Equity markets have been under a correction phase for more a year now; Nifty topped out in Oct’21 and is now back to near highs. In fact, last month’s close was an all time high close for Nifty on a monthly basis and 1st ever close above 18000 levels.
Though such market corrections are not good from the return’s perspective, but they play a very important role. Such market corrections are the bedrock from which new trends emerge and thus a market correction provides a very good opportunity to upgrade one’s portfolio by rotating capital from old trends to new emerging trends.
This rotation is extremely important because every new market cycle is led by new trends and most of the old trends becomes weak. Trends that can continue to outperform across multiple market cycles are very rare. And thus, it is imperative for an investor to use such a market correction as an opportunity to progressively exit stocks that are not doing well and add new stocks that are showing strength.
Understanding different phases of a market correction is important to carry out this rotation-
The following snippet from Coatue provides a good insight on the qualitative aspects of what happens across different phases of a market correction.
But a more quantitative way to look at above phases is to look at relative performance of a stock’s price compared to an index like Nifty. Leading stocks are always more resilient to market corrections and this price action strength provides a very good signal of which stocks are leaders and which are laggards.
Using this price action as a tool, the different market correction phases can be described as follows-
Phase I- During the initial phase of market correction, almost everything corrects. During this initial phase, it is very difficult to differentiate leaders vs laggards. And thus, during this phase, one might not find new opportunities to invest in. But the stocks that show strength during this initial phase of correction are typically the strongest stocks and leaders of the next market cycle.
Phase II- During this phase, market takes a breather and there is slight recovery. And this is when one gets some initial signs of leadership. Future leaders recover much faster & much more than the Index, while laggards hardly recover. During this phase, one can find a lot of new opportunities that are showing strength and should look to capitalize on these newer opportunities.
Phase III- During this phase, the divergence between Leaders & Laggards is much more evident. Leaders starts hitting news highs much before the index does and laggards in most cases will break their earlier lows. And this is when it is very important for an investor to cut out the laggards in the portfolio and rotate into new opportunities that are showing strength.
What investors do in Phase II & III is what determines how well they will do in the coming bull market.
To get a better perspective & understanding of above, consider the following chart-
The above chart is a slide from our September’22 concall, wherein we shared with our members how this rotation has played out for us. We have taken the daily chart of Nifty for last 1-year and added our stock actions on top of that.
(Exits are highlighted in RED)
We started Surge towards the end of Feb’22, at that time the market was already under correction and thus we were cautious and recommended only 8 stocks wherein we believed that fundamentally there is enough upside and price action was also showing strength.
During the Phase I of correction, which was till June, we could hardly find new opportunities as there were very few stocks that were showing strength and were able to add only 3 new ideas.
One of the 1st stocks we added during this period was Vadilal Industries. The stock was clearly showing strength and started making new highs in March-April, even when everything else was correcting. Fundamentally the stock was seeing a strong momentum from its US business.
You can read the full research on Vadilal here-
The market bottomed in Jun’22 and then made a good recovery. This was the Phase II of the market wherein we got an initial sign of leadership and we were able to add a lot of new ideas which started making new highs even before the index. At the same time, we could see that some of our earlier ideas which were old trends of last cycle were clearly showing weakness. While the index made a good recovery, these stocks were moving sideways. This was the initial sign of weakness for us.
From mid Sep’22 onwards, the market again started correcting (Phase III) and this is when we could see clear signs of leadership. The stocks we added during Phase II were clearly showing strength and stocks that were showing weakness during Phase II started making new lows. And this is when we aggressively started cutting our losers and continued adding new emerging leaders.
As we are sitting at near new highs for the index, we have seen a significant rotation from old trends to new trends and that provides us a strong base for the coming bull market.
In summary, market corrections are an important period to refresh portfolio. Market is near highs now and thus it is important that one holds stocks that are showing signs of leadership and are making new highs before the index, rather than holding stocks that are making new lows.
If you have not refreshed your portfolio, it is high time to do so, it is still not too late.
Also, if you are looking to jump start this process for yourself, do consider Surge’s Membership. We have a lot of interesting ideas that we have recently added, that you can consider for your portfolio.
Disclosure: www.surgecapital.in (here in referred to as Surge Capital) is a domain owned by Ankush Agrawal. Ankush Agrawal offers independent equity research services under SEBI (Research Analyst) Regulations 2014. SEBI Registration No: INH000008941.
The above blog and examples given are in no means a recommendation in any manner and should be used for educational purposes only. We may or may not have vested interest in the examples above.