An important lesson from stock market history is that a sharp crash is followed, more often than not, by a sharp rebound. Stock market often overreacts both on the upside and the downside. During the euphoria of a bull market, valuations reach unsustainable levels leading to a sharp correction. The panic during a crash takes valuation to very low levels, which in turn, leads to buying triggering recovery. This pattern repeats. This has implications for investors.
Let’s take the history of recent market crashes and the rebounds from the crashes. During the tech bubble of 1996-2000, valuations reached unsustainable levels triggering a massive crash of 49 percent from the 2000 peak. The market consolidated for a while, and then, there was a sharp rebound of 140 percent in 9 months during 2003-04. One of the worst crashes in stock market history happened in 2008 during the Global Financial Crisis. The crash was a massive 65 percent. Then, from the lows of March 2009, there was an impressive rebound of 180 percent in 15 months. The crash of 40 percent following the outbreak of the pandemic in March 2020 was swift and huge. This was followed by a sharp rebound of 135 percent in 18 months.
What is the lesson from this trend? Stock market returns come in fits and starts. There will be periods of euphoric rise, sharp corrections, and consolidation. Big money is made not by buying at the peak of the bull market, but by systematically and patiently investing through a bear market. More importantly, superior returns are generated by a simple investment strategy: Investing in high quality stocks that consistently generate superior cash flows. Smart investment strategy is like running a marathon; not like running a sprint. Timing the market is impossible. Spending time in the market is more important.
It appears that the sprint following the crash of March 2020 is over. This sprint, which took the Nifty from 7511 in March 2020 to 18604 in October 2021, generated 135 percent return in 19 months. This one-way rally has ended with above 10 percent correction from the peak. Unsustainable valuations and relentless FII selling has put a cap to the upside now. Returns in 2022 are likely to be moderate. Therefore, the focus of investors should be two-fold: one, look for segments and stocks that can generate market-beating returns and two, invest patiently for the long-term. New variants of the virus and rising interest rates may pose challenges in 2022. Market corrections triggered by these challenges may turn out to be buying opportunities.
In 2022, prospects for IT, financials and construction related segments look good. The valuations of financials, particularly that of leading banks, are attractive thanks to sustained FII selling. IT is in a multi-year up cycle triggered by accelerating digitization. IT valuations are high, but earnings visibility is very good. Low interest rates are driving a boom in construction, which would benefit all construction related stocks. Focus on high quality stocks in these segments can generate market–beating returns in 2022. More importantly, look beyond 2022 and invest patiently for the long-term. Continue with SIPs. Put on your running shoes and start running the marathon.