the worst news arrives. The recent Covid 2020 crash was a classic case where the Indian markets rallied by 40% before actual covid cases peaked in the first wave. This is a pattern seen across most bear market recoveries, both in India and around the world.

Pattern 2: A market decline has several false upside rallies and the actual recovery also has several false declines.

There are a lot of false upside rallies in the middle of a market fall. Once you experience several false upside rallies in the middle of a market fall and add to it the continuing bad news, there is a high likelihood that you may dismiss the actual recovery as yet another false upside rally. To make things more confusing, even the actual recovery has a lot of false intermittent declines. As a result, it is very difficult to distinguish between the real recovery and the false upside rally.

Pattern 3: Recovery is usually extremely fast.

Waiting for a few months (say, around six months) to confirm a recovery (versus a false upside) also does not work well as, most of the time; the initial recovery rally is extremely fast. Sample this: the Sensex gained 85% in just three months during the 2009 recovery.

Pattern 4: We get psychologically anchored to the bottom levels.

Once you miss the market bottom, you generally get psychologically anchored to the bottom levels and it’s behaviorally challenging to enter back at higher levels.

Pattern 5: No one can predict the markets in the short run.

Even the best market experts can’t exactly predict the timing of a market recovery on a consistent basis. There are several evolving factors that impact the markets in the short run and it’s difficult to predict how millions of investors are going to react to that. If you plan to wait for your favorite market expert to let you know when to enter back, this may not be a great idea.

Overall, while it’s easy to move out, these five counterintuitive patterns along with the fact that it’s difficult to predict short-term market movements consistently make it extremely difficult to time your entry back if you exit now. A temporary fall while no doubt painful is the emotional fees that equity investors need to pay for long-term superior returns. As we mature, our approach to market falls becomes one of acceptance rather than denial.

The best course of action will be to stick to your original plan i.e. your asset allocation between equity, debt and gold. If the market fall continues, keep rebalancing back to your original asset allocation (i.e., increase equity and reduce debt/gold) at regular predetermined intervals.

The boring but proven mindset necessary for successful investing remain the same—stay patient (stick to at least a 7-year time horizon), be humble (do not try to time the market), be prepared (to endure temporary market falls) and remain optimistic for the long term (faith in human ingenuity).

  By Arun Kumar, mint publication, 01 July 2022