Why the Sensex Could Hit an All-Time High in August

July turned out to be an excellent month for global stock markets.

The US benchmark gained an impressive 8.4% during the month. The Euro Stoxx 50 and the Nikkei weren’t far behind with gains of 7.3% and 5.3% respectively.

Back home, the Indian stock market also moved in sync with its global counterparts. The Sensex rose an impressive 8.7% during the month.

In the words of Jim Rogers, a ‘spark’ of some kind was responsible for the global stock market. He was of the view that pessimism was at its peak at the start of the month.

And when everybody’s pessimistic, something happens. A spark comes along that causes a huge rally.

Rogers had pinned his hopes on the peace in Ukraine as the possible source of the spark. However, that hasn’t materialised yet.

Instead, the spark that has caused the markets to rally traces its roots to Fed Chairman Jerome Powell’s comments. He said the pace of interest rate hikes could slow sooner than expected.

As you are aware, the US Fed has raised interest rates quite aggressively over the last few months. This was to bring inflation under control. However, economists expect the pace of rate hikes to moderate in the coming months. This has boosted sentiment on the street.

Also, the earnings performance has come in better than expected as nearly 75% of S&P 500 companies announcing results that beat estimates.

Well, with the change in market sentiment, the narrative has also undergone a change.

If the headlines earlier were about how long before the stock market makes a bottom, the experts are now talking about the time it could take for the markets to reclaim their previous highs.

Here’s some number crunching by investing.com…

· Historically, the S&P 500 takes about 19 months to recover from a bear market. However, since 1982, if the bear market does not fall more than -30%, we have seen quick and consistent recoveries.

For example, in 1982, it took 3 months for the index to recover fully; in 1990, 4 months; in 1998, 3 months; in 2011, 4 months; in 2018, 4 months; and in 2020, 5 months.

Well, I have crunched the numbers for the Indian markets and my findings aren’t very different.

You see, there have been 10 instances over the last 30 years when the index has not entered a bear market (a fall of a minimum 20% from the top).

It has only threatened to do so by falling anywhere between 10% and 20%. But it never fell below the 20% mark. It instead recovered and went past the previous highs.

So, whenever the Sensex has fallen anywhere between 10% and 20% from its highs, it has reclaimed its lost ground in a little under 2.5 months on average. The maximum it has taken is 5 months. The minimum it has taken is 1 month.

Now, how does this compare with the current recovery? The current recovery is after a 16.8% fall from the top which was reached around 42 days ago.

Therefore, if the past average was to hold true, we could see the Sensex taking out its previous high by as early as the end of August.

In other words, if we don’t enter a bear market and if the recovery continues, we could see Sensex making a new lifetime high inside the next one month.

This is indeed a big U-turn from how things were just a couple of months ago.

Now, what should an investor do in light of this? Should you buy more stocks now that the market is likely to go up again? Or should you wait for some time before taking the plunge?

I’m sure you are aware there are mainly two ways to profit from stock price fluctuations.

The first one involves trying to forecast or predict the stock price a few weeks or a few months from now. Then buying when the prediction is favourable and ignoring the cases when it is not.

The second method involves trying to figure out the fair value or the intrinsic value of the company. Then buying the stock if its price falls well below this value and selling it when the price exceeds the fair value.

In fact, it’s only the second type of investor who’s called by the name ‘investor’ in the true sense of the term. The first type of investor is usually labelled as a trader or a speculator.

Therefore, for a trader or a speculator, it may be a good time to buy stocks right now. The market could regain its all-time high in the next few weeks unless the trend reverses again.

For a trader, the concept of fair value or intrinsic value does not matter. All that matters is whether the prices will go up or down.

However, as far as investing is concerned, the concept of fair value is of utmost importance.

In fact, I look at not only the fair value or the intrinsic value of individual stocks but also consider the fair value of the broader market.

Here’s how my strategy works.

If the broader market is undervalued based on historical data, I recommend maximum exposure of 75% to stocks and the remaining 25% to bonds.

If the broader market is fairly valued, the exposure could be 50:50.

Lastly, if the broader market seems overvalued, the exposure could come down to only 25% in stocks and the remaining 75% in bonds.

Right now, the market seems fairly valued. Therefore, one can consider an exposure of 50:50 in stocks and bonds.

Or perhaps 75:25 (in favour of stocks) if one wants to be more aggressively. Coming to stocks, even fundamentally strong stocks should be shortlisted the same way. Focus on whether they are trading at a discount to their fair value or not.

Thus, as the market moves up over the next few months, one can reduce allocation to stocks and move into bonds. And if the market falls, increase exposure to stocks.

This approach will ensure you don’t get a bad return on your investments. This is because toggling between stocks and bonds, takes care of the biggest mistake people make while investing i.e. buying high and selling low instead of buying low and selling high.

Happy Investing! This article is syndicated from Equitymaster.com

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