It is tough to ignore the fact that the Nifty 50 has roughly doubled from the lows that it hit one year ago. During this period, a strategy of buying the dip has given excellent returns. That doesn’t mean that this ‘buying the dip’ strategy will work in the future as well. 

A lot of ink is spilled on words like, ‘bull market’, and ‘bear market’. There are no clear and precise definitions of either of these terms. So, I’ll just ignore the semantics and focus on the fact that as on date, nothing looks cheap from a historical perspective. The problem is that markets are forward looking and historical perspectives aren’t of much use when we want to select stocks.

In my opinion, we are likely to have a scenario where economic growth trends higher, corporate earnings too are higher, but the market multiples on those earnings are either lower or flat. The reason being, future expectations are already baked into the current market prices of most stocks. That brings us to the concept of a sideways market. 

Apart from bull and bear markets, there is another type of market and that is known as a sideways market. A sideways market is one in which the benchmark (Nifty 50) barely changes over time; it is one that doesn’t have any easily identifiable or discernible trend. Sideways markets tend to trade in a broad range; even the edges of the range aren't defined, they too keep changing in a non-material manner. Nobody can define the precise range in which the market will trade, but it is possible to estimate whether one is closer to the top of the range or to the bottom.

Savvy traders can exploit the trading range to their advantage, but that is not as easy as it sounds. So, good luck with that. One of the peculiarities of a sideways market is that there is plenty of variation in prices of the stocks that are outside the benchmark, i.e. the Nifty 50. So, even if the benchmark continues to remain in a trading range, the non-index components can move all over the place.

Currently we seem to be stuck broadly between 14,400 and 15,400 on the Nifty 50; that’s not even 10 percent. Market participants seem to be in a wait and watch mode, and that is after the Nifty has doubled in twelve months; so it’s not surprising either. There will be plenty of false signals on both sides of the trading range. Whenever the market trades outside the range, expect to read and hear the words ‘break out’. Markets ‘breaking out’ means that the market has moved decisively in a particular direction. In other words, if the Nifty 50 breaks the lower end of the range decisively, markets will trend lower and vice versa.

There are always many false break outs, but one of those break-outs will be the ‘real thing’. Which one and in which direction? We will know only with the benefit of hindsight. How long will the market remain sideways? These kind of a trend less market conditions can stretch for inordinately long periods of time. It can be weeks, months or even years. Nobody can predict that either. Predicting market directionality is dangerous, to say the least. Why do I say that?

Imagine a scenario where you had a crystal ball, and in February 2020 you had perfect foresight and were able to see that the pandemic would lead to a exponentially adverse outcome. Would you still have been able to predict that the Nifty 50 would rise from the lows? Could anyone have predicted the magnitude of the rise? And if you were indeed one of the super forecasters, were you a buyer of stocks in the second quarter of calendar year 2020? I don’t think there is any need to answer any of those questions! Hence, not buying stocks just because the benchmark has doubled doesn’t make sense to me.

There are two ways of answering the question of ‘when not to buy’. Some folks might feel that the market is richly valued and some kind of an exogenous surprise will trigger a crash. These are exactly the folks who don’t buy (and they didn’t buy in the second quarter of the calendar year 2020), when the market actually does crash!  And then there are the folks who are perma-bulls, and they seem to think that markets are supposed to climb during every single trading session. The truth lies somewhere in between. 

It is easier to answer the question of ‘when not to buy’ by first deciding one’s time horizon. The longer one’s time horizon is, the less important timing becomes. As some wise investor has said, what matters is time in the market, not timing the market. And the Buffett line is: if you aren’t willing to hold a stock for 10 years, don’t hold it for 10 minutes.

Those who have time horizons that are less than 3 years, maybe they shouldn’t be investing in the stock market at all! Anyone who has a time horizon of 3 years and above, should be more concerned with what to buy, than with when to buy.

To view this post in your browser or to share it click When not to Buy - Sideways Markets