Market volatility – how should investors respond?

By BankBazaar.com | August 12, 2011

The market has shown extreme fluctuation for last couple of months. The volatility has increased in last few days after Standard & Poor downgraded US credit rating from AAA to AA+ and warned to downgrade further to AA if the situation persists.

This has created panic selling in American and European markets leading to the same fear in Indian stock markets as well! Media is also not helping making sense of the recent events. Few analysts suggest investors to buy; few warn that the bottom is not yet reached.

In such a situation what should the investors do? How can he or she cut through the noise and listen to the right voices and make an informed decision? We will discuss few points in this article.

Remember the fundamentals

No matter how markets behave, the fundamentals remain the same. Equities are still the best bet in the long run. There will be a short term fluctuation in the market but equities will outperform all investment assets in the long run. We tend to forget this fundamental principle in the time of unusual market reaction.

Don’t forget the asset allocation. If you have taken care of asset mix in the first place, you will not worry much about the market volatility.

Right time to buy at reasonable valuation

This kind of situation creates opportunities for investors to own good blue chip stocks at reasonably favourable valuation. Usually, blue chip stocks are almost always fairly priced or overpriced. We seldom get a chance to buy them at a fair price. This volatility has provided the right environment to own a few good stocks in the long run. In last few days, the sensex PE ratio went down to 17. If you look at individual stocks in sensex, you will find few stocks which are a good bet.

Remember the difference in making good returns and great returns is when you buy it. Investors who buy stocks when the market is volatile and down usually make great returns.

Indian story is consumption led

Let’s look at the Indian economy. Our economy is based on domestic consumption which will remain as it is. The export, while an important part of the economy, doesn’t have decisive power to alter the economic fortune of India. This means the global disturbances will have limited impact of the growth of Indian economy. Moreover, the commodities prices may come down because of slow recovery in the United States and Europe. This will let people save more and thus invest more.

Emerging markets have positive long term outlook

India, China, and many others have positive outlook in the long run. While America and Europe still impact world market, their influence is going down rapidly. We have already seen the 2008 crisis – how India was able to withstand the financial turmoil in developed countries and was still able to clock a growth rate of 6.8% at the height of recession in developed economies.

The investors should not panic because of market reaction which is very short term. If you own good stocks with sound businesses, hold on to it. If you want to own good stocks with reasonable valuation, go for it after you do your study.

Lastly, remember that investment is only for the long term. You may have started investing in the stock market very early in life hoping to reap the benefits when you are ready to invest in other assets like a home, for which the returns from your equity could help you pay a hefty down payment for your home loan, thus saving on the total interest cost of your loan.

In times of market turmoil, don’t lose focus in panic,  stay invested keeping in mind the fact that there will be short term fluctuation in returns but in the long run, your investment will provide better returns.

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