Sensex, Nifty new highs: The current stock market is seeing upward momentum, making Sensex and Nifty scale new heights

Sensex, Nifty hitting new highs every other day: Will this continue or is the big stock market crash imminent? However, the current bull market is yet to see a big stock market crash. The question is how long this bull run will last and what you should do to prepare for it

Sanjeev Govila

Certified Financial Planner (CM), CEO, Hum Fauji Initiatives.

The Indian stock market has been on a remarkable journey over the past several months, with share prices climbing to unprecedented levels. Investors, both seasoned and new, are riding this wave of optimism, but many are beginning to wonder-when will it stop? Or more importantly, what should they be doing in the face of such uncertainty?

The market is driven by cycles of fear and greed, and in times like these, it's easy to see greed overpowering caution. Indian markets, powered by strong industrial growth and effective economic policies of the government, have surged ahead. The Reserve Bank of India (RBI) has done a commendable job of managing inflation and interest rates. Yet, it's important to remember that even in a bullish phase, market correction cycles are inevitable with the famous 'reversion to mean' occurring sooner than later.

The current bull run: A double-edged sword

There's no denying that India's economic fundamentals are strong. Industrial production is rising, consumer sentiment is optimistic, and the government's push for reforms has further added momentum. But as stock prices have surged, so have concerns that some segments of the share market have quite outpaced their reasonable valuations. This means investors may be paying too much for future growth that may never materialize.

Take the Initial Public Offering (IPO) frenzy, for example. New companies are coming to stock market at prices that assume decades of uninterrupted growth. This is the classical 'greater fool theory', where investors buy overpriced stocks believing that someone else will buy them at an even higher price. While this strategy works in rising markets, it's incredibly risky when a stock market correction occurs.

The nature of overvaluation: Can it last?

While valuations in some pockets of the stock market are undeniably high, it's also true that share markets can stay irrational for longer than we expect. Stocks that seem overpriced today might rise even higher before the eventual correction, whenever it happens.

This creates a dilemma for investors: Do you stay invested and ride the wave, knowing it could go down at any moment, or do you book profits and risk missing out on further gains? Howard Marks would argue that it's not about predicting when the correction will come, but about being prepared for it.

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As one seasoned market analyst put it, "If you're 10% cash, you're 90% invested". This means even holding a portion of your portfolio in safer assets like cash won't protect you fully from a downturn. When markets fall, nearly every stock-whether it's a high-growth tech company or a defensive stock in a safer sector- and equity mutual funds will all fall in tandem.

Emotional resilience: A key factor

In a stock market where share prices defy logic, emotional resilience becomes more important than ever. Many new investors have yet to experience a significant stock market correction. When that happens, fear will drive many to make hasty decisions-selling at the bottom, panicking at the sight of falling prices, or abandoning long-term strategies for short-term relief.

This is why it's critical to manage not just your investment portfolio, but your emotions. Behavioural finance-a field that studies the impact of psychology on financial decisions-suggests that most investors act irrationally in times of extreme stock market volatility. This is where the real challenge lies. Benjamin Graham, often called the father of value investing, said, "The investor's chief problem-and even his worst enemy-is likely to be himself".

Common mistakes new investors make

A large portion of today's stock market participants are new investors who have only seen the share market in a state of upward momentum. This group is prone to making some classic mistakes, such as:
1. Extrapolating growth too far into the future: Many investors assume that industries like technology or electric vehicles, which have shown rapid growth, will continue to grow at the same pace for the foreseeable future. But this kind of linear thinking can lead to overvaluation.
2. Assuming good times will last forever: Stock markets move in cycles. The current bull run may give the illusion that stocks can only go up, but history tells us otherwise.
3. Ignoring execution risks: Just because a company has a great business model or a promising future doesn't mean it will execute flawlessly. Risks related to management, competition, and external factors are often overlooked during euphoric times.
4. Double-counting growth: Some investors mistakenly believe that growth potential, already factored into current stock prices, will somehow provide further upside. In reality, today's prices often reflect not just the current growth, but future growth as well.
5. Equating market frenzy with broad market opportunities: A few sectors, like technology or fintech, may be experiencing exponential growth. However, this doesn't mean the entire stock market is a 'buy'. Good value stocks exist, but it requires high quality research to find them.
6. Changing strategies based on market fluctuations: Investors often let emotions dictate their decisions. On up days, they believe stock markets will only rise, while on down days, they are convinced of a stock market collapse. Most also believe that they will get out when stock markets reach highs or are about to go down and get in when they are at the bottom. Nobody has ever been able to do this with any amount of consistency.

Navigating the road ahead: Stay nimble, Stay cautious

So, what should you, as a common investor, do in the face of such market dynamics?
1. Diversify your portfolio: A well-diversified portfolio spreads risk across different asset classes and sectors. While the temptation may be strong to pile into high-growth sectors like technology or consumer goods, it's important to have exposure to safer assets like bonds and gold too, which can provide stability during volatile times.
2. Avoid timing the market: Trying to predict when the stock market will peak or crash is a futile exercise. Nobody can do it with any reasonable level of correctness or consistency. Instead, adopt a long-term strategy that aligns with your financial goals. This doesn't mean ignoring market signals but rather preparing for both good and bad times.
3. Rebalance your investment portfolio: If some of your holdings have grown disproportionately due to the market's rise, consider rebalancing. Selling a portion of overvalued stocks and reallocating to undervalued or defensive assets can reduce risk.
4. Stay informed but don't react to every headline: Media often exaggerates stock market movements, fuelling either euphoria or panic. Stick to your investment thesis and avoid making decisions based on daily news cycles.
5. Keep cash on hand: Cash might seem like a boring asset during a bull market, but it can be incredibly useful during corrections. Having some liquidity allows you to buy quality stocks at lower prices when others are selling out of fear.
6. Don't fall in love with your stocks: As stock markets continue to rise, it's easy to develop an emotional attachment to certain holdings. But remember, when the correction comes, even your favourite stocks might have to be sold.

And finally, prepare, don't predict

The current bull run might continue for another few weeks, months or even years. But instead of trying to predict the timing of a market correction, investors should focus on being prepared for it. Diversification, emotional resilience, and a long-term view are key to navigating these turbulent times.

John Maynard Keynes has cautioned for such a time when he said, "Stock markets can remain irrational longer than you can stay solvent". The goal is not to avoid corrections but to manage them wisely when they occur. As Howard Marks would say, "Risk is not something that happens to you; it's something you take on."

The key takeaway? Stay cautious, but don't panic. Keep your emotions in check, your investment portfolio diversified, and your long-term goals in sight.

(The article is written by Sanjeev Govila, the CEO of Hum Fauji Initiatives, a financial planning firm.)(Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com.)

This story originally appeared on: India Times - Author:Faqs of Insurances