When the stock markets give strong upward moves, like the one we have seen in the last year, investors cannot avoid thinking of a bubble building up in the stock market. For some investors, a high price-to-earnings ratio appears frightening. Some investors turn nervous when the index starts hitting a new all-time high and enters uncharted territory. The notion of asset prices getting into the bubble zone plays on the investor’s minds, and many can neither buy, sell or even stay put in this market. How does one deal with this?
An obvious approach is to stay out of markets. The rationale behind this is to invest after the prices crash. But this is easier said than done. Spotting a bubble can only be done in hindsight. The first challenge is to identify if we are in a bubble phase. There are no clear guidelines on how to spot them. Even if the valuations quote at the higher-end, investors may keep pushing up the prices for longer than expected for one reason or the other. In the words of British economist—John Maynard Keynes, “The markets can remain irrational longer than you can remain solvent.” It is difficult to predict how long it takes to build a bubble and how long it lasts. It may be a few months or even a couple of years for a bubble to burst. If you decide to stay out thinking of a bubble that was never there, then there is an opportunity lost.
Even if there is a bubble, you have to be perfect when timing the market. First, you have to identify the top, and then you have to get it right at the bottom. In 2007 the Indian markets were enjoying high valuations in some pockets. But the markets cracked in early 2008. Those who sold the stocks in early 2007 were disappointed. Even if you have got the top right in early 2008, how many would have the courage to buy stocks at the bottom in October 2008? Getting both the top and bottom right is almost impossible.
Put simply; investors cannot postpone their investments thinking of some bubble and waiting for it to burst. Investors should stick to their investment plan based on asset allocation, which is derived after factoring in their risk appetite. Investing across asset classes with low correlation with each other can help reduce anxiety. Not all asset classes move in one direction—be it up or down or sideways.
Staggered investments over time or SIPs in various asset classes ensure that you reduce the timing risk. You are neither investing all your money at the top nor investing at the bottom.
When the prices are moving up fast, investors should use this to their advantage by rebalancing their asset allocation at regular intervals. This is a disciplined method of selling that asset class that has appreciated and buy assets that have not appreciated or fallen.
Lastly, the most important tool an investor has is time. The longer the time frame of an investment, the higher is the likelihood an investor will make enough money to take care of financial goals.
So, the next time you hear someone talking about bubbles, know that it is time to hang on and not hang up one’s boots!
— Pratik Oswal is Head of Passive Funds Business, Motilal Oswal Asset Management Company. The views expressed are personal
This article was originally published on CNBC TV18 March 23, 2021, 01:07 PM IST