Market Notes 16.02.25

Reset, When will it end, Some perspective, Risk Reward, SmallCaps, Portfolio

Disclaimer

Nothing you read here, should be construed as investment advice. I do not know your circumstance and so please treat the below as nothing more than what my thoughts are, which are subject to change without notice. Please do your own work and consult your own financial advisor. We may own positions in all stocks, sectors and indices discussed and can exit them without notice. You will very likely lose money if you use any information in this post without your own due-diligence.

Reset.

The mid and small cap indices are ~20-25% off their highs. The median stock is probably 35% off the high. The small cap bull run that started in April 2023 seems to have ended in December 2024 - a duration of ~20 months and a gain for the period of ~100%.

The ferocity, breadth and depth of this correction so far makes it look like a reset, which means that the post the initial recovery, a new set of stocks are more likely to take the markets back up rather that the leaders of the last 20 months.

The big question on everyone’s mind is how much more to go and what should we do now? I want to provide a few perspectives from my limited experience. As usual, take it with loads of salt.

When will it end?

Going by the previous corrections and the breadth, we’re most definitely in the last leg of this correction. This last leg of selling i.e. at extremes, the price is always driven more by emotions and panic where sellers sell indiscriminately and the buyers prefer to wait and watch. This leads to a very lopsided demand supply equation albeit temporarily. The prices we’ve seen on Friday and if the correction continues, the prices we will see from tomorrow onwards are not normal equilibrium prices. So anyone who is thinking of reducing exposure by selling now should be very careful. When this resolves you will see a ferocious pullback as the selling exhausts to set the demand supply equation right. When exactly that happens is unpredictable as there is no logic that can be applied here. Once the pullback comes - that is when any major adjustments need to be done, not at panic prices.

Perspective.

As things stand today after this correction midcaps and small cap returns over the last 3 years are around 70-80%. If you study the data over the long term you will see a trend. Whenever you’ve had good back to back years for mid and small caps they are always followed by a correction or subdued years. So the fact that 2025 is going to be a year of consolidation and digestion after a very good 2023 and 2024 was fairly predictable. But what’s not predictable is the extent i.e how deep or shallow will it be and how long it will last.

So what’s happening should not surprise any long term investor. We’ve seen many corrections like this one and we’ll see through this one also. It’s important to understand that these corrections are the price we pay to earn higher returns than FD. The price of higher returns in equity are periods of pain like this. There is no running away from it. Those who can take advantage of it by deploying incrementally should do it and others should at the least try to stay put for now.

What every correction has taught us without a single exception is that every correction has been a buying opportunity for the long term investor. Why should this time be any different? We’ll most definitely sail through this one and look back on this in hindsight as an opportunity. All previous corrections look like an opportunity but when we’re in the middle of one we lose all perspective.

Risk-Reward.

I see a lot of analysis on twitter about what one could have and should have done to avoid this drawdown? We need to understand one thing - there is no free lunch in the markets. Drawdowns are a cost and they have to be paid. There is no investor out there who has made big money and consistently avoided drawdowns. You can either avoid drawdowns or make money but not both. You can do it may be once or twice but not over an investing career. The best investors who’ve made the biggest wealth in the market have sat through the worst periods digesting much higher pain. This understanding is pertinent to mature as an investor. Does that mean there is no way one can avoid pain? No there is.

The risk optimization has to happen at the asset class or product selection level. If you’re someone not comfortable with drawdowns of 20-30% or more then you cannot be in a product that offers 20-30% or more cagr. A product that promises high cagr will most likely have high drawdowns. That’s the price for the higher return. There is NO product that promises you the best of the returns with the least of drawdowns. It’s just not possible. Period. Think about it even from the global perspective. Bitcoin, Tech Stocks and what have you. The equation is native to markets. No product can challenge this equation over the long term.

So if you’re not comfortable with drawdowns, stick to large caps or balanced funds knowing very well what you’re getting and what you’re giving up. You can get better returns in an FD or a balanced fund understanding this equation than some brilliant stock picker who doesn’t understand this and tries to game this equation.

The key is product selection at the outset. Asset allocation, they call it - but at the outset - not in the depths of the correction.

Small Caps, really?

The word small cap evokes a feeling of fear and risk because of how they’ve behaved over the previous bear markets. But I think fundamentally something has changed. 5-10 years back a small cap was truly a very small company with a market cap of ~1000 crores or less but now what AMFI categorises as small cap starts from 35000 crore market cap or about $4 billion dollars. So a portfolio may be called a small cap portfolio but really the businesses are not “small cap” in the way we perceive the word small cap. Not only is the size of a typical small cap much bigger today but also the quality of the managements and corporate governance and SEBI oversight is orders of magnitude more than what it was 5 or 10 years back. So the labelling of small cap or mid cap is a bit misleading unless investors really take the time to think about it.

So don’t directly equate small-caps to risky. Yes they’re relatively riskier than large caps for sure but the average small cap is not “risky” today as a business in absolute sense as they were 5 or 10 years back.

What to do?

The key thing to do is to ensure that the portfolio remains forward looking. This means replace the companies where you’re not sure of the earnings with those where you’re reasonably sure that the earnings will come through in FY26. This will be a bit of a painful exercise and it will mean selling few stocks at a loss etc and buying some things which may not have fallen as much. But it is critical that this portfolio surgery is done. Also the market is not likely to be in a mood to be very liberal with valuations for sometime now as it was over the last 18 months before this correction started. That has to be taken into account.

Like i said you need not rush to do this tomorrow and i’d rather you not do it now at panic prices, except for smaller chunks of the portfolio if need be. Any major reshuffling should happen post some stability. Now that the result season is over barring a few MNCs who have Dec year end, the next couple of months is a great time for the portfolio reshuffling. If you’re confident that the stocks you own are all doing as well as you expected them to then just stay put.

Conclusion.

To summarize and put it simply this overall correction is a correction to adjust for the slowdown in growth in 2025 - there is NO crisis so to speak. The balance sheet of the businesses and the balance sheet of India is much much superior today. We’re no longer a fragile 5. We’re the 3rd largest economy globally. This perspective is very important when thinking about Indian markets over the long term.

Having understood this, focus on getting your asset allocation right based on your risk-reward needs. Understand the risk-reward equation. There is no running away from it.

Anything that you need to do in terms of adjusting exposures, don’t rush and do it during the panic phases, let there be some stability which should hopefully come in the next few weeks or days!

Given the pain, i don’t expect a V shaped recovery back to all time highs. There will be a rebound, a choppy phase of readjustment and churn and then mostly a new set of stocks are likely to take the markets up. Some old sectors may very well comeback as an exception but that will depend on how well their earnings and fundamentals pan out.

Corrections are very much part of the game. There is nothing to worry as long as you can stick around for few years.