April 2021 Newsletter: The Urge to Predict

We say we don’t like to predict but every day prediction is what most of us end up doing. Is the market too high, Is the market going to crash, Is the RBI or the Fed going to raise Interest Rates, Is the price of Crude going to pull Inflation higher, Is … the questions never end.

When things start to do way too well, there is this lingering fear that the judgement day is not too far away. Markets for most part have been incredibly well and even that would be an understatement of sorts. 

S&P 500 for instance had a one year return of 61.50% (as of April 2021). This is the second highest one year return from any starting point it had seen since its inception. The largest one year return came post the 2008 crash (66.60% As of March 2010).

Market falls of the past were seen as shaking off the weak long position holders as well as clearing dead wood. Investors used to panic and sell out at lows only to see the markets climb back again. But for a moment there, investors were happy to have bailed out of their positions even with incredibly large losses. 

Today, Investors are so well educated that rather than jump out during market crashes, they jump in even more. Berkshire Hathaway meeting these days witness Millions log in live to hear two grandpas speak about Investing. The cult of long term investing that has been endearing to say the least. 

Stocks have been going up for so long that an idea has taken shape that if you are willing to hold on for long enough, you shall be profitable. But stocks don’t go up one way all the time. We climb up mountains, we climb down mountains and in between spend time in the valley’s.

While the number of Covid Cases and deaths continue to climb up, the markets too continue to move higher. This discrepancy is explained off by saying that markets are looking at the future and not the present or the past and in a way this is indeed true.

But the question is how far into the future is the market discounting.  Start discounting too far and you have too many edge cases that can derail the excel formulas that run many of these models. 

From the US to India, we are seemingly headed higher in terms of inflation. How high is too high before the Fed or the RBI starts stepping to stem the wave before it becomes a tsunami that is impossible to control?

From the low’s of 2016, the Nifty Small Cap 100 Index went up 130% over the next 2 years. From the low’s of March of last year, the same Index has gone up 170% in a span of just around 14 months. 

Some of this can be explained that unlike in 2016 where the Index had come out of a long time based correction but one that did not really hit big on the prices, this time around, we had seen both time and price correction (2018 to 2020) and hence even though the rise seems too much, it’s still well within reason.

Narratives generally color our ability to form a conclusive opinion. Snowflake, a US listed stock for instance, got played up on its IPO debut since it had an investment from the Legendary investor Warren Buffett. Today when it’s down  50% from the peak and back to where it opened at, none seem to harbor any remembrance. 

We have seen that in India too when prominent Investors are seen as applying or holding stocks that are coming up with an IPO. Personally I would say give an IPO stock a year before taking a call on whether it’s worth investing for many a time the strong balance sheets become weak very soon after its IPO. 

But back to the question – why are the markets heading higher even as uncertainty pervades. I found this quote from the book (More Than You Know: Finding Financial Wisdom In Unconventional Places  by  Michael J. Mauboussin) 

The practical difference between . . . risk and uncertainty . . . is that in the former the distribution of the outcome in a group of instances is known . . . while in the case of uncertainty, this is not true . . . because the situation dealt with is in high degree unique.

 —Frank H. Knight, Risk, Uncertainty, and Profit

I think this explains why the market behaved in the way it did in March 2020 when we had barely any cases of Covid versus how it’s behaving today. March 2020 was a time of uncertainty that was unique and never experienced before, today it’s a risk we know that at best will be offset over time.

Momentum has been extremely strong. My own returns for the month of April were the second best since I started out in May 2017. Stocks that were Value a few months back are today part of Momentum Portfolios This is dangerous territory for like a rubber band, if it’s stretched too far on one side, the only outcome is that it will lash back angrily. Yet, are we really too one sided?

Every bull market is different and Every crash is different. When we were trading in the dot com bubble, it’s not that most of us were immune to the valuation or the risks but a narrative of “this time is different ” was enough to make most investors want to get onto the infotech bandwagon.

In 2007, while it was housing in the US, in India it was Infrastructure and Real Estate that were the primary drivers of the narrative of a new India. 12 years later the Nifty Real Estate Index is still 43% below its peak of 2008. 

Having said that, I am yet to see any reason to be fearful of the markets. While the large cap Index itself has gone nowhere since the beginning of this year, we are seeing some really good results when it comes to individual stocks in sectors that are hot at the moment. Breadth of the markets is as good as you can get indicating that the bull market is broad and not limited to a few individual stocks.

I surmise that the first leg of a bull market is always difficult to digest for there are multiple reasons that seem to suggest that there is something wrong with the markets. All indications are we are currently seeing one such run. A fall I would seek as more of an opportunity than an indication of a total reversal of gains we have lodged until date. 

Regardless of where the market is going to go, the Virus seems to have decided to stay for now. Be Safe and Get Vaccinated at the earliest.  

Book Reco: One of the better AutoBiographies I read this month was that of Robert Souk. Starting his life as a Rice Merchant who later in life was a well known Sugar Trader (trading in future while at the same time diversifying to both growing Sugarcane as well as having his own Sugar factories), his biggest achievement would probably be the establishment of Shangri-La Hotels & Resorts. Starting from nowhere, it’s impressive that today they  own and/or manage over 100 hotels and resorts throughout Asia Pacific, North America, the Middle East and Europe. 

Amazon Link: Robert Kuok: A Memoir