stock market correction: Decoding market corrections: A deeper look at time and price factors


It is widely recognised that equities have outperformed other asset classes like debt, real estate, and gold over the past few decades in terms of returns.

However, to capitalise on these superior returns, equity investors must navigate through market corrections, which are generally unwelcome, whether they are minor or substantial. Yet, when approached strategically, these corrections can offer valuable opportunities to enhance long-term investment gains.

Analysing data spanning the entire 21st century, which encompasses the past 23 years, we observe that major stock market indices such as the Sensex and Nifty 50 have experienced a minimum 10% correction on an annual basis (with the exception of CY2021), a roughly 15% correction approximately every 3 years, and a more significant correction ranging from 30-40% occurring once every 10 years.

Sustained negative returns over two consecutive years are very rare. Furthermore, investors must also be prepared for time corrections, where the market may take an average of around 30 months over the past decade to recover and reach previous peak levels.

India, in particular, has experienced relatively few country-specific corrections.

To illustrate this point, let’s examine two instances: The global financial crisis (GFC) of 2008 and the COVID-19 crisis of 2020.

Both of these periods saw the headline market index decline by more than 35%.While it took nearly 30 months for the market to recover to its previous high during the GFC, the same feat was achieved in less than 12 months during the COVID-19 period.

In hindsight, such corrections have proven to be opportune for long-term investments. However, when markets are in the midst of corrections and stock prices are consistently falling, it becomes challenging to maintain an optimistic outlook for the future.

It’s equally daunting to commit to investing when sentiment is overwhelmingly pessimistic. Those who managed to do so, though, have been rewarded with substantial returns. This underscores the significance of recency bias in shaping investment decisions.

The assumption that rising markets will continue to rise and falling markets will continue to fall often influences investment choices. A declining market erodes confidence in underlying fundamentals, while a surging market fosters overconfidence. These biases often work in tandem, as seen in the common pursuit of timing market bottoms and selling at peaks.

While this approach may seem appealing in theory, executing it successfully in practice is rare.

Investors, especially newcomers (post-COVID period), should place the highest emphasis on mean reversion and the base rate.

In the period from 2021 to 2022, market returns have ranged between 25-35% CAGR. However, this doesn’t accurately reflect the base rates at which the Indian economy is growing.

Over the long term, equity returns have averaged around 15%, slightly above the country’s nominal GDP growth rate. It’s important to note that any significant deviations from this figure should naturally correct themselves in the medium term, either through price adjustments or over time.

In conclusion, it is safe to assert that market corrections are an intrinsic aspect of the investment landscape. It’s imperative to avoid succumbing to recency biases and instead focus on long-term data, which consistently indicates that equities, as an asset class, are likely to deliver favourable returns when compared to other asset classes.

However, when the market deviates significantly from long-term averages, it’s crucial to apply the principles of mean reversion and act accordingly.

(The author is Chief Investment Officer, Tamohara Investment Managers)

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