Hold on to those quality, high-conviction stocks during market correction

Being diversified across asset classes will also help to stem your losses when the economy is recovering

The Sensex fell from 61,235 on January 13 to 57,491.5 on January 24, registering seven days of losses. The heightened volatility in the equity markets has unnerved many novice investors, who have only witnessed a bull run since April 2020.

Fed tightening causing jitters

Globally, market participants are focused on the potential tightening of liquidity and increase in interest rates by the US Federal Reserve. “While the US Fed had telegraphed the fact that it will raise rates this year, the minutes of its meet released recently also signaled that it is discussing cutting down its balance sheet size, which effectively means it will start sucking out liquidity. That came as a surprise to the markets,” says Vinay Paharia, chief investment officer, Union Mutual Fund. He adds that the market is now beginning to price in a reduction in the Fed balance sheet.

“Globally, there is fear that the availability of zero-cost money from the US Fed and other central banks will reduce. Global funds are now undertaking risk-off trades. They are reducing allocations to risky assets and preserving their capital by getting into cash,” says Abhay Agarwal, founder, Piper Serica, a Securities and Exchange Board of India (Sebi)-registered portfolio management service (PMS). Piper also manages foreign portfolio investor (FPI) funds out of Mauritius.

Elevated valuations in the Indian market have also made it susceptible. The latest quarterly results of a number of companies have also signaled weakness in the rural economy. Finally, the Russia-Ukraine standoff is adding to market pessimism.

Hold on to high-conviction picks

Retail investors’ response to the market decline should be governed by the conviction they have in their stock holdings. “If you had bought stocks after a careful assessment of their fundamentals and valuations, then you should not sell in panic just because the price has fallen. Rather, if the original investment thesis is intact, this price drop could be an opportunity to add to your holdings,” says Jatin Khemani, founder and chief executive officer, Stalwart Investment Advisors, a Sebi-registered independent equity research firm.

Those who have bought stocks on the basis of hearsay or tips will find it difficult to hold on to them during a steep correction, given their lack of conviction. They should seek expert advice on their holdings.

According to Khemani, averaging down blindly in such market conditions, without understanding the business, its prospects and valuation, would be a mistake. 

Avoid bottom fishing at this stage. “When markets across the globe turn bearish in tandem, they remain down for a while. So don’t go bottom fishing expecting a quick turnaround,” says Agarwal. If at all you wish to buy stocks, do so in instalments over the next few months.

Khemani warns against leveraging or dabbling in futures and options, especially in these volatile times. “One day of outlier move can wipe out years of gain and sometimes the entire portfolio,” he says. Staying power in the market, he says, only comes when you rely on your own capital.

If you have invested in one of the recent loss-making initial public offers (IPOs), which were accorded extremely high valuations based on expectations of future growth, re-evaluate your positions. “The price correction is likely to be very steep in such stocks. Instead, try to enter companies with strong fundamentals, whose valuations are gradually moving into the attractive zone owing to the correction,” says Ankur Kapur, managing partner, Plutus Capital, a Sebi-registered investment advisory firm. Those who have invested in small, poor-quality companies should also consider exiting them.

In recent times, many conservative investors have also got lured into investing in so-called turnaround or restructuring stories. “Consider exiting your positions in such speculative stocks even if you have to take a loss. Your losses will only increase in such stocks and they may not recover even when the market recovers,” says Agarwal.

The cost of capital is likely to rise in the near future. “Companies whose return on investment far exceeds the cost of capital will be affected less,” says Kapur.

Agarwal also suggests moving into quality stocks. “These stocks will decline less during the correction phase and recover faster,” he says. He suggests entering companies that are leaders in high-growth industries, have positive earnings and cash flows, and are not dependent on external capital to fund their growth.

MF investors should stick to plan

Equity mutual fund (MF) investors, according to Paharia, should stick to their long-term investment plans in a disciplined manner. They should not make the mistake of stopping their systematic investment plans (SIPs) during a market downturn. “Investors who are new to the market and who don’t have a financial advisor may invest via balanced advantage funds,” says Paharia.

Kapur suggests that retail mutual fund investors who have only invested in equity funds should diversify into fixed-income and gold as well. More evolved investors should consider diversifying into international funds and international real estate investment trusts (REITs).

Benefit from tax-loss harvesting

If you decide to sell stocks or equity funds that you think have poor prospects, you can set off your losses in them against gains in others and thereby reduce your tax liability. However, you need to keep a couple of points in mind. “Long-term capital losses can only be set off against long-term capital gains. Short-term capital losses, on the other hand, can be set off against both short-term and long-term capital gains,” says Suresh Surana, founder, RSM India.

Moreover, long-term capital gains from sale of listed shares or equity-oriented mutual fund units are tax exempt under Section 112A up to a threshold of Rs 1 lakh. “Tax-loss harvesting will not be applicable on that threshold of Rs 1 lakh,” says Surana.

How to save money through tax-loss harvesting
In this example, the investor saves Rs 44,500

	With tax harvesting (Rs)	Without tax harvesting (Rs)
Short-term capital gain on listed shares	5,00,000	5,00,000
Less: Short-term capital loss	(1,00,000)
Short-term capital gain chargeable to tax	4,00,000	5,00,000
Tax @ 15% u/s 111A (A)	60,000	75,000
Long-term capital gain on listed shares	6,50,000	6,50,000
Less: Exempt up to Rs 1,00,000	(1,00,000)	(1,00,000)
Less: Long-term capital loss	(3,00,000)
Long-term capital gain subject to tax	2,50,000	5,50,000
Tax @ 10% u/s 112A (B)	25,000	55,000
Total capital gains tax liability (A) + (B)	85,500	1,30,000
Source: RSM India