Author: Prashanth Krish

Nassim Taleb describes a black swan as : A BLAC K SWA N is a highly improbable event with three principal characteristics: It is unpredictable; it carries a massive impact; and, after the fact, we concoct an explanation that makes it appear less random, and more predictable, than it was.

Lets look at Oil and check whether it fits the definition.

Was the steep fall in oil something that was predicted: No. I know of no study that suggested oil prices will fall and fall so steeply.

Is it something that shall have a massive impact elsewhere: Yes, oil is the main currency of many countries. While many are small, we do have a entire sub-continent in Middle East which depend on oil for most of their revenues. We also have Russia which has huge dependency on Oil to balance its budget.

While there is a direct benefit to countries such as India since we pay a lower price for oil, we will get impacted too as a large part of our foreign exchange earnings comes from Indians working in Middle East and repatriating a major part of their earnings. If that is impacted, it will have an impact on the Rupee – USD which in itself will then impact on a whole lot of other industries.

And finally, are we able to con-cot a explanation for the fall: Yep, blame the shale oil for the fall say the experts. Yes, a surge in production in US may indeed have had an impact, but why was that impact not a slower process than one we have seen.

Well before oil fell, Coal prices were falling at a pretty steep pace. But interestingly that was not seen as damaging (other than for countries such as Australia / Brazil among others). The question though is, was it a fore-bearer to the crisis that is coming?

Collateral damage is pretty hard to predict. Russia is going through a crisis that seems to show no signs of ending. In 1997, they defaulted on their own currency bonds and hell broke out in most markets though India being more closed was relatively safer. But if we were to see a repeat of something on that scale, what would be the probable impact?

Much of the rise in markets has been due to the continuous flow of funds by FII’s. How much of the funds are coming from countries (sovereign funds) or funds that have exposure to oil (directly or indirectly). Last week saw them selling though the net impact was +ve due to the sale of shares by Infosys promoters. If one removes that trade, net flow is -ve. If oil is really a positive to India, why are FII’s starting to pull out now?

One of the key reasons for the sudden crash in ASEAN countries was the over-leverage by corporates and countries since the currency rate being fixed, the assumption was that it was a zero risk venture. How many of our big caps have un-heged overseas exposure that may come back to haunt them in case Rupee takes a tumble?

Of course, all is not lost as of now. Nifty trailing four quarters PE is not exactly in bubble territory. But that said, we aren’t cheap and unless we grow, even these levels aren’t sustainable.

The last time we fell from a similar PE level was in 2004 and while we did recover, the Draw-down in that year was 30% from the peak. At current Nifty, that would mean a fall to 6000, something that was seen way before the “Acche din affect”.

In one of my earlier posts, I had provided the future returns based on current Nifty PE and at 21.5 (where we were a few days ago), we were coming close to a point where we had a average gain of a few percentage points over the next three years.

I don’t believe that the way forward is by trying to predict, especially using macro views. After all, the housing bubble that was the reason for 2008 began not in 2007 but in 2005 and by 2006, it was seen as spreading like a wild weed. Markets take their own sweet time to react to events and it makes zero sense to try and trade on that. Instead, what we need is a plan, a plan on what will one do if our portfolio drops X% and what they shall do when it drops X-10%.

Every crisis is a opportunity if only you can survive the crisis in the first place. Opportunities come once in a while and only early preparation can help one not only to tide over the crisis but take advantage of the same. So, write down your plan and more importantly, stick to it.

Pundits (be on Television or Newspaper) have a way to rationalize everything that happens. Every market move is due to some or the other news. When markets are bullish, all reasons are bullish in nature and even those that aren’t turned around to mean as such.

So, if the markets are up despite there being a bad IIP nos, its explained away as Investors / Traders betting on a Interest rate cut. If it falls, of course IIP no’s were the culprit. One day the markets rise is explained by what happened in China while the next day, China does not even matter since market action was due to the downgrade of ______ (Fill up the country of your choice).

People love rationalizing. Period. Every move has to be explained by some event or the other. So, yesterday’s move down in our markets were due to selling of shares by the Ex-Promoters of Infosys while for today’s move, we have China to blame.

The interesting thing about China is that, much of the world did not even know that there existed a stock exchange in Shanghai until it started rallying in recent weeks. Today’s one day fall in the market has in a way stuck a match for the others with markets around the world falling in sync. Incidentally, Shanghai Index is way way below its 2008 highs. The relative performance chart of Shanghai vs Sensex showcases how despite being up 38% up in this year, the performance is nowhere comparable to our performance.

As in the past, China will be quickly forgotten as soon as the markets have something else to bother with. Not too long ago was Cyprus / PIIGS a big problem for the market. Right now, most cannot even remember what the issue was about in the first place.

To conclude, I am reminded of Judy Croome’s quote “Today’s news is tomorrow’s history.”. The only way to win in the markets is by sticking with a plan. News neither makes nor breaks the markets. So, stop rationalizing 🙂

Most of the top investors subscribe in one way or the other to the Charlie Munger concept of investing in stocks that one can understand. Of course, its quite another thing that most of us have literally no clue regarding how a company makes profits (other than that its products are popular and hence its making profits).

Lets take a simple Example. Bata India. Its the largest shoe company in India and at one time or the other, most of us would have bought for our-self or for family a shoe or a slipper from a Bata Store. But is the business really simple to understand. I doubt that most investors can really understand a company enough to risk serious money on the company (or any company for that matter).

I am more of a subscribe to Technical Analysis as a much simpler and better way to place our bets (we are after all, knowingly or un-knowingly betting on certain outcomes) but even here, I wonder how many a trader really digs deep enough.

Lets take a simple RSI for instance. Since it comes installed as a default indicator in most technical analysis software, most traders who use charts would have encountered the same in one way or the other. But how many really understand how the RSI is calculate, how many understand why the default number is 14, how many understand what a divergence in RSI and Price is really showcasing, how many know why 30 and 70 are seen as barriers (at least in the default version).

The other day, a friend of mine looking at a chart of Nifty with Stoch said that markets are overbought and shall fall. Of course, he is falling into the classic trap of mistaking overbought as a signal to sell. But I would not blame him since he is least bothered with what the indicator is all about as long as it provides a signal or a view to support his bias.

While reading a article today, I learnt that 42% of Americans do not read another book after they have completed their studies. With a average life expectancy of 78 years and assuming one finishes his education by the year 22 / 23, that is really a long period of no structured learning.

In the markets, it does not matter what approach you choose as long you are willing to learn everything and anything that concerns it. So, if Trend following is your poison of choice, learn all about the strategy, learn and understand what are the risks in using that strategy, what are the limitations of using trend following strategy in stocks vs using them on Indices and finally what is the reward for pursuing the strategy.

As Henry Ford says,

Anyone who stops learning is old, whether at twenty or eighty. Anyone who keeps learning stays young.

Learning about your system will help you in times when the seas are rough and the mind says that the best way forward is to abandon the ship. It can be a tremendous moral booster when the ride turns rough since once you understand the nature of your system and the reason for its current volatility, you will be much more prepared to take the next trade rather than worrying whether it makes sense to abandon the strategy in favor of another that is seeming to have succeeded during these tough times.

Research / Recommendations once upon a time required one to be connected to the right guys. Stock brokers usually seemed to be the most connected and even today, any call to a broker generally starts with “khabar kya hai” (What is the news). While stock broking in itself has come a long way since the time of out cry, the lure of news / tips has remained strong as always. Even today, in small mofussil towns, information from Bombay is seen as sacrosanct.

The advent of Internet and now Social media though has set about changes that could not be fathomed just a few years ago. These days, tips are plentiful and every other guy seems to be a expert in the market. The rules that have now been promulgated by SEBI is an attempt to ensure that there is some order to the chaos.

Hence anyone who wants to broadcast publicly his views (Television / Internet or any other public medium) is required to register himself with SEBI and provide details of his registration along with his recommendation.

A simple Google search on NSE / BSE tips turns out literally hundreds of websites peddling their wares, all for a small fee of course. With not many a site even bothering to inform as to who is the guy running the show, it all comes down to luring the chaps with promises of enabling them to make mind boggling returns. Will these guys bother to register? I sincerely doubt that since most of these are 1 man bucket shops with the intention to fleece anyone wishing to take a short cut to riches.

The rule by SEBI I believe is based on the SEC rule governing Research Analysts. But while, SEC requires one to pass a exam – Research Analyst Qualification Exam (Series 86 / 87), here all one requires is to pay a fee and register himself (if he meets certain qualifications).

SEBI has been instrumental in making the industry much safer than in the days before it came into existence when brokers used to literally do as they pleased. Broker defaults are not even heard these days even though the volume of transactions (both Qty and Value-wise) has gone up massively.

While the current step in reigning the Analysts does not meet all the requirements, it is a step in the right direction. What would be needed in future is some sort of Audit so that claims made by these research houses are backed by evidence and not just picked at random.

Gazette Notification: http://www.sebi.gov.in/cms/sebi_data/commondocs/RESEARCHANALYSTS-regulations_p.pdf

List of Registered Analysts: http://www.sebi.gov.in/sebiweb/home/pmd_mb.jsp?PmdIndxName=A&listCode=L