Stock Investing in Volatile Markets

From the second half of 2020 to the festive season of 2021, it was almost like equity markets were in constant party mode, unwilling to break the euphoria much even for the second covid wave. However, now there seem to be some indications that this breakneck speed may not be really sustainable with some portholes around the corner. Hence, the v-word is now trending making investors understandably wary and unsure of what to do next.

What is volatility?

Volatility is sharper price movements, be it up or down. As per Investopedia, 15% standard deviation from the mean is par for the course and generally to be expected.

Higher volatility really comes into play when it breaches this number. One good indicator to see if as an index we are approaching those signs is to track the VIX index. The India Volatility Index in short is termed India VIX. It indicates the degree of volatility or fluctuation traders expects over the next 30 days in the Nifty50 Index.

How to tackle volatility?

Volatility generally hits direct equity portfolios much harder than mutual fund portfolios as those come highly diversified.

But, even with your direct equity portfolio, volatility could be a blessing in disguise if you know how to see it from the right lens.

1) Trim out stocks that don’t fit into your long term objectives:

A rising tide lifts all boats. With euphoria, markets often go to unreasonable heights. Use this time to eliminate stocks that may not fit into your long term bill because you will get an exit at a better, more reasonable price.

2) Look at buying stocks that were on your wishlist but not among current trader favourites:

       There are good quality stocks that often face the brunt of investor disinterest in volatile times. If a particular sector is hit by a bout of bad news, often good quality stocks within those also take a punch. This is a good time to keep a watch for the stocks you aspire to and look at accumulating those. You could look at a 200-day moving average to notice which one of those are at a decent to substantial discount currently and add to your portfolio.

3) Ensure you are in high liquidity stocks:

        One of the ways to ensure you are in a good place during volatile times is to check that you are invested in highly liquid stocks. With volatility, things can often move sharply. If you want to take quick action, liquidity becomes key. Hence, check for the average daily traded volumes in all the stocks you own to make sure that none of them will leave you on a sticky wicket at any point.

4) Stay away from meme/penny/speculative stocks:

When markets are buoyant, at times investors give wind to the most unlikely stocks. However, those parties don’t last too long.  When a correction makes its way, only companies with the strongest fundamentals continue to stand their ground. Let penny and speculative stocks keep playing their role in meme creations. It is not for serious investors.

Look at metrics like Free Cash flow generation, EPS growth, ROE/ROCE to be confident about the stock picks.

5) Have a balanced portfolio:

Not all stocks move the same way. There have been phases when defensives like FMCG have held the fort while all else has crumbled around it. At other times when the economy seems to be about to take flight, banking stocks are in favour. Then we also have the phase of commodities which may be sluggish at most points but suddenly end up surging at times. Understand how the different stocks in your portfolio behave in relation to each other and arrive at the allocation that fits your portfolio mandate.

Two of the most predictable ways to do so are by market cap and sector. Check out how different indices and sectors have performed in various calendar years:

 201020112012201320142015201620172018201920202021 YTDAverage CY Returns
Nifty 5017.69-24.7028.345.8931.46-3.872.7227.584.5511.6615.0721.3011.47
Nifty Next 5016.68-32.2150.283.9744.267.666.9943.18-9.020.6515.8126.6814.58
Nifty Midcap 15017.59-32.9246.49-3.6360.019.085.2852.76-13.160.0425.3741.2317.34
Nifty Full Small Cap 10016.84-34.4138.81-8.1954.247.072.9455.97-29.44-9.2722.0151.3213.99
Nifty Auto32.65-20.3545.098.6957.180.1111.9927.49-22.77-10.5912.9414.5413.08
Nifty Bank30.11-32.5658.27-10.0264.69-9.135.4640.897.2818.20-2.7311.6315.17
Nifty FMCG29.227.2151.0211.7417.640.632.6028.8613.91-0.5413.757.3315.28
Nifty IT27.48-17.01-2.9756.8418.52-0.36-7.2311.5624.958.8055.5554.2719.20
Nifty Metals  18.61-15.738.00-32.0447.8044.87-20.00-10.8216.5568.5512.58
Nifty Pharma36.07-10.5832.6026.5942.479.67-13.94-6.71-7.65-9.4061.573.7613.70
Nifty Realty-25.49-51.9958.08-34.657.35-13.40-1.85101.45-31.6925.416.2350.857.53
Nifty Commodities2.24-34.6820.19-9.5416.92-9.2125.5032.10-15.670.4211.0044.186.95
Nifty Energy3.57-28.0312.72-0.018.82-0.4219.9337.171.4811.436.1833.068.82

You will notice that apart from Small Cap, most diversified indices are stable showing fewer colour variations. FMCG has shown itself to be the poster boy of defensive stocks with just one calendar year of slightly negative return (although in that year other broader indices gave much better returns). Cyclical sectors like metals, pharma and realty are higher volatility as can be seen from the colour variation in the chart.

The true mettle of any investor is seen by how they handle the down curves and especially rough rides. Use these tips to convert volatility from being a curse to an opportunity for realigning your portfolio.