What next for investors after Nifty at 21,000 and Sensex at 70,000

We said this change in trend is extremely positive for stocks and could result in the markets going even higher than current levels.

Here’s what we wrote…

There are early signs that foreign investors are coming back to Indian stocks. This holds the potential to turbocharge the stock market.

It's still early days so there is no definitive trend yet. However, there has been a change in FII activity since the last week of November. Buying has consistently exceeded selling.

This is great news for all those who have patiently held on to their stocks through the volatility of the last two years. Their portfolios would be in the green by now.

It's also great news for anyone who has entered (or re-entered) the market recently. These investors have enjoyed some quick profits.

However, it would be wrong to say that FIIs are solely responsible for taking the markets to new highs.

Earlier, in the absence of positive FII participation, the Indian retail investor took it upon themselves to take the market higher or at least hold it steady.

Monthly SIPs into equity mutual funds brought in thousands of crores of rupees. This was on top of all the direct investments made by retail, HNWI/UHNWIs, PMS, and India dedicated offshore funds.

It's no wonder that every dip over the last two years was bought into. Despite significant global volatility, the Indian stock market has remained resilient.

And now that foreigners have joined the party, new all-time highs for the market are very likely.

The Nifty and Sensex are within touching distance of 21,000 and 70,000 respectively. If and when these milestones are achieved, there would be only blue skies in front of the market.

A Blue-Sky Stock Market

What should you as an investor do in this case? Should you abandon your long-term investing strategy and try to make quick profits?

Well, you would be tempted of course.

The more you see others make easy money in speculative stocks, the more you will feel like doing the same. It's called FOMO or fear of missing out. It's a dangerous emotion that can consume the minds of investors and make them lose their rationality.

We saw it in full effect in the bull market of 2020-21. We could see it happen again. Such a scenario, if not accompanied by regular corrections to keep the enthusiasm in check, could result in a euphoric market, in which prices go up just because everyone expects them to go up.

It’s important to understand that such a stage usually signals the end of bull markets.

We would prefer the markets to move up in a calm and orderly way so that investors find good quality stocks to buy at reasonable valuations. But that's not how human emotions work in a blue-sky market.

A Cause for Concern

We want to emphasise here that everything we’ve written about above does not concern the bulls at all right now. They’re just interested in the prices of their stocks going up and nothing else.

After all, the sentiment is very positive. No one wants to hear any words of caution. If you talk to anyone with money in the market right now, they are likely to be bullish. In fact, it's hard to find a bear these days on Dalal Street.

Well, we are not bears either but we wouldn’t be doing our job if we did not point out the signs which you should pay attention to, some of which are not positive.

You see, the latest narrative doing the rounds is that of a pre general election rally. For whatever reason, the market now expects it. It's as if everyone wants a self-fulling prophecy to play itself out...after publicly stating the prophecy out loud.

This reminds us of the old piece of market wisdom about the market rising because it’s rising. The actual reason for the rise is not important.

This may not be a problem for the bulls at the moment. However, it's important to understand that such sentiment, if disconnected from fundamentals and valuations, were to become the norm – i.e., people buy stocks just because everyone else is buying – then stock prices will lose touch with reality.

In this scenario, the reverse price action becomes just as feasible i.e., stocks can go down for seemingly silly reasons, or no reason at all. This is something market veterans know very well.

When stock prices are disconnected from reality, then logic is replaced with emotions. Investors and traders stop caring about anything other than the price.

Thus, when stock prices begin to fall even a little bit - the reason won't be important - they will sell. Seeing this, others will sell too. Fear will replace greed. Thus, everyone will sell because that's what everyone else is doing.

This boom-bust cycle happens when investors, sophisticated or otherwise, believe that sentiment is so positive that it only makes sense to buy without asking too many questions. We are beginning to see this in the Indian stock market now.

And that is a cause for concern.

What is the Best Course of Action Right Now?

First of all, we believe in long-term investing. If you’re a short-term trader, please ensure you follow a proven trading strategy and follow rock-solid money management practices.

If you’re already a long-term investor, there are some options in front of you…

Buy more of the same stocks

Put in extra effort to find a hidden gem

Do nothing

Sell some stocks

This is fine in theory but how does one decide among these options for practical action?

Here’s how…

Buying More of the Stocks in Your Portfolio

This is a good idea if the following conditions are met:

The stocks are genuinely high quality, i.e., you didn’t make a mistake.

The fundamentals are still intact or have become better.

Your original idea for buying them is still valid or has improved.

The stock has corrected due to short term reasons.

Be very careful in assessing these conditions. Sometimes we get carried away by the quality of our own portfolios, especially if we have done a lot of work selecting the stocks. This might make us think that there are no better stocks in the market.

Putting Extra Effort to Find a Hidden Gem

If you think you can do this, we're all for it. There is nothing more satisfying for an investor than finding the next multibagger.

But this approach has a low probability of success. It's not because you won't or can't find a multibagger. It's because everyone else is doing the same. The competition is immense. You're probably underestimating your competition.

Chances are the stock you narrow down has already been discovered by the market. This does not mean that you shouldn't buy it. But expecting multibagger returns can lead to disappointment.

The 'Do Nothing' Approach

This is useful if you have a clear strategy. Otherwise, it's not productive.

If your strategy calls for no action at a time when markets are trading at expensive valuations, like they are now, then it makes sense to sit tight and wait for a correction.

But if this is not your strategy, and you're doing nothing because you don't know what to do, then it's likely you have gone wrong somewhere. It's a good idea to get back to the basics and kind an investing approach that works for you.

Selling Some Stocks

This is a good idea if the fundamentals of some of your stocks has deteriorated or if you are not comfortable with a stock in your portfolio.

Another reason could be selling a stock that has soared to astronomical valuations like a PE ratio above 100 or other similar reasons.

This is fine but you should also ask yourself what you would do with the proceeds. Do you have a plan to invest it in another stock? Or do you want to keep it in an FD? Whatever you decide, have a clear plan for the funds.

Conclusion

If the market were to fall, then high quality stocks could fall to attractive prices. It makes sense to buy them at that time.

In that case, you would have been vindicated for waiting for a meaningful decline in the market. But if a correction doesn't happen soon, you could end up waiting for a long time.

In either case, your focus should be the fundamentally strongest stocks.

You can get started by checking out our stock screener for Best Long Term Stocks in India.

Happy investing.

Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such.

This article is syndicated from Equitymaster.com