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Learnings from a bear market

It is easy to make money in bull markets. In fact, in a year like 2017, it is extremely difficult not to make money in stock markets. The Nifty Midcap 50 index climbed from 3678 to 5540 in 2017. The percentage return is astonishing 50%+. Mind you, we are talking of an index and not a particular stock. The current value of the Nifty Midcap 50 at the time of writing this article is 4212. That is a steep fall from the highs. The deep-red portfolios are an eye poke for all the investors trapped at high valuations. At its peak, the Nifty Midcap 50 index was trading at PE ratio of more than 100. Below is the PE chart for the index:

5 year PE chart for Nifty Midcap 50 index

Many of these super-charged bulls of 2017 have burnt their fingers enough to say good bye to the markets. The burns are causing excruciating pain while placing buy orders. On this occasion of Teachers' Day, let us look at some lessons that bear markets teach:

  • Boom and bust phases are real: One point that most investors miss in a bull market is the probability of a fall. The Euphoria and the associated joy of minting money makes one almost forget that bear markets do exist. An investor who has seen and learnt from bear markets should ideally start getting conservative once markets are heated up.

  • Quality triumphs: In most bull markets, almost all stocks rise. Among these, the so called 'kachra stocks' are the roaring lions. The inherent human tendency of chasing momentum is enough to cause temporary blindness while analysing stocks. When the tide turns, these junk stocks take a hard hit, and quality companies follow their natural course.

  • Consolidations are painful: A typical painful characteristic of bear markets is the consolidation phase. Lack of one directional movement is frustrating. However, the reality is the market consolidates or stays side-ways most of the time.

  • Value traps are dangerous: This is perhaps the most common mistake that many investors make. A value trap occurs when you buy some stock that looks attractive on valuations, but turns out to be a problematic stock. Recently, many investors were caught in an Indian Bank. Huge wealth destruction occurs due to value traps.

  • Technical Analysis has a role to play: Many investors who like to call themselves 'value investors' outrightly reject the premise of technical analysis. The rejection is so intense at times that it comes out as hatred. Technical Analysis is not self sufficient by itself. However, it gives you a fair sense of entry and exit points. The techno-fundamental approach to investing combines the best of both worlds: Technical Analysis and Fundamental Analysis.

  • Markets are a slave to earnings per share: Stock prices are a function of expected earnings from the company. While PE ratio expansion is a reality, prolonged lack of earnings growth is probably the ultimate reason why a bull market ends. With respect to Nifty 50, earnings have been flat for almost 5 years now. Reasons attributed to the current distress are many, however one of the main reasons is earnings have not caught up as expected.

Let's end this post with two famous quotes:

"An Investment in knowledge pays the best interest"(Benjamin Franklin)

"There will always be bull markets followed by bear markets followed by bull markets"

(John Templeton)

Happy investing!

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