How much more can this market fall?

To be honest, no one has a clue...

I studied every bear market since 1990 ( definition of a bear market is a fall of 20% or more from the top)....and here's what I found

There have been 10 bear markets since 1990 with the gap between two consecutive ones being as low as 2 years to as high as 5 years....

Percentage fall from the top has also varied a great deal....with the biggest fall being 61% back between Jan 2008-Mar 2009 to the smallest fall being 23% betn Jan 15 - Feb 16

And finally, they have all been of different durations, ranging from 1 month and 5 days to over 2 years....

So the takeaway is this....no one has any clue on how low the markets can go...the best strategy therefore is to keep booking small profits after every rise of say 35%-40% and to keep buying small quantities after every fall of 20%....my preferred approach is to be 25% invested in both stocks as well as bonds at all times and move the remaining 50% between stocks and bonds based on the broader market valuation.

If markets r cheap, as much as 75% can be in stocks and when they turn expensive, we can have 75% in bonds

Sensex down 1,500 points as I write this.

These are of course scary times.

However, the key is to not panic.

Here’s what I would do.

If you have good quality stocks in your portfolio that were brought at attractive valuations, it makes sense to continue holding on to them.

Maybe it is still not too late to get out of risky mid and small caps that were bought on hope but have weak fundamentals and leveraged balance sheets.

These stocks go down the most during a market crash.

Is this is a good time to take more exposure to stocks? I don’t think so.

Investing is all about getting the odds in your favour and I think these are still not in our favour.

The broader markets are still expensive.

I think it could be a good idea to increase exposure once the Sensex PE moves to around 20x-21x, which is its long-term average.

Right now, it is still at 25x PE.

Lastly, investing is all about having a sound and a proven process in place and then having the discipline to follow it at all times.

A well-documented process helps in staying the course and stops us from panicking and taking a rash decision.

In my paid services, I moved from a 75% stock allocation to a 50% allocation in the past few months based on a well-documented process.

I will start thinking of increasing exposure to stocks once the broad market PE moves towards its long- term average. 

 

The portfolio managers at US based Clipper fund have done an interesting comparision.

They have pitted current market darlings like Tesla, Nvidia and Shopify vs quality stocks like Berkshire Hathaway, Intel, American Express and others.

Market darlings trade at a huge market cap of US$ 2.3 trillion with the combined PE ratio of 115x

The quality basket comprising Berkshire and others also trades at a similar market cap but a low PE of just 17x

Perhaps market darlings like Tesla deserve a premium but should the premium be as high as 115x vs 17x.

They are almost 7 times more expensive despite earning profits that's almost 1/7th the quality basket.

It looks highly unlikely that stocks like Tesla and Shopify can outperform the other group over the next 10 years.

Of course in order to invest successfully, both the company' current earnings and future prospects need to be considered.

In fact, looking for companies growing at above average rates but available at below average PE multiples is the holy grail of investing.

But paying a very high PE multiple upfront is not how you should go about it. That way lies danger.