Stock markets world over have rallied spectacularly since early March of this year. In India, the major indices have gone up 40-45% since the lows of March 9, 2009. In a matter of a less than 2 months, we have seen gains of over 100% in some large cap names as well, not to mention smaller companies whose share prices have gone up by even more.
The rally has caught most people by surprise. Just a couple of months ago, there was doom and gloom all around. With the Nifty at around the 2550 level, lower levels seemed imminent. But like always, the markets proved the consensus wrong and raced up to its current levels of 3650+
How the sentiment has turned around so quickly! We are now hearing many optimistic voices. A few are going ahead and calling it the return of a bull market. Even the not as optimistic do not expect the markets to fall to their previous lows. So what is this rally in reality? Is it a bear market rally or is it the return of a bull market? Does it stop here or does it have more legs to go up further? Are happy days back again or is it a false dawn?
Let us first look at the facts.
1.) We had last year, an unprecedented global economic recession, perhaps the worst in over 50 years. We witnessed the bursting of a 25 year long credit bubble. We witnessed economic growth in developed countries collapsing. The slowing down in developing countries feels like a recession even though growth is positive. We witnessed massive losses on asset prices. The patient had a massive heart attack and had to be wheeled into the ICU. The patient does not start sprinting the day he comes out of ICU. Economic data continues to be bad and is likely to stay bad for some time. World economic recovery would take time.
2.) Corporate earnings still face a lot of downward pressure. First, the era of cheap plentiful capital is past gone. Second, there is economic cyclicality to earnings. Third, earnings got to a higher base over the last few years. We are likely to see lukewarm corporate performance over the medium term.
3.) History does not repeat itself, but it rhymes. All previous bear markets took time to complete their course. Never have we seen a V shaped recovery out of a bear market. It is unlikely that 'this time it is different'. Remember, 'It is different' are the three most expensive words in investing. Bear markets end with revulsion as people get indifferent to stocks. They recover gradually and not like a 45% rally in 2 months. A new bull market begins with a different sector taking the lead, not by the most beaten down sectors rising the sharpest.
I think we are witnessing a bear market rally of suprising proportions. Make no mistake, a bear market rally was always on the cards, we never knew when that would happen. We never knew how large it would be. Last year, the fall was practically linear and quite spectacular. The bear market rally also has been spectacular. Like all bear market rallies, it has been sharp and swift, it has created a sense of optimism, it has given a lot of people a 'left-out' feeling and planted doubts in the minds of the bears.
The optimists say that we are moving out of the woods now. They say that markets forsee things about 6-9 months ahead of time, that they discount the future. That is not always true. Markets sometimes get things wrong. That is where crashes originate. The markets did get it right from 2003-2007. The markets got it wrong in Jan 2008, then again in October 2008. Do not fall prey to this 'wisdom' that markets always discount the future. Sometimes they are unable to do so.
Will this rally last? How long does it continue? One never knows. But lets look at a few facts again.
Early March this year, the consensus opinion was that markets would go down further. We could not fathom why anyone would buy stocks. People were talking about levels like 2100 or even 1800 on the Nifty and something like 7000 on the Sensex. That has not happened (at least yet) and the market headed higher instead.
Now people are talking about higher levels like 4000, 4100 and even 4300 if things go well. The general opinion is that the worst is behind us, the markets have put in place a bottom, that markets would not go below 3300 on the Nifty. Talking heads now opine how people have missed out the rally and how everyone is waiting with money to invest on a correction. Recall how in January 2008, with the Sensex well above 20000, everyone was saying the same thing.
When everyone thinks alike, no one is actually thinking. Its a monkey see - monkey do like behaviour. Markets have a remarkable way of proving consensus wrong. The consensus was wrong at 21000 Sensex level, the consensus was proven wrong again at the 8000 Sensex level. The stronger the consensus, the higher is the chance of it being wrong.
I perceive the consensus now to be much more on the positive side maybe not at peak levels, but getting there. No one is talking about a deep correction, say 25% or more. No one is talking about the possibility of corporate earnings not being worse than expected. Everyone is talking about a small correction, if any. Some are talking about higher levels ahead. There is a sense of being left out among investors, just like what it was back in October 2007. Back then every 6-7% correction was gobbled up intra-day as left out investors piled in. I sense something similar now.
Valuation wise, the Nifty is quoting at a PE of 17.23, with a P:BV of 2.99 and dividend yield of 1.53%. Hardly cheap; expensive in a bear market context. I thought that stocks were cheap by November 2008 end (Read my post http://shashankcurrentissues.blogspot.com/2008/12/it-is-time-to-buy-stocks.html). I do not think they are cheap anymore. Even the BSE-100 index has a PE of 18.5 now, up from 10.78 in October 2008!
Empirical evidence from history of the markets since 1991 suggests that whenever the markets have risen sharply by 30% or more in 2 months, they have usually been 15-20% lower three months from that point.
So can this rally go further? Sure it can; they say that risk-taking has returned. In my opinion, risk has returned. It is time to be cautious...
Thursday, May 7, 2009
Thursday, December 4, 2008
It is time to start buying stocks, or is it?
There is a psychological behaviour that humans, and especially investors fall prey to. This is referred to as the 'Conservatism bias'. Under the spell of this bias, once we make up our mind or take a view on the markets, we are unwilling to change our views. On most occassions, there is enough bullish and bearish data to hold a particular view on the markets. Once we make up our mind or take a view on market direction, we can see only data that supports our views and fail to observe contradictory evidence. We do not remain neutral and do not go with the flow of the markets. We seek information in the markets that supports our views. We stick with our views even as we keep losing money, convinced that we are right (and that the markets are wrong). After deep losses we may or may not get wiser, but we definately get poorer.
No investors would want to fall prey to this bias, I certainly dont. As investors, we want to keep an open mind and respect the market for what they are telling us. We do not want to be headstrong in the face of contradictory evidence.
In my previous blog (http://shashankcurrentissues.blogspot.com/2008/12/it-is-time-to-buy-stocks.html), I had argued that perhaps it was time to start buying stocks. Lest I should become a victim of the conservatism bias, let us examine if I could be wrong (and I certainly could be wrong) and what factors could potentially lead us to that eventuality.
PE derating and valuations:
I had argued that stocks are cheap; in fact they are as cheap as they ever were in the last 17 years. But 17 years does not constitute the history of stock markets. From the early 1980s, we had a large period of credit expansion and increasing leverage across the world, which probably ended this year in the form of the credit crunch. Now with deleveraging of the financial system, the era of cheap credit might be behind us, at least for a long long time. We might see stocks as an asset class being accorded much lower valuations in terms of PE ratios and other conventional valuation benchmarks. So what looks cheap on a historical basis could actually be normal under the new paradigm. I had written a post earlier (http://shashankcurrentissues.blogspot.com/2008/09/are-we-in-watershed-moment.html) arguing how we could be in an epoch making period which we are unable to recognise. Most market participants and advisors possess experience only from the period of financial leveraging. We have not seen financial deleveraging and what it could do to valuations. Money might not flow into emerging markets are it did earlier and this could lead to secular derating of stock markets across the world. If a PE ratio of 11 for the markets might have been cheap in the past, cheap in the new era could mean a PE of 8!
Corporate Profits:
The situation on corporate profits looks dismal, though we do not know whether the markets have fully discounted them in the price already. Corporate profits might be worse than widely anticipated. Earnings might fall going ahead making current valuations not as cheap as they optically look. In addition, costlier and scarcer money would dent demand and dent corporate profits, especially for leveraged players.
Globalisation:
Globalisation had a beneficial effect on prosperity across trading member countries over the past decades. Free trade has been widely hailed in its role towards wealth creation. But I am not sure we can take free trade for granted now. Under economic stress and compulsions to keep the citizens in better shape, we could see adhoc measures that could decrease globalisation based on free trade principles. USA differs with UK, which differs with France. Asia differs with USA and China want to keep its currency weak to stimulate exports. Such competitive devaluation of domestic currencies and protectionistic measures could get destructive for the world trade, and hence to prosperity. While world leaders are well aware of this, one can never be sure of how things might evolve on this front. Perhaps an year ago, this was unthinkable and globalisation was in full swing. Now we have to consider the possibility of globalisation slowing down as well.
Greater Regulation:
There is no doubt that the financial system will be subject to greater regulation post the current mayhem. In the developed world, the iron fist of the government might get a greater share in proceedings compared to the free hand of the markets. In developing countries, it could mean an attempt to prevent incidents similar to those that occured in the west. In either case, we could see greater regulation, less freedom, especially to finance. With fiscal simuli being thrown around like there is no tommorrow, it could lead eventually to higher taxes to make up those expenses and hence could lower earnings growth.
Terrorism:
We watched with horror, shock and dismay the events of terror in Mumbai last week. This has conflagrated into a big thing, and deservedly so. We might see the negative economic consequences to flow through over time. Decreased foreign investment could be the most obvious effect. Animal spirits of entrepreneurship could be also affected. More government money might get diverted towards preventing terror attacks in the future. Taxes could be raised to gather more money for this cause. Any conflict, either direct or indirect, reduces return on capital employed and hence reduces stock valuations.
Essentially, for whatever reasons, if earnings go down or if the PE ratio assigned to stocks by the markets goes down, stocks prices could go down. In addition, if there is a structural downward shift in the valuation metrics like the PE ratio, and if business environment remains tough, stocks could stay down for a long period.
All of us need to understand that supernormal returns are not possible across all time horizons in the real world. There always will be periods of above normal returns and periods of below normal returns. What causes these cycles could vary across such cycles. The bottomline is that over time, good and bad periods get evened out to result in normal returns. An example I always like to quote: If in the year 1000 A.D, any of our ancestors had invested Re.1 at 5% per annum, the value of that rupee would today be 45 quintillion US dollars!!! (One quintillion = a million trillion). This would be about 0.86 million (8.6 lakh) times the world's annual output! The interest at 5% per annum from this would be 42300 times the world's annual output! Over long (really long) time horizons, the return from most stock investments is zero! Capitalism ensures that. Even the East India Company eventually went bankrupt after practically ruling India for more than 100 years!
Now, no one in his right mind would look at returns over a 1000 years. Lets look at century returns. The Dow Jones Industrial average went up from a value of 71 in the year 1901 to 8500 currently. This is an annual return of only 4.5% (add another 3% for dividends). Anyone for the idea 'stocks for the long run'? Noteworthy is the period from 1982-1999 where the Dow went up from 875 to 11497 generating a CAGR of 15.3%. This period coincides with the begining of proliferation of financial leverage and massive credit expansion. That might explain the above-normal return compared to history. The greatest bull market in Japan from 1970 to 1989 saw the Nikkei go up from 2000 to 40000, a return of 16%; attractive but by no means spectacular! Maybe returns are mean reverting and revert back to normal long run values.
The short of this long story is that stocks today do look cheap when valued in the context of the existance of cheap money, high leverage and low taxes. The future might look very different from the past. Stocks might not be cheap in the context of more regulation, scarce and expensive money, less leverage and higher taxes.
How would the world evolve? Only time will tell.
Happy Investing!
No investors would want to fall prey to this bias, I certainly dont. As investors, we want to keep an open mind and respect the market for what they are telling us. We do not want to be headstrong in the face of contradictory evidence.
In my previous blog (http://shashankcurrentissues.blogspot.com/2008/12/it-is-time-to-buy-stocks.html), I had argued that perhaps it was time to start buying stocks. Lest I should become a victim of the conservatism bias, let us examine if I could be wrong (and I certainly could be wrong) and what factors could potentially lead us to that eventuality.
PE derating and valuations:
I had argued that stocks are cheap; in fact they are as cheap as they ever were in the last 17 years. But 17 years does not constitute the history of stock markets. From the early 1980s, we had a large period of credit expansion and increasing leverage across the world, which probably ended this year in the form of the credit crunch. Now with deleveraging of the financial system, the era of cheap credit might be behind us, at least for a long long time. We might see stocks as an asset class being accorded much lower valuations in terms of PE ratios and other conventional valuation benchmarks. So what looks cheap on a historical basis could actually be normal under the new paradigm. I had written a post earlier (http://shashankcurrentissues.blogspot.com/2008/09/are-we-in-watershed-moment.html) arguing how we could be in an epoch making period which we are unable to recognise. Most market participants and advisors possess experience only from the period of financial leveraging. We have not seen financial deleveraging and what it could do to valuations. Money might not flow into emerging markets are it did earlier and this could lead to secular derating of stock markets across the world. If a PE ratio of 11 for the markets might have been cheap in the past, cheap in the new era could mean a PE of 8!
Corporate Profits:
The situation on corporate profits looks dismal, though we do not know whether the markets have fully discounted them in the price already. Corporate profits might be worse than widely anticipated. Earnings might fall going ahead making current valuations not as cheap as they optically look. In addition, costlier and scarcer money would dent demand and dent corporate profits, especially for leveraged players.
Globalisation:
Globalisation had a beneficial effect on prosperity across trading member countries over the past decades. Free trade has been widely hailed in its role towards wealth creation. But I am not sure we can take free trade for granted now. Under economic stress and compulsions to keep the citizens in better shape, we could see adhoc measures that could decrease globalisation based on free trade principles. USA differs with UK, which differs with France. Asia differs with USA and China want to keep its currency weak to stimulate exports. Such competitive devaluation of domestic currencies and protectionistic measures could get destructive for the world trade, and hence to prosperity. While world leaders are well aware of this, one can never be sure of how things might evolve on this front. Perhaps an year ago, this was unthinkable and globalisation was in full swing. Now we have to consider the possibility of globalisation slowing down as well.
Greater Regulation:
There is no doubt that the financial system will be subject to greater regulation post the current mayhem. In the developed world, the iron fist of the government might get a greater share in proceedings compared to the free hand of the markets. In developing countries, it could mean an attempt to prevent incidents similar to those that occured in the west. In either case, we could see greater regulation, less freedom, especially to finance. With fiscal simuli being thrown around like there is no tommorrow, it could lead eventually to higher taxes to make up those expenses and hence could lower earnings growth.
Terrorism:
We watched with horror, shock and dismay the events of terror in Mumbai last week. This has conflagrated into a big thing, and deservedly so. We might see the negative economic consequences to flow through over time. Decreased foreign investment could be the most obvious effect. Animal spirits of entrepreneurship could be also affected. More government money might get diverted towards preventing terror attacks in the future. Taxes could be raised to gather more money for this cause. Any conflict, either direct or indirect, reduces return on capital employed and hence reduces stock valuations.
Essentially, for whatever reasons, if earnings go down or if the PE ratio assigned to stocks by the markets goes down, stocks prices could go down. In addition, if there is a structural downward shift in the valuation metrics like the PE ratio, and if business environment remains tough, stocks could stay down for a long period.
All of us need to understand that supernormal returns are not possible across all time horizons in the real world. There always will be periods of above normal returns and periods of below normal returns. What causes these cycles could vary across such cycles. The bottomline is that over time, good and bad periods get evened out to result in normal returns. An example I always like to quote: If in the year 1000 A.D, any of our ancestors had invested Re.1 at 5% per annum, the value of that rupee would today be 45 quintillion US dollars!!! (One quintillion = a million trillion). This would be about 0.86 million (8.6 lakh) times the world's annual output! The interest at 5% per annum from this would be 42300 times the world's annual output! Over long (really long) time horizons, the return from most stock investments is zero! Capitalism ensures that. Even the East India Company eventually went bankrupt after practically ruling India for more than 100 years!
Now, no one in his right mind would look at returns over a 1000 years. Lets look at century returns. The Dow Jones Industrial average went up from a value of 71 in the year 1901 to 8500 currently. This is an annual return of only 4.5% (add another 3% for dividends). Anyone for the idea 'stocks for the long run'? Noteworthy is the period from 1982-1999 where the Dow went up from 875 to 11497 generating a CAGR of 15.3%. This period coincides with the begining of proliferation of financial leverage and massive credit expansion. That might explain the above-normal return compared to history. The greatest bull market in Japan from 1970 to 1989 saw the Nikkei go up from 2000 to 40000, a return of 16%; attractive but by no means spectacular! Maybe returns are mean reverting and revert back to normal long run values.
The short of this long story is that stocks today do look cheap when valued in the context of the existance of cheap money, high leverage and low taxes. The future might look very different from the past. Stocks might not be cheap in the context of more regulation, scarce and expensive money, less leverage and higher taxes.
How would the world evolve? Only time will tell.
Happy Investing!
Monday, December 1, 2008
It is time to start buying stocks
“Be fearful when others are greedy, and be greedy when others are fearful” – Warren Buffet.
In reality, be greedy when others are fearful and only when there are valid reasons for being greedy.
The current environment can be best described as fearful. Investors are engulfed with fear, fear of losing money, in most case fear of losing more money. There are valid justifications of such fear. The world economy is slowing down. Many large developed nations are in recessions, people have lost so much money across asset classes. In India, there is an economic slowdown playing out. If all this was not enough, we witnessed the most terrible incidents of terrorist attacks in Mumbai that threatens to adversely impact economic prospects in the medium term. There are many valid reasons to be fearful and people are justified in being afraid of committing capital behind risky assets like stocks.
On the Indian stock markets front, they have corrected over 55-60% from their highs made earlier this year. Some stocks are down 70-90% and this includes many blue chip names as well. A spate of bad economic news has hit us and corporate results have not made us jump in excitement. We probably would continue to see more bad economic news come ahead. In the short run, stock prices are likely to go down further.
Yet, amidst all the gloom and doom, I think it is time to start buying stocks. Why? In this article, we shall look at the facts one by one and then look at the collective weight of the facts put together to try to figure out why investors should start buying stocks.
The markets have already corrected significantly. The market capitalisation:GDP ratio on the NSE now stands close to 0.6, down from its lofty value of 1.5 in Jan 2008. Prices however do not go down to zero, the productive enterprises of India are going to be valued and valuable as long as humanity exists. Yet, a large price correction is never a good enough reason alone to buy stocks. Stocks can fall and keep falling.
But at some point the fall stops as stocks get cheap and value investors step in to buy. Compounding returns by buying cheap assets is a very successful way of building wealth. Are stocks attractive now? I believe they are even as I acknowledge that what is attractive can get even more attractive.
The BSE Sensex quotes at a value of 9092 (28 Nov 2008 trading day end) implying a PE ratio of 11.62, a Price to Book Value of 2.43 and a dividend yield of 1.96% (Source: BSE Website). This compares favourably with previous lows. In fact, this is at the lower end of valuations for the Sensex since 1991. The same is the case with all other indices. The earnings yield of the Sensex stands at 8.6% which is higher than the 10 year Government of India security whose yield is around 7.2%. Stocks are yielding greater in return than government bonds. On a post tax basis, stocks are yielding more than most 1 year Fixed Deposits currently. Stock yields (earnings) rise over time but fixed deposit interests remain the same. Many stocks are currently quoting at ridiculously cheap valuations.
Over the past 17 years, there have only been 4 incidences when the Sensex got to such low valuations. This happened in Nov-Dec 1996, Aug-Oct 1998, October 2002 and April 2003. And what were the returns achieved in one years time post these periods? Here is the data:
Period________Return 1 Year hence
Nov-Dec 1996___25-30%
Aug-Oct 1998___50-75%
October 2002___70% +
April 2003_____100%
While 4 data points can hardly be a statistician’s delight to draw some inference, we have to do with whatever data we have. The data hence can only be indicative. The point to be noted however is that on every single occasion, the 1 year return has been positive, more often quite spectacular.
The PE ratios of stocks are way below their moving averages and trend lines suggesting oversold markets. Of course, you only have to look at the price to see how oversold these markets are.
India is slowing down, but the fears of an economic meltdown seem exaggerated. The last major bear market was the one between 2000 and 2003. Many blue chip stocks are currently quoting at 2003 bear market bottom valuations. And India’s GDP growth in 2002 had fallen to 3.8%. In the current turmoil, not even the most pessimistic analyst expects GDP growth to fall to those levels (although nothing can be ruled out). But stocks are already discounting an outcome as bad as that of 2002, perhaps worse. While that can still happen, it seems a trifle unlikely at this point. Yes, economic growth will be lower, but life still goes on. Good companies will not vanish. Their future profits will not go to zero; in fact they are likely to rise in the long run. We do not stop living because there is an economic slowdown. Life goes on, with some adjustments and some pain. Eventually, humans come out ahead of such circumstances. Since 1991, we have witnessed a Harshad Mehta scam in the equity markets in 1992, bomb blasts in the Bombay Stock Exchange in 1993, a boom bust cycle of 1994-97, the severe South East Asian crisis in 1997, economic sanctions on the country post Pokhran in 1998, a technology bubble meltdown in 2000, a war in Kargil, terrorist attacks on the Parliament in 2001, communal riots and plague epidemic in Gujarat, countless acts of terrorism in various cities in the country including cities like Mumbai and Delhi. And guess what? The markets still gave compounded returns of 15%+ (including dividends) over the last 17 years, even after the current crash! The Sensex still managed to move up from 999 in Jan 1991 to 9092 today! A boom follows a slowdown and at some point, things will again look up.
Let us also not forget that, generally speaking, the corporate sector is in far better shape than it was during all the previous downturns. It is perhaps better placed to endure this downturn. Be it Return on Equity or Return on Assets or other return figures, corporate India is more efficient today than it was in the past.
There are many positive macro economic factors that are going unnoticed, or perhaps being looked at with the glass half empty mindset. After the first crash in Jan 2008, the glass was half full. Now it seems half empty (or maybe almost empty). A few important macro economic variables are turning positive. First, inflation is no longer the enemy, at least for now. The central government and the RBI are trying to get more money into the financial system. This would most likely lead to lower interest rates and lower yields on debt, thereby making stocks even more attractive. A fall in interest rates boosts investments and boosts demand and also boost corporate profits by lowering their interest costs. All is positive for economic growth. Crude oil prices have come down to 2005 levels, down to 50+ USD per barrel. This is a huge boost to the India’s trade account and can perhaps counterbalance the loss in exports. Commodity prices have crashed, which though negative for commodity producers, is beneficial for commodity consumers.
So stocks look cheap on a historical basis; in fact almost as cheap as they ever were. History suggests that such occasions are infrequent but buying done at such levels rewards investors handsomely over time. In addition, today, many macro economic variables that were plaguing India since the beginning of the year have started turning benign.
Don’t get me wrong here. I am not in any way suggesting that the pain is over. More likely that we will see many more negative data points being thrown up. I do not know when good days will be back again. I suspect markets might see some more downside ahead. So would it be a wise idea to wait till all the downslide is over? If you are an investor, the likely answer is ‘no’. Investing is a game always played with incomplete information and uncertain external conditions. One has to make a reasoned judgment and take decisions decisively. One has to accept risk and accept the possibilities of making mistakes or being proven wrong. If you keep waiting for things to clear up or wait to feel comfortable again to invest, you are most likely to miss the boat altogether. Permanent bearishness or caution (or permanent bullishness) does not serve an investor well.
It is generally observed that stock markets lead economic development, what market observers call ‘discounting’, that news gets discounted into the price. We can never know whether the market has fully discounted all future bad news or not. We have to make an educated guess and a reasoned judgment and yet run the risk of being proven wrong. But we know that markets bottom out much before all bad news comes through. Bad news is an investor’s friend. At some point, it allows the investor to buy stocks cheap. If you are an investor, you welcome bad news. And you should buy when stocks are cheap. If you do not buy then, and if stocks run away, you not only look like an idiot. You are proven to be an idiot.
Having said this, bear markets do not end one fine day and then run away like a bullet train. They offer you ample time to spread your buying over time. How long is anyone’s guess, but in my judgment, you could start buying now and keep buying in equal amounts for the next 18 months. You should avoid companies that are highly leveraged or are in weak competitive positions in the marketplace. And then invest with some method of risk control, that if you are proven wrong, you don’t get hurt too much.
For most part of this calendar year till recently, I was advocating cash as king. Perhaps cash is no longer king.
Happy Investing!
In reality, be greedy when others are fearful and only when there are valid reasons for being greedy.
The current environment can be best described as fearful. Investors are engulfed with fear, fear of losing money, in most case fear of losing more money. There are valid justifications of such fear. The world economy is slowing down. Many large developed nations are in recessions, people have lost so much money across asset classes. In India, there is an economic slowdown playing out. If all this was not enough, we witnessed the most terrible incidents of terrorist attacks in Mumbai that threatens to adversely impact economic prospects in the medium term. There are many valid reasons to be fearful and people are justified in being afraid of committing capital behind risky assets like stocks.
On the Indian stock markets front, they have corrected over 55-60% from their highs made earlier this year. Some stocks are down 70-90% and this includes many blue chip names as well. A spate of bad economic news has hit us and corporate results have not made us jump in excitement. We probably would continue to see more bad economic news come ahead. In the short run, stock prices are likely to go down further.
Yet, amidst all the gloom and doom, I think it is time to start buying stocks. Why? In this article, we shall look at the facts one by one and then look at the collective weight of the facts put together to try to figure out why investors should start buying stocks.
The markets have already corrected significantly. The market capitalisation:GDP ratio on the NSE now stands close to 0.6, down from its lofty value of 1.5 in Jan 2008. Prices however do not go down to zero, the productive enterprises of India are going to be valued and valuable as long as humanity exists. Yet, a large price correction is never a good enough reason alone to buy stocks. Stocks can fall and keep falling.
But at some point the fall stops as stocks get cheap and value investors step in to buy. Compounding returns by buying cheap assets is a very successful way of building wealth. Are stocks attractive now? I believe they are even as I acknowledge that what is attractive can get even more attractive.
The BSE Sensex quotes at a value of 9092 (28 Nov 2008 trading day end) implying a PE ratio of 11.62, a Price to Book Value of 2.43 and a dividend yield of 1.96% (Source: BSE Website). This compares favourably with previous lows. In fact, this is at the lower end of valuations for the Sensex since 1991. The same is the case with all other indices. The earnings yield of the Sensex stands at 8.6% which is higher than the 10 year Government of India security whose yield is around 7.2%. Stocks are yielding greater in return than government bonds. On a post tax basis, stocks are yielding more than most 1 year Fixed Deposits currently. Stock yields (earnings) rise over time but fixed deposit interests remain the same. Many stocks are currently quoting at ridiculously cheap valuations.
Over the past 17 years, there have only been 4 incidences when the Sensex got to such low valuations. This happened in Nov-Dec 1996, Aug-Oct 1998, October 2002 and April 2003. And what were the returns achieved in one years time post these periods? Here is the data:
Period________Return 1 Year hence
Nov-Dec 1996___25-30%
Aug-Oct 1998___50-75%
October 2002___70% +
April 2003_____100%
While 4 data points can hardly be a statistician’s delight to draw some inference, we have to do with whatever data we have. The data hence can only be indicative. The point to be noted however is that on every single occasion, the 1 year return has been positive, more often quite spectacular.
The PE ratios of stocks are way below their moving averages and trend lines suggesting oversold markets. Of course, you only have to look at the price to see how oversold these markets are.
India is slowing down, but the fears of an economic meltdown seem exaggerated. The last major bear market was the one between 2000 and 2003. Many blue chip stocks are currently quoting at 2003 bear market bottom valuations. And India’s GDP growth in 2002 had fallen to 3.8%. In the current turmoil, not even the most pessimistic analyst expects GDP growth to fall to those levels (although nothing can be ruled out). But stocks are already discounting an outcome as bad as that of 2002, perhaps worse. While that can still happen, it seems a trifle unlikely at this point. Yes, economic growth will be lower, but life still goes on. Good companies will not vanish. Their future profits will not go to zero; in fact they are likely to rise in the long run. We do not stop living because there is an economic slowdown. Life goes on, with some adjustments and some pain. Eventually, humans come out ahead of such circumstances. Since 1991, we have witnessed a Harshad Mehta scam in the equity markets in 1992, bomb blasts in the Bombay Stock Exchange in 1993, a boom bust cycle of 1994-97, the severe South East Asian crisis in 1997, economic sanctions on the country post Pokhran in 1998, a technology bubble meltdown in 2000, a war in Kargil, terrorist attacks on the Parliament in 2001, communal riots and plague epidemic in Gujarat, countless acts of terrorism in various cities in the country including cities like Mumbai and Delhi. And guess what? The markets still gave compounded returns of 15%+ (including dividends) over the last 17 years, even after the current crash! The Sensex still managed to move up from 999 in Jan 1991 to 9092 today! A boom follows a slowdown and at some point, things will again look up.
Let us also not forget that, generally speaking, the corporate sector is in far better shape than it was during all the previous downturns. It is perhaps better placed to endure this downturn. Be it Return on Equity or Return on Assets or other return figures, corporate India is more efficient today than it was in the past.
There are many positive macro economic factors that are going unnoticed, or perhaps being looked at with the glass half empty mindset. After the first crash in Jan 2008, the glass was half full. Now it seems half empty (or maybe almost empty). A few important macro economic variables are turning positive. First, inflation is no longer the enemy, at least for now. The central government and the RBI are trying to get more money into the financial system. This would most likely lead to lower interest rates and lower yields on debt, thereby making stocks even more attractive. A fall in interest rates boosts investments and boosts demand and also boost corporate profits by lowering their interest costs. All is positive for economic growth. Crude oil prices have come down to 2005 levels, down to 50+ USD per barrel. This is a huge boost to the India’s trade account and can perhaps counterbalance the loss in exports. Commodity prices have crashed, which though negative for commodity producers, is beneficial for commodity consumers.
So stocks look cheap on a historical basis; in fact almost as cheap as they ever were. History suggests that such occasions are infrequent but buying done at such levels rewards investors handsomely over time. In addition, today, many macro economic variables that were plaguing India since the beginning of the year have started turning benign.
Don’t get me wrong here. I am not in any way suggesting that the pain is over. More likely that we will see many more negative data points being thrown up. I do not know when good days will be back again. I suspect markets might see some more downside ahead. So would it be a wise idea to wait till all the downslide is over? If you are an investor, the likely answer is ‘no’. Investing is a game always played with incomplete information and uncertain external conditions. One has to make a reasoned judgment and take decisions decisively. One has to accept risk and accept the possibilities of making mistakes or being proven wrong. If you keep waiting for things to clear up or wait to feel comfortable again to invest, you are most likely to miss the boat altogether. Permanent bearishness or caution (or permanent bullishness) does not serve an investor well.
It is generally observed that stock markets lead economic development, what market observers call ‘discounting’, that news gets discounted into the price. We can never know whether the market has fully discounted all future bad news or not. We have to make an educated guess and a reasoned judgment and yet run the risk of being proven wrong. But we know that markets bottom out much before all bad news comes through. Bad news is an investor’s friend. At some point, it allows the investor to buy stocks cheap. If you are an investor, you welcome bad news. And you should buy when stocks are cheap. If you do not buy then, and if stocks run away, you not only look like an idiot. You are proven to be an idiot.
Having said this, bear markets do not end one fine day and then run away like a bullet train. They offer you ample time to spread your buying over time. How long is anyone’s guess, but in my judgment, you could start buying now and keep buying in equal amounts for the next 18 months. You should avoid companies that are highly leveraged or are in weak competitive positions in the marketplace. And then invest with some method of risk control, that if you are proven wrong, you don’t get hurt too much.
For most part of this calendar year till recently, I was advocating cash as king. Perhaps cash is no longer king.
Happy Investing!
Tuesday, November 25, 2008
Imaginary Wealth
The current fall in the stock markets has wiped out about Rs. 39 lakh crores (0.8 trillion US Dollars at current exchange rates) in market capitalisation off the National Stocks Exchange since the begining of the year. This is equivalent to the GDP of India for 2007-08. The entire output of the country has been wiped out in 10 months in the stock markets!!
If you include the fall in value of other assets like commodities, real estate, etc, the total wealth destruction could go well beyond Rs. 100 lakh crores. So many people have lost so much wealth. So many investors have had massive wealth destruction.
Or have they?
Have investors really lost wealth? I would tend to think no.
Consider the following example. Lets assume that there are 4 investors A, B, C, D, each with 500 shares of stock XYZ. The current market price of stock XYZ is Rs 100 per share. So the value of each investor's holding is Rs 50000. Collectively they own Rs 200000 worth of share XYZ.
Along comes investor E and buys just 1 share of stock XYZ from investor D at Rs 110 per share. He pays D Rs.110 and gets one share in return. This price now becomes the market price for everyone. At Rs. 110 per share, the value of the shares held by investors A, B and C becomes Rs. 55000 each. The value of shares of investor D becomes Rs, 54890 (499*110) plus he has Rs 110 as cash received from the sale of 1 share of XYZ. The sum total of the wealth held by all investors now becomes 220110 (Rs 55000 each for A, B, C, D and Rs 110 as value of share held by investor E). The total wealth went up without any productive activity.
Now for some reason, E sells off the one share he had purchased from D to another investor F at Rs 90. He accepts a loss of Rs 20 (110-90), but the new price of Rs 90 becomes the market price now. Everyone who owns any share of XYZ now has to value his shares at this price. The value of shares held by investors A, B, C now becomes Rs 45000 (500*90) each. Investor D has a worth of Rs.45020 (499*90+110). Investor E has a net worth of Rs -20 as he lost Rs 20 and investor F has a share worth Rs. 90. The total value across all investors is now 180090 (45000*3+45020-20+90)
All investors, put together, have lost Rs. 40020 (220110-180090)! Just one share sold by E to F caused wealth destruction by Rs. 40020! Does it seem right? How is it possible that such an insignificant action can result in loss of wealth by such a significant amount (20% of the initial sum of Rs 200000 together)? And where has the money gone? Surely, if someone lost, someone else would have gained that amount, right? This money has to go somewhere, right?
Wrong! The wealth has simply vanished. It has disappeared into thin air! How is that possible? How can something vanish suddenly?...unless it never existed in the first place!
Precisely! There was never any wealth to begin with (or at least not as much as dictated by prices). It was all 'maya'. Just as wealth went up when prices went up, wealth went down when prices went down. All imaginary, all an illusion.
Asset prices rise even if just one buyer and one seller agree on that price. This impacts all those who hold the asset even as they do nothing to influence this price. Conversely, just one buyer and one seller who agree on a lower price of an asset are enough to get down the wealth of all others who hold that asset. We see this all the time in the markets. When markets have gap-up or gap-down openings, it is usually only one buyer and one seller who make the market.
The wealth that an investor holds lies merely in the mind of that investor and in the minds of those who agree with him. When the point of agreement changes, so does the value of the holdings in the assets. Wealth instantaneously turns into thin air. Looking at it in another way, in reality, the investor never has any wealth. All his wealth is merely illusionary, based on what others thought the wealth to be. And when others think what your wealth is, it can disappear in the blink of an eye.
So in the current meltdown, Mukesh Ambani did not lose 40 billion Dollars. He never had that to lose. K.P.Singh (DLF promoter) did not lose 85% of his wealth. He never had that to lose.
Consumerism is good. But comsuming using wealth that never exists is potentially dangerous. As people in the USA have discovered. Rising home prices gave an illusion of wealth increase. People capitalised on this 'wealth' by borrowing money from banks against this 'increase in wealth'. Banks also lent out on such illusion. Now the magic trick is over and everyone has begun to realise that all that wealth against which consumers borrowed and banks lent, actually never existed except in their minds. The ill effects are there for all to see.
Wealth is not the value of the assets we hold. Indeed, wealth is something that we value in our life and not the money in our bank account or the value of our homes and stocks. Wealth is created by productive activity and its voluntary exchange for something else, and not by a series of passing the assets' parcel at higher and higher prices. When a car manufacturer processes raw materials, manufactures a car and sells it to a consumer, wealth is created for the car manufacturer (and not to the owner of the car). When a plumber fixes a leak on our request, he creates wealth for himself. When the government taxes us to pay its unproductive employees who do nothing, wealth is destroyed.
Here's to more productive activity! Here's to more wealth for everyone!
If you include the fall in value of other assets like commodities, real estate, etc, the total wealth destruction could go well beyond Rs. 100 lakh crores. So many people have lost so much wealth. So many investors have had massive wealth destruction.
Or have they?
Have investors really lost wealth? I would tend to think no.
Consider the following example. Lets assume that there are 4 investors A, B, C, D, each with 500 shares of stock XYZ. The current market price of stock XYZ is Rs 100 per share. So the value of each investor's holding is Rs 50000. Collectively they own Rs 200000 worth of share XYZ.
Along comes investor E and buys just 1 share of stock XYZ from investor D at Rs 110 per share. He pays D Rs.110 and gets one share in return. This price now becomes the market price for everyone. At Rs. 110 per share, the value of the shares held by investors A, B and C becomes Rs. 55000 each. The value of shares of investor D becomes Rs, 54890 (499*110) plus he has Rs 110 as cash received from the sale of 1 share of XYZ. The sum total of the wealth held by all investors now becomes 220110 (Rs 55000 each for A, B, C, D and Rs 110 as value of share held by investor E). The total wealth went up without any productive activity.
Now for some reason, E sells off the one share he had purchased from D to another investor F at Rs 90. He accepts a loss of Rs 20 (110-90), but the new price of Rs 90 becomes the market price now. Everyone who owns any share of XYZ now has to value his shares at this price. The value of shares held by investors A, B, C now becomes Rs 45000 (500*90) each. Investor D has a worth of Rs.45020 (499*90+110). Investor E has a net worth of Rs -20 as he lost Rs 20 and investor F has a share worth Rs. 90. The total value across all investors is now 180090 (45000*3+45020-20+90)
All investors, put together, have lost Rs. 40020 (220110-180090)! Just one share sold by E to F caused wealth destruction by Rs. 40020! Does it seem right? How is it possible that such an insignificant action can result in loss of wealth by such a significant amount (20% of the initial sum of Rs 200000 together)? And where has the money gone? Surely, if someone lost, someone else would have gained that amount, right? This money has to go somewhere, right?
Wrong! The wealth has simply vanished. It has disappeared into thin air! How is that possible? How can something vanish suddenly?...unless it never existed in the first place!
Precisely! There was never any wealth to begin with (or at least not as much as dictated by prices). It was all 'maya'. Just as wealth went up when prices went up, wealth went down when prices went down. All imaginary, all an illusion.
Asset prices rise even if just one buyer and one seller agree on that price. This impacts all those who hold the asset even as they do nothing to influence this price. Conversely, just one buyer and one seller who agree on a lower price of an asset are enough to get down the wealth of all others who hold that asset. We see this all the time in the markets. When markets have gap-up or gap-down openings, it is usually only one buyer and one seller who make the market.
The wealth that an investor holds lies merely in the mind of that investor and in the minds of those who agree with him. When the point of agreement changes, so does the value of the holdings in the assets. Wealth instantaneously turns into thin air. Looking at it in another way, in reality, the investor never has any wealth. All his wealth is merely illusionary, based on what others thought the wealth to be. And when others think what your wealth is, it can disappear in the blink of an eye.
So in the current meltdown, Mukesh Ambani did not lose 40 billion Dollars. He never had that to lose. K.P.Singh (DLF promoter) did not lose 85% of his wealth. He never had that to lose.
Consumerism is good. But comsuming using wealth that never exists is potentially dangerous. As people in the USA have discovered. Rising home prices gave an illusion of wealth increase. People capitalised on this 'wealth' by borrowing money from banks against this 'increase in wealth'. Banks also lent out on such illusion. Now the magic trick is over and everyone has begun to realise that all that wealth against which consumers borrowed and banks lent, actually never existed except in their minds. The ill effects are there for all to see.
Wealth is not the value of the assets we hold. Indeed, wealth is something that we value in our life and not the money in our bank account or the value of our homes and stocks. Wealth is created by productive activity and its voluntary exchange for something else, and not by a series of passing the assets' parcel at higher and higher prices. When a car manufacturer processes raw materials, manufactures a car and sells it to a consumer, wealth is created for the car manufacturer (and not to the owner of the car). When a plumber fixes a leak on our request, he creates wealth for himself. When the government taxes us to pay its unproductive employees who do nothing, wealth is destroyed.
Here's to more productive activity! Here's to more wealth for everyone!
Friday, October 24, 2008
Market crash, cry babies and cheap valuations
There seems to be no end to the current stock market crash.
Today, the Indian stock markets as represented by the BSE Sensex and the NSE Nifty-50 crashed by over 10%. Some stocks fell much harder...Unitech fell 50%! If you owned Unitech yesterday, you would be half as rich today on Unitech.
Current market conditions and the crash are truly unprecedented. A great change seems to be afoot. And in times of great change, there are obvious winners and losers. So far, the bears have been winning and the bulls have been losing big time.
Some battered bulls are now crying out for help. These are not the average investors but many are so called experts that you see so many times on business channels. Many such bulls have lost money and continue to lose money. It is obviously hurting. And hence these people are calling for help from all corners.
Some people cry for a ban on short selling.
Others want rate reductions and easier money.
Some want the government to do something, as if it were the job of the government to protect asset prices in some way.
Some want hte government to set up a market stabilisation fund to prop up the markets.
Some want a change in the way futures are settled on settlement day.
Some are angry that there is no level playing field between local investors and FIIs.
Some desperately seek any kind of silver lining in bad news.
People simply want the markets to go up again and for better times to return.
I was amused to see the remarks of one such celebrated fund manager and CIO of Reliance Mutual Fund, Madhu Kela. He seemed to have anguish in his voice complaining that mutual funds are not allowed to go short in any signficant manner while FIIs are allowed to do anything. He added that he would have loved to short the market as well given a choice. I found it quite amusing.
For one, a mutual fund is not a hedge fund. It is designed as a vehicle for the average investor to participate in the stock market. Short selling has a greater risk than long only buying and it requires greater skill. By not allowing short selling in any big way, the average investor is protected against incompetence of the fund manager, if any, to sell short.
Also, if someone finds stocks cheap, he/she should go ahead and buy. Reliance mutual fund is saying on the one hand that stocks are cheap and then stating on the other hand that they are waiting with a lot of money to buy when markets stop falling. By abstaining from buying, is Reliance Mutual fund not also contributing to the fall?
And assume if mutual funds were allowed to short sell as well? Would the markets have not gone down faster as mutual funds would have come around to shorting the markets instead of the buying that some have been doing?
And speaking generally, when the markets were going up, no one was complaining about anything. Everyone was happy when the markets went up 50% in 2-3 months in Sep-Nov 2007. Now that the markets are crashing, these experts are now crying for help and lamenting about how things are biased against them.
They are behaving like cry babies. Where is the personal accountability? Anyone who made a loss, made it because they chose to invest in the markets. They and they alone are responsible for their losses. Period! They lost money because they made a bad choice and were blind to extreme events occuring.
There is no point in cribbing and complaining. There is no point in whining. Yes, there might be genuine issues with the markets and all the problems that these experts talk about might be valid. But these have existed and are not something that have been thrust upon them overnight. They were aware of these issues when the markets were going up, and hence should not complain how these caused them losses.
Markets go up and markets go down. A downcycle is a way of cleaning out all excesses of the previous cycle. Just like a jungle fire, it cleans out all existing vegetation and new life begins. When people want to sell, they will sell regardless of external artificial measures. Interfering with natural processes create dislocations in other areas and create new problems to deal with.
Having said that, till very recently, I was arguing that markets were not cheap yet. Now the picture might have changed. The markets do look attractive now, based on traditional measures.
The BSE Sensex (8701) now trades at a PE of 10.63, Price to Book Value (PBV) of 2.25 and Dividend Yield of 2.12%.
The BSE Midcap index has the same values at 8.02, 1.46 and 2.46%
The BSE SmallCap index has the same values at 5.62, 0.91, 2.78%
Same is the case with NSE indices.
Historically, these are in line (by and large) with previous lows.
But before we jump ahead and buy, we don't know how future earnings would be. We dont know whether earnings will rise, fall or stay stagnant. If they rise, how much they would rise by? And what PE multiples would the markets give the markets? So even though stocks optically look attractive, this could be an illusion as earnings fall short of expectations. But, generally speaking, stocks might be worth buying into starting now...with a caveat that I could be wrong, earnings could disappoint, markets could go down...and hence you should invest in a manner that if you are wrong, you dont lose much.
Looking at the current picture, there is no hurry to buy anyways. The next few years could turn out to be an investor's delight. He would get stocks cheap, perhaps very cheap, and would not be in any hurry to buy. Keep cash handy.
Happy Investing!
Today, the Indian stock markets as represented by the BSE Sensex and the NSE Nifty-50 crashed by over 10%. Some stocks fell much harder...Unitech fell 50%! If you owned Unitech yesterday, you would be half as rich today on Unitech.
Current market conditions and the crash are truly unprecedented. A great change seems to be afoot. And in times of great change, there are obvious winners and losers. So far, the bears have been winning and the bulls have been losing big time.
Some battered bulls are now crying out for help. These are not the average investors but many are so called experts that you see so many times on business channels. Many such bulls have lost money and continue to lose money. It is obviously hurting. And hence these people are calling for help from all corners.
Some people cry for a ban on short selling.
Others want rate reductions and easier money.
Some want the government to do something, as if it were the job of the government to protect asset prices in some way.
Some want hte government to set up a market stabilisation fund to prop up the markets.
Some want a change in the way futures are settled on settlement day.
Some are angry that there is no level playing field between local investors and FIIs.
Some desperately seek any kind of silver lining in bad news.
People simply want the markets to go up again and for better times to return.
I was amused to see the remarks of one such celebrated fund manager and CIO of Reliance Mutual Fund, Madhu Kela. He seemed to have anguish in his voice complaining that mutual funds are not allowed to go short in any signficant manner while FIIs are allowed to do anything. He added that he would have loved to short the market as well given a choice. I found it quite amusing.
For one, a mutual fund is not a hedge fund. It is designed as a vehicle for the average investor to participate in the stock market. Short selling has a greater risk than long only buying and it requires greater skill. By not allowing short selling in any big way, the average investor is protected against incompetence of the fund manager, if any, to sell short.
Also, if someone finds stocks cheap, he/she should go ahead and buy. Reliance mutual fund is saying on the one hand that stocks are cheap and then stating on the other hand that they are waiting with a lot of money to buy when markets stop falling. By abstaining from buying, is Reliance Mutual fund not also contributing to the fall?
And assume if mutual funds were allowed to short sell as well? Would the markets have not gone down faster as mutual funds would have come around to shorting the markets instead of the buying that some have been doing?
And speaking generally, when the markets were going up, no one was complaining about anything. Everyone was happy when the markets went up 50% in 2-3 months in Sep-Nov 2007. Now that the markets are crashing, these experts are now crying for help and lamenting about how things are biased against them.
They are behaving like cry babies. Where is the personal accountability? Anyone who made a loss, made it because they chose to invest in the markets. They and they alone are responsible for their losses. Period! They lost money because they made a bad choice and were blind to extreme events occuring.
There is no point in cribbing and complaining. There is no point in whining. Yes, there might be genuine issues with the markets and all the problems that these experts talk about might be valid. But these have existed and are not something that have been thrust upon them overnight. They were aware of these issues when the markets were going up, and hence should not complain how these caused them losses.
Markets go up and markets go down. A downcycle is a way of cleaning out all excesses of the previous cycle. Just like a jungle fire, it cleans out all existing vegetation and new life begins. When people want to sell, they will sell regardless of external artificial measures. Interfering with natural processes create dislocations in other areas and create new problems to deal with.
Having said that, till very recently, I was arguing that markets were not cheap yet. Now the picture might have changed. The markets do look attractive now, based on traditional measures.
The BSE Sensex (8701) now trades at a PE of 10.63, Price to Book Value (PBV) of 2.25 and Dividend Yield of 2.12%.
The BSE Midcap index has the same values at 8.02, 1.46 and 2.46%
The BSE SmallCap index has the same values at 5.62, 0.91, 2.78%
Same is the case with NSE indices.
Historically, these are in line (by and large) with previous lows.
But before we jump ahead and buy, we don't know how future earnings would be. We dont know whether earnings will rise, fall or stay stagnant. If they rise, how much they would rise by? And what PE multiples would the markets give the markets? So even though stocks optically look attractive, this could be an illusion as earnings fall short of expectations. But, generally speaking, stocks might be worth buying into starting now...with a caveat that I could be wrong, earnings could disappoint, markets could go down...and hence you should invest in a manner that if you are wrong, you dont lose much.
Looking at the current picture, there is no hurry to buy anyways. The next few years could turn out to be an investor's delight. He would get stocks cheap, perhaps very cheap, and would not be in any hurry to buy. Keep cash handy.
Happy Investing!
Not protecting yourself
You buy motor insurance for your cars. That is mandatory by law.
You are wise and buy life insurance and medical insurance (If you don't, you should)
But what about investment insurance?
For most of our lives, things keep going along the same way they always do. Today is much like yesterday and tommorrow will be most like today. And we believe that the future will be like the past.
But there comes a time when the world changes upon us, at least in the investing world. The future is hardly like the past.
When such incidences occur, past experiences do not count. Asset prices crash and crash hard. A collosal amount of wealth is lost. This has happened in the past and will continue to happen in the future...one such time is now. A massive wealth destruction has occured in the almost all asset markets, especially in the stock markets.
While we are never able to predict such events, their timing or their magnitude. But we can stay awake to the possibility of such events occuring...and have a plan to protect our wealth when they do occur.
Else, paper gains do not take time to erode into huge losses...and into horror stories.
Look at the kind of damage many bluechip stocks (all are Nifty 50 stocks) have had over this year from their highs, and especially this month (data as on 23 Oct 2008 market closing):
Stock---------Fall
ABB Ltd.------64%
BHEL---------59%
Bharti---------45%
DLF-----------78%
Grasim--------70%
Hindalco-------71%
ICICI Bank----75%
Idea-----------74%
Infosys--------46%
L&T-----------63%
Ranbaxy------62%
Rel Comm-----72%
Rel Infra------83%
Rel Petro------67%
SAIL----------71%
Siemens-------73%
Sterlite--------78%
Suzlon---------83%
Tata Motors---78%
Tata Steel-----78%
TCS-----------59%
Unitech-------89%
And falling....
Not to mention many smaller companies that have seen greater damage.
Clearly, the need to protect your investment is never more clear than in the current environment. Of course, protection should have been deployed much earlier.
Wise investors manage risk and protect themselves when things go bad. There are many ways to minimise losses. One is to risk small. The other is to stay out of large downtrends (recognise it first naturally) by either staying with cash or using derivatives as hedges.
Regardless of which method an investor chooses to use, every investor should learn how to protect his/her portfolio...and learn not to live in hope and blind optimism.
You are wise and buy life insurance and medical insurance (If you don't, you should)
But what about investment insurance?
For most of our lives, things keep going along the same way they always do. Today is much like yesterday and tommorrow will be most like today. And we believe that the future will be like the past.
But there comes a time when the world changes upon us, at least in the investing world. The future is hardly like the past.
When such incidences occur, past experiences do not count. Asset prices crash and crash hard. A collosal amount of wealth is lost. This has happened in the past and will continue to happen in the future...one such time is now. A massive wealth destruction has occured in the almost all asset markets, especially in the stock markets.
While we are never able to predict such events, their timing or their magnitude. But we can stay awake to the possibility of such events occuring...and have a plan to protect our wealth when they do occur.
Else, paper gains do not take time to erode into huge losses...and into horror stories.
Look at the kind of damage many bluechip stocks (all are Nifty 50 stocks) have had over this year from their highs, and especially this month (data as on 23 Oct 2008 market closing):
Stock---------Fall
ABB Ltd.------64%
BHEL---------59%
Bharti---------45%
DLF-----------78%
Grasim--------70%
Hindalco-------71%
ICICI Bank----75%
Idea-----------74%
Infosys--------46%
L&T-----------63%
Ranbaxy------62%
Rel Comm-----72%
Rel Infra------83%
Rel Petro------67%
SAIL----------71%
Siemens-------73%
Sterlite--------78%
Suzlon---------83%
Tata Motors---78%
Tata Steel-----78%
TCS-----------59%
Unitech-------89%
And falling....
Not to mention many smaller companies that have seen greater damage.
Clearly, the need to protect your investment is never more clear than in the current environment. Of course, protection should have been deployed much earlier.
Wise investors manage risk and protect themselves when things go bad. There are many ways to minimise losses. One is to risk small. The other is to stay out of large downtrends (recognise it first naturally) by either staying with cash or using derivatives as hedges.
Regardless of which method an investor chooses to use, every investor should learn how to protect his/her portfolio...and learn not to live in hope and blind optimism.
Tuesday, October 14, 2008
Obsessed with bottoms
Have we hit the bottom in the stock markets?
These days people seem to be obsessed about finding bottoms. Television anchors keep asking so called experts about whether we have hit rock bottom and whether prices will now stop falling.
Some think that we made market bottom last friday. Others think that the bottom is not yet made. So far, the no-sayers are winning the battle as markets have kept going down.
Bottom seekers live with the hope that if the market bottom has been identified, they can start buying again and avoid losses.
But I have a few things to say.
First, bottoms can only be identified in hindsight. Much later than today, when we look back at what happened, we should be able to say whether markets did make a bottom on 10th October 2008 or not. Sitting in the present, it is impossible to call a bottom except by pure luck.
No one can spot a bottom except in hindsight, after it has been formed. Trying to find bottoms is a meaningless exercise, an exercise in futility.
Secondly, we invest to make money, not to not lose money. While not losing a part of the game, the basic idea is to make money.
So the key issue is whether we should be able to make money regardless of whether a bottom is made or not, identified or not. Even if we are able to call a bottom correctly, if prices do not go up after we buy, we are not going to make money. In fact, we would pay an opportunity cost of not having deployed the same money into other investments like say fixed deposits (which currently are offering 10-11% returns).
What we as investors should focus on is the prospects of gains rather than finding bottoms. If we think that prices are not headed up, it does not make sense to buy even if we buy at the bottom.
Look at the prospects of gains in preference to finding market bottoms. Keep observing the market with an open mind and look for signs that the markets are headed higher.
It is better to wait for a bottom and then let the markets tell you that it is possibily going up. This is an easier task and more profitable one than trying to find bottoms.
These days people seem to be obsessed about finding bottoms. Television anchors keep asking so called experts about whether we have hit rock bottom and whether prices will now stop falling.
Some think that we made market bottom last friday. Others think that the bottom is not yet made. So far, the no-sayers are winning the battle as markets have kept going down.
Bottom seekers live with the hope that if the market bottom has been identified, they can start buying again and avoid losses.
But I have a few things to say.
First, bottoms can only be identified in hindsight. Much later than today, when we look back at what happened, we should be able to say whether markets did make a bottom on 10th October 2008 or not. Sitting in the present, it is impossible to call a bottom except by pure luck.
No one can spot a bottom except in hindsight, after it has been formed. Trying to find bottoms is a meaningless exercise, an exercise in futility.
Secondly, we invest to make money, not to not lose money. While not losing a part of the game, the basic idea is to make money.
So the key issue is whether we should be able to make money regardless of whether a bottom is made or not, identified or not. Even if we are able to call a bottom correctly, if prices do not go up after we buy, we are not going to make money. In fact, we would pay an opportunity cost of not having deployed the same money into other investments like say fixed deposits (which currently are offering 10-11% returns).
What we as investors should focus on is the prospects of gains rather than finding bottoms. If we think that prices are not headed up, it does not make sense to buy even if we buy at the bottom.
Look at the prospects of gains in preference to finding market bottoms. Keep observing the market with an open mind and look for signs that the markets are headed higher.
It is better to wait for a bottom and then let the markets tell you that it is possibily going up. This is an easier task and more profitable one than trying to find bottoms.
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