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D.Muthukrishnan (Muthu), Certified Financial Planner- Personal Financial Advisor

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Corrections are normal

Posted by Muthu on May 12, 2015

I wrote two pieces in December and March when the markets were at 26000 levels and 27000 levels respectively, falling close to 10% from their recent highs. As always, it is to reinforce the idea that how volatility and corrections are very normal.

Today market is again at close to 27000 levels (26877 to be precise). None of you called or wrote to me asking about this kind of volatility. I’m glad that all of us are together evolving and maturing as long term investors.

There is nothing unusual about volatility and corrections. This is the very nature of markets and having stayed the course even in bear markets, you are very clear about the same. Still I feel it is my responsibility to reinforce basic tenets of long term investing on a regular basis. As I often repeat, my role is to assist you shape your behaviour towards long term investing.

In this regard, I want to share with you what I wrote in February about corrections in bull market. At that time the market was at 29000 levels. I’m reproducing the piece below as it is without any changes. Please read on:

We are in a bull market. From when? Different people have different answers. The consensus seems to be when 21000 levels were breached decisively in late 2013. So we are in a bull market for last 15 months.

Bull markets on an average last for 5 years and bear markets for 3 years. This is only an average and averages can be deceptive. Many opine that this up cycle would last for 7 to 10 years and some even suggest that we are in a structural bull market which may last 2 decades. So we are in a bull cycle for next 4 or 6 or 9 or 19 years, depending on who is saying it.

I’m not writing this piece to share my opinion. The honest answer is I don’t know. All I know is if you regularly invest for long run in a portfolio of stocks (like equity funds), accept volatility and have patience; you would do very well. I’ve given you innumerable examples in the past to explain this.

There have been structural bull runs for long run in various economies and if we are lucky we may experience one too. One such structural bull market is when Dow moved from 777 on August 12, 1982 to 11,722 by January 14, 2000. Markets multiplied by 15 times in 17.4 years; annualised return of around 17%. Though this bull market lasted for nearly 2 decades, it went through many ups and downs. One unforgettable event was ‘Black Monday’.

On October 19, 1987 (popularly known as ‘Black Monday’), the Dow fell by 22.61%. This is the highest every one day stock market fall (in percentage terms) in U.S so far. Though many reasons are given including program trading, nobody saw it coming and no one knows why it happened! At 29000 levels of Sensex today, a 22.61% fall means; fall by around 6600 points. How we would react if Sensex in a single day goes from 29000 to 22400 levels?!

The whole U.S. market got paralysed and dooms day prophets mushroomed. Everyone predicted a great catastrophe. The funny part is market recovered and closed marginally higher in December than what it opened in January. So 1987 was actually a positive year for Dow! In the long term graph, this one day fall of 22.61% looks like a minor blip.

Even in our recent 2003-2008 bull markets, when the index multiplied by 7 times in 5 years, there were many corrections and steep falls. As Morgan Housel has mentioned, since 1871, the market has spent more than 40% of all years either rising or falling more than 20%.

Though the annualized returns from equities are good; we need to learn to live with higher standard deviation (volatility). A 20% rise or fall in a year is very normal. Sensex is now at 29000 levels. Going by this point, it can even swing widely between 23200 to 34800; which is perfectly normal. No explanation required. This is how it works!

As we say repeatedly, if you can learn to live with this volatility and even use it wisely, big money can be made. Withstanding volatility and having patience will really take you to great heights.

All of you have seen a bear market and had conviction to invest through those gruelling years. That behaviour of yours has got translated now into excellent portfolio returns.

Sharp corrections and steep falls would continue to happen in bull markets as well. Be mentally prepared for it. Show the same resolve you showed in bear markets when you face such corrections. You’ve to ignore corrections and continue to stay the course.

As I’ve mentioned before, in his 5 decades of managing Berkshire Hathaway, Buffett faced 4 instances when Berkshire’s market value fell by more than 50%. In our entire investing career we may have to face at least 2 or 3 such instances. The last time it happened in India was 2008. Counting that as one; be ready to face at least 2 more similar instances within next 20 years. If it doesn’t happen, it’s fine. If you’re mentally prepared, even if it happens, it’s all the more fine:-)

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