Does a market high automatically mean a fall? What should investors do?

Temporary market declines of more than 30%, historically has occurred once every 8-10 years

Indian stock markets witnessed a mixed performance last week. While major indices like the Nifty 50 hit a new all-time high, extending their winning streak to seven weeks, broader markets like mid-caps and small-caps faced a correction, snapping their six-week rally. When markets reach all-time highs, investors often feel uneasy and worry that it may fall from the current levels. 

And the big dilemma is this:  What if you decide to reduce your equity exposure but the market goes up further to hit a new all time high? What if you don’t reduce your equity exposure and the market falls?

Does a market high automatically mean a fall?

The short answer is no. Historically, hitting new highs hasn't necessarily signaled an imminent drop. In fact, data suggests that the market often continues to climb after reaching new peaks.

FundsIndia's research indicates that in 57% of cases, the one-year returns following an all-time high were positive.

All Time Highs automatically don’t imply a market fall. The average 1Y returns when invested in Nifty 50 TRI during an all-time high, is 14%

According to Jiral K Mehta, senior analyst at FundsIndia,  all-time highs are a normal and inevitable part of long-term equity investing. Without all-time highs, markets cannot grow and generate returns. For any asset class that is expected to grow over the long run, it is inevitable that there will be several all-time highs during the journey as seen below.

"If you expect Indian equities to grow at say 12% per annum (in line with your earnings growth or GDP  growth expectation), then mathematically it means the index will roughly double in the next 6 years, become 4X in the next 12 years, and 10X in the next 20 years.  In other words, the index will inevitably have to hit and surpass several all-time highs over time if it has to grow as per your expectation.  So there’s nothing special or frightening about all-time highs," said Mehta.

Equity Markets tend to break out and rally sharply after a few repeated patterns of “all-time highs followed by a fall” to reach higher all-time highs.  There have been frequent phases in the past where the Indian stock market gets stuck in a range for a while and tends to fall every time it hits an all-time high.  During such phases a lot of investors get frustrated and start to assume that every all-time high will lead to a market decline. But that’s not always the case.  Over time, however, after a period of stagnation the market eventually breaks out, surpasses the previous levels, continues to grow, and reaches a new all-time high.

Flashback 1: Between 2008 and 2011, Nifty 50 was stuck at 6,000 levels for some time…

"As seen above, the Nifty 50 between 2008 and 2010 hit all-time high levels around 6,000 levels two times in Jan-08 and Nov-10.  In both instances, Nifty 50 fell 60% and 28% after that.   Again in 2014, the market hit all-time high levels, and a lot of investors were already scarred by what happened in the previous two instances and assumed this would lead to another large fall.  and then came the surprise – Nifty went up by a whopping 73% and went on to hit new all-time highs," said Mehta.

For the last 24+ years, FundsIndia checked for all the periods where Nifty 50 TRI hit an “all-time high”. FundsIndia then checked the 1-year, 3-year, and 5-year returns following those “all-time high” levels. 

"The Nifty 50 TRI gave positive returns 100% of the time on a 5-year basis if we had invested during an all-time high.  The average 1Y returns, when invested in Nifty 50 TRI during an all-time high, is ~14%! (This gets even better for active funds with 20Y+ existence – HDFC Flexi cap fund and Franklin Flexicap fund – the average 1Y returns were much higher at 18% and 20%)," said Mehta.

• For Nifty 50 TRI,  47% of all-time highs were followed by 1-year returns of more than 15%
• 57% of the times – the 1Y returns exceeded 12%

This clearly shows that “all-time highs” automatically don’t imply a market fall and in fact, the majority of times, market returns have been strong post an all-time high.

So what should an investor do right now? 

Mehta has the following advice for invstors:

• Maintain your original split between Equity and Debt exposure  
• If your Original Long Term Asset Allocation split is for eg 70% Equity & 30% Debt, continue with the same (do not increase or reduce equity allocation)
• Rebalance Equity allocation if it deviates by more than 5% from the original allocation, i.e. move some money from equity to debt (or vice versa) and bring it back to the original asset allocation split 
• Continue with your existing SIPs
• If you are waiting to invest new money 
• Debt Allocation: Invest now
• Equity Allocation: Invest 30% now and stagger the remaining 70% via 6 Months Weekly STP