5 Ways You Can Prepare For The Next Stock Market Crash

Since the financial crisis in 2008 and the major crash that wiped out alot of investors, many people are asking if this can happen again, and what are the best things to do to esure you are prepared.

Investors are caught in a great quandary. On the one hand, there are highly experienced and respected stock market analysts like Raamdeo Agrawal, Sandip Sabhrawal and Rajen Shah who are exhorting investors to take advantage of the low prices and buy top-quality stocks. On the other hand, Shankar Sharma of First Global has warned of an impending global stock market crash will send the Sensex spiraling down to a level of 16,000 in a few months time. So, what do poor investors do?

Lets' understand Shankar Sharma's logic for making the doomsday prophecy. In his interview to CNBC-TV18, Shankar Sharma gave several reasons on why a global bear market was in the offing.

First, Shankar Sharma explained that he had read the tape and it was telling him a clear story. While the emerging markets were crumbling in the wake of poor economic data, the US and European markets were still holding on. This was the reverse of what had happened in 2007 when the US & Europe markets had crumpled and the emerging markets had held on for some time before following suit. We are presently in the "twilight zone" and the US markets would soon follow the emerging markets and begin to crumple, Shankar Sharma said. Even Japan, which has had a near vertical rally, would end very, very badly, he warned.

Second, Shankar Sharma explained that the markets had yet factored in the horrifying implications of a country like Cyprus going bust. Cyprus is not isolated and it will lead to other countries also doing a rethink and there are many, many countries in Europe still which have outsized banking sectors relative to their economies. He cited the example of Malta where the banking sector is seven to eight times its national GDP.

Third, Shankar Sharma pointed out that there were serious domestic issues which made India an unattractive destination for foreign investors. The move in the Budget 2013 to treat the "Tax Residency Certificate (TRC)" as a not-sufficient condition was a "rude shock" by Finance Minister P. Chidambaram, he said. Shankar Sharma was particularly upset about the fact that while the headlines in the Budget speech was that we want to be perceived to be an attractive destination through stable taxation policies and attract global flows, we had done the opposite in the subtext.

Shankar Sharma's fourth reason was the "terrible macro situation" in India. The fact that marquee institutions like IIM Ahmedabad and IIM Calcutta are unable to get their placements of 300-400 MBAs done at all or easily in a USD 2 trillion economy told you how grim the situation was at the ground level, he said.

Shankar Sharma also cautioned that as the macro numbers were not improving, there is room on the downside for macro numbers to disappoint even from the 4.5-5 percent that has been projected lately. He also pointed out that with the macro situation being so vicious to any kind of lending, be it retail lending or corporate lending, it was absurd to think that banks would continue to keep growing earnings at 20-25 percent. Banks and autos would disappoint and take the entire market into a tailspin he warned.

Shankar Sharma also cautioned that he was extremely bearish on private and public sector banks because the earnings expectations are irrational. Going into a very slowing economy, you cannot expect banks to stand out and make a lot of money while other sectors are hurting or the consumer is hurting, he said.

Fifth, Shankar Sharma warned that what was keeping the market afloat was the exchange traded fund (ETF) money flows of several billions. However, since such funds come as a momentum driven strategy, it can reverse quickly. A sale of about a billion dollars will trigger a limit in the stock market, he warned.

On the projected levels, Shankar Sharma made the grim prognosis that the Sensex would slump to about 15000-16000 this year. He suggested that investors guard themselves by tanking up on the bear market defensives - the ITs, the consumers and the pharmas. Those are broadly the areas where investors will at least save some money. It is absolutely disastrous to stay invested in traditional economies such as metals, manufacturing, capital goods, banking and infra he said.

Now, the million dollar question is as to what you should do. It is true that you cannot ignore Shankar Sharma's prophesies. At the same time, it is true that you cannot ignore the fact that he has been horribly wrong on previous occasions. So, what I am proposing (from past experience) is the famous "halfway house" philosophy. What is I propose is this:

1 First, get rid of all the junk, trash and non-performing stocks in the portfolio. It doesn't matter how much loss you book. These worthless cretins will crumple at the first sign of trouble. Just get rid of them;

2 Make your list of top-10 or top-20 dream stocks. These will be dominant market leaders in their sector with a powerful management, good balance sheet and a strong product line. Take a look at Rakesh Jhunjhunwala Model Portfolio for inspiration;

3 Check your portfolio allocation. Make sure you have adequate resources invested in liquid/ debt funds. My personal allocation at the moment is 40:60 Equity: Debt and so I have plenty of gun powder left to take advantage of lower prices;

4 Buy in driblets. On a regular day, buy a bit of your favourite stocks. On a bad day, buy a bit more (maybe, double) of your favourite stock. This way, if the stock price slumps, you get to buy more and average your cost

5 By next Quarter (June 2013, September 2013) we will know for sure whether Shankar Sharma's prophecy is coming true or not. We'll review the position then.

Till then, its' action stations. All hands on deck. Get ready to battle the barbaric and marauding Bears. Take no prisoners.

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