SMART tips for investors when stock markets crash

The Indian stock market has shown extreme fluctuation since the end of 2007. It went sky high at 21,000, slumped to the bottomless pit at 9,000, and again came back at 20,000 and now going down once again in August 2011. The reasons are many.
 
Slower than expected market recovery in the United States and Europe, high inflation in India, interest rate hikes, and overall uncertainty in the global market. These events have created a confusing situation in the market.

What made it worse was the downgrade of US credit rating by S & P from AAA to AA+ with warning of further downgrade if US doesn't take strong steps to correct the situation. Media too is not very helpful as there are many opinions. Some analysts ask you to wait, some ask you to invest.
 
We will point out some steps that investors should take in such a crisis-like situation.

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1. Go back to the basics of investing

Markets may fluctuate in the short term, stocks of companies may suffer because of market gloom, but remember at the end of the day, stocks prices go up and down based on the expected earnings in future. This expectation is set by many factors of which past earning growth is the most important one.

If the company in question doesn't have any apparent impact because of these crises, the investors need not worry about the temporary fall in the prices. Market punishes all for chaos and confusion but the punishment is temporary for companies that have great fundamentals, a scalable business model, encouraging performance, and a sound management.
 
We are fortunate to have a very recent crisis in 2008 where we saw temporary crash in the market but most of the companies that fulfilled the criteria mentioned above bounced back with the same intensity.

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2. Don't forget the history of returns

If you look at history of returns in the long term, equity has beaten down every other asset by a big margin. This fact doesn't change even now. We tend to forget this fundamental observation that equities outperform all other assets. BSE Sensex has given a CAGR (compounded annual growth rate) of 16% in last 12 to 14 years.

If you are afraid to invest in equities, invest in equity diversified mutual fund after due analysis of it.
 
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3. Remember that you have built your portfolio over time

If you are a serious and long term investor, you probably have spent days and nights studying companies, looking at numbers, talking to your brokers, or doing research on their annual report, numbers, and management updates on your own. If the companies in your portfolio are not prone to global market situation, it doesn't make any sense to sell because of temporary market slowdown.

As the investment guru, Benjamin Graham puts it, "Stocks do well or poorly in the future because the businesses behind them do well or poorly -- nothing more, nothing less.

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4. Treat fall in prices as discount given by market

This is the most crucial step that investors can take in a falling market, though it is easier said than done. Imagine you are in a shopping mall and you have all the fancy things you ever wanted but could not buy because of high price tag attached with them. Now you have got the discount of 25% to 50% on these items. I am sure you will happily buy them.

Similarly in a crisis, stock market creates a situation where many blue chip stocks or good companies' stocks are available at discount. These are the companies that are always over priced in normal market situation. There are many good companies' shares that have fallen by up to 50% in last couple of weeks.

The crisis could be a godsend opportunity for you to accumulate some good companies' stocks for the long term.
 
In fact Mohammed Apabhai of Citi Asia Pacific has told in an interview that India looks attractive for the first time since Sep 2010.

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5. The story of India and emerging markets is still positive

There is slowdown in western economies and this should be a matter of concern if not panic. However, the expected growth in India and other emerging economies like Brazil, China, Sri Lanka, and South Africa, and many more are comfortably high.
 
The impact will surely be felt by the stock market and businesses in emerging markets. However, the impact will not be uniform. Countries which depend on western market for the consumption will face little harder problem than the ones that depend on domestic consumers.

India falls in the second category. Its story is led by domestic consumption which has faced marginal impact but the expected growth rate is still good at 7.5%.

Final words

Fear and greed, these two emotions, and their innumerable mutants drive the stock market sentiments. These are certainly powerful sentiments that can make up do things which we may not do when we are in our senses. This is why it is important to maintain our sanity and decide upon our action based on sound analysis of the situation. I have just tried to give some thoughts which may help you make your judgement better.