Updated a couple of paragraphs at end.
Getting the right perspective #Nifty
Updated a couple of paragraphs at end.
Author: Prashanth Krish
Getting the right perspective #Nifty
As long as the going is good, one has not a care of the factors that are driving or the factors that are being ignored. But as soon as the markets start to react, all the worst kept fears start coming up as the reasons markets may continue to fall and even though markets are already down quite a bit, commentators make it seems that this is just the start of a massive fall that can continue for long.
Since 2008, every fall (and we have seen a nice intra-year correction every year, but more of it later) is seen as the start of the fall which will be similar if not even more severe than 2008.
In 2013, markets made the low of the year on 28-08-13. On that day, we closed 14.58% below the highest close of the year. The key reason ascribed for the fall was “US military action on Syria”. Of course, while Syria continues to burn, markets themselves made a splendid recovery.
Its interesting how media can blow up news to make it seem that the End of Day is nearby. This India Today (Link) report seemed to suggest that the end for India was near – Doomsday being the word used. Do check the date of the report – its a day before markets bottomed out. Markets closed the year flat (gaining around 20% from the day of the low).
23rd of May 2012 was when markets made the low of that year. On that day, Economic Times carried a article which quoted the following
“It seems all grim,” Morgan Stanley’s Ridham Desai said in a note. “The macro mix exposes India to global events more than it may choose to.” Morgan forecasts current account deficit — the excess of imports over exports — and fiscal deficit to fall this year, which will help equities.
Another reason for the crash was Greece. Remember the PIIGS? While once again, we are yet to see there being any recuperation by those countries from the hole they dug themselves into, markets recovered pretty strongly. In fact, one of the reasons that is being ascribed to the current fall comes back to the issue of Greece.
December turned to be a pretty bad month for Indian markets in 2011 as it capitulated towards the close of the hear. Instead of having a Santa Claus rally, we saw the fear of Halloween. The whole year as such was one of bearishness but the final cut came as RBI did not cut CRR as markets expected in face of a weak IPP indicated a economic slowdown. Analysts were worried about the worsening asset quality of banks, especially those in the public sector.
While markets did not recover in 2011, we saw one of the best rallies with the start of 2012 with January and February posting a very strong up-move.
The average draw-down we see every year comes to around 13% and this year, we had not seen a deep draw-down till date. Even after today’s fall, we have fallen just 5.43% from the peak of the year.
As the above chart clearly lays out, from the top for the year, Nifty has in no year retraced less than 10.66%. Some food for thought, eh 🙂
I strongly believe that the current situation is not anywhere close to what we witnessed in 2007 / 2008. By almost all parameters, we are much better, much cheaper and better equipped to handle any fall out that may arise out of international events. But with markets becoming volatile, its easy to lose perspective and go with the herd. The herd unfortunately as evidence has pointed out many a time in the past tends to act wrong at the worst possible time.
In my earlier view on Nifty, I had said that this time maybe different. While markets had immediately bounced back, the reasoning I had was not unfounded and I believe that even now, some more pain maybe on the cards. But instead of rushing to the exit, that maybe the best time to load onto stocks that you had missed when it had rallied earlier.
What now for DLF
DLF seems to be having an awfully bad time. First came the CCI order which for now has been upheld by all the courts where it approached for its squashing. Next came the decision of HSIIDC to cancel 350 acres allotted to it. As in case of the earlier order, its at its last appeal process at SC. And now comes the SEBI order banning the company and its promoters from accessing the market for 3 years for what is quite clearly a fraud. That it took SEBI 7 years to come up with this says a lot about the slow cycle of justice in India.
I have never been a fan of Real Estate companies and the way the Realty Index has acted in these many years just confirms as to how ridiculous a investment it could have turned out to be.
With the stock crashing 28.6% yesterday, the question on top of the mind is whether there is value in bottom fishing. After all, bottom fishers in Wockhard, Satyam have been amply rewarded for the risk taken. I defer though in case of DLF (though for now, I have turned out to be wrong in case of Wockhardt).
DLF is what could be called “Politically linked company” and I am sure owes a large part of its growth to that link which helps in various ways. Unfortunately, this political mileage can cut both ways and for now, DLF seems to be on pretty sticky ground.
The fundamentals of the company is pretty bad. 5 Year compounded sales growth is -5.75%, 5 Year compounded profit growth is -26.78% and 5 Year compounded ROE is at 4.73% (All data from www.Screener.in). With yesterday’s fall, market capitalization of the company is at sniffing distance of its Debt, something that tells its own story.
FII’s own a large part of the free sharholding in the company. I assume that this is due to DLF being a proxy to exposure to Indian Real Estate as well as compulsion due to DLF being part of Nifty. But if rumors circulating about the stock being excluded are anything to go by, one may see further pressure on the stock as Institutions start to exit enmasse.
On the other hand, DLF is no small company to go down without a fight and I wonder as to at what price, market shall realize that its something that is worth risking. Unlike many Infra companies where debts exceed the assets owned the company, DLF indeed has assets which should be more valuable than the total debt it has.
The book value of the company is 154 and I wonder if at a price of around 75, the stock makes for some high risk buying. After all, its when blood is on the street that valuable assets are available for a price that is lower than what it ordinarily would have sold. On the other hand, with quality companies available (sector being the same), there is also this line of thought that there is no point in trying to catch the proverbial falling knife when the same risk could be taken with a good share and one where the probability of success is much higher.
Since the stock is hitting all time lows, there is no point in looking at the stock technically until it starts trend reversal happens. All in all, I think at the current juncture, buyers of this stock would be literally buying a lottery ticket though the jackpot at best maybe 2x the investment and even that could take years to come.
Eliminating Mistakes
Mistakes are the hubris of most investors / traders and its no wonder they generally are doomed to fail regardless of what superior qualities they may possess elsewhere. But many investors and traders who aren’t affected by that characteristic still fail and the reason for the vast majority of them comes down to avoidable errors, some that they knew about and did not implement and some they did not even know about (the Unknown Unknown).
Right from Warren Buffett to the ordinary investor, mistakes happen by everyone. But while the professional investor understands and rectifies his mistake, the amateur investor believes that the mistake is not his but his bad luck.
The biggest mistakes happen due to the fact that we ignore the Heuristic Biases that affect our way of thought, way we understand things and how we go about implementing them. I come across investors who choose to ignore such biases rather than learn how to avoid the traps laid out by such biases.
I am generally a skeptic of strategies which cannot be tested using a software and while patterns can be tested, ability to code and test is not something I have the ability and hence will rather ignore such strategies than do a manual test which shall suffer from all kinds of biases (Selection of only those that have succeeded being the major bias here). Again, I am not suggesting that patterns aren’t a way to make money in the markets. After all, one of the top Hedge Funds with incredible returns is rumored to use patterns (though they aren’t the general ones we find in every TA text book).
The other day I met this friend of mine who believes in patterns and he was saying about how high a success rate this particular pattern had. The only catch being that you need to recognize it correctly. Wanted to inform my friend that this is a circular logic that leads to one over-estimating the predictive nature of the pattern, but then again, have burnt too many bridges trying to correct the logical errors of others and hence kept quiet.
The same error affects Elliot as well. If the move is not as per what Elliot logic predicts, the way out one is told is to go back and change the wave counts till the current action matches the one that was supposed to happen. If only the broker allowed me to change my trades after they failed 🙂
Every mistake in markets costs not only in terms of money but also can wear us down to the extent that after X number of losses (many of which could have been avoided), we feel that the mistake lies in us coming to the markets in the first place. The churn ratio at any big brokerage firm shows how a large set of investors and traders bow out every year just to be replaced with new sheep most of whom too will bow out in time.
Elimination of mistake requires two things. One, the ability to understand that you are wrong (and not the market) and Secondly, the openness to accept that my chosen method / path / logic is wrong and try to see where and how one can make amends to that.
Checklist is now seen as a proven way to reduce and eliminate mistakes that we have either made earlier or know about it. If you are yet to read The Checklist Manifesto by Atul Gawande, I urge you strongly to do as soon as possible. A checklist before you commit a trade is one of the easiest way to eliminate simple mistakes.
Once known mistakes are reduced, the next step comes in trying and reducing mistakes that we do not know we are making in the first place. Compared to the ability to reduce mistakes that we know is happening, this is quite difficult but not impossible.
To me, eliminating the unknown unknown mistake requires constant effort on part of the investor / trader. Profits occur due to combination of Luck and Skill. There are quite a few ways to separate the two – Bootstrap and Monte Carlo testing being the ones I prefer and use.
Every trade / investment has a expected return and a real return. One needs to constantly check for divergence between them and then focus on whether the divergence is due to something that can be avoided / acted upon or something that we just have no control upon.
Eliminating mistakes is a process and it has no ending since our aim always has to be becoming a better investor today than one we were yesterday. But that requires quite a bit of effort and that can come only if you are passionate enough as well as have the ability to understand, accept and rectify mistakes. If you cannot do that, its always better to invest in MF’s / ETF’s and spend the time in activities that bring pleasure to your mind.
Investing / Trading has no shortcuts to success. You either are the hunter or you are hunted. The choice is yours as to what you want to become 🙂
When not to throw the towel
Strategies are dime a dozen in markets. While broadly speaking, we have 3 major strategies – Fundamental / Technical and Quantitative, each of them in-turn have more strategies than your fingers can count. And best of all, each and almost every strategy has its day in the Sun. What it means is that I can always pick and choose as to why this strategy is something that should be followed using my knowledge of Hindsight bias, Selection Boas and Survivor Bias.
But if one dig’s a bit deeper, one can see why many a strategy are not worth pursuing. Most fail and ironically they fail at the exact moment you need them to support your cause.
It does not matter how much one reads about having the discipline to stick to a strategy come hell or high water, its easy for us to find ourselves vulnerable to the very Greed and Fear which we are told to overcome. My own belief is that the more we understand our system better, the higher the chance that we will stick when the going is bad so as to enable us to make the best of it when the turnaround comes.
Take a strategy such as Trend following for example. While on one hand it seems pretty simplistic and easy to follow, the truth is that trend following is a difficult way to make money in markets. Most strategies of trend following nature have a negative win-loss record (in other words, more losses than wins). While a strategy is good if it has positive expectancy and beats the underlying on a Buy & Hold basis, that in itself counts for nothing when the chips are down.
Most trend following systems not only have a inferior win loss ratio but also has a distinct disadvantage in terms of serial losses. Most systems I have tested have serial losses of 8 or more (13 in one instance). While numbers alone do little justice to the pain, just think about it as falling down 13 times in a row while in a marathon race. Not only every competitor you see has moved forward (one never sees behind, its always forward :P), but one now has to recover from the self inflicted (as our mind tends to make us believe) injuries.
Its in these depressing and dark times that most people lose their nerve and abandon their strategy, a time which in hindsight shall prove was when they should actually have been loading up for the good times ahead. But at the moment when the decision was made, it looks like the best decision under the said circumstances.
So, the question is, how to overcome such repeated acts of omission and commission owing to our inability to overcome many of our heuristic biases?
To me, the best way is to understand in depth the vulnerabilities of the strategy we choose to apply. No strategy provides a one way road to riches and in markets, unless you are a seller of a tip service, you cannot have a strategy that has a 99% win record. Once you have understood the philosophy and its draw-backs, the “throwing in the towel” will not happen as regularly as before.
For instance, if your back-test has shown that your worst streak was a 13 trade loss, you will need to stay with it and not lose sleep when you hit the 7 trade mark since this is something that has happened and should be expected too. Heck, since I believe (and have using OOS samples found evidence) that the worst draw-down is the one in the future one should expect even that high number of 13 to be broken forward sometime in the future.
Once you know and prepare for your worst case scenario, you know that you have reduced your ability to fail at the crucial moment to a very small degree, something that you can control.
This time its different #Nifty
After weeks of nightmares about how to fund today’s Marked to Market margin, Bears finally had something to be happy with Nifty cracking by 1.3% by end of day. While a 1% fall in markets should be common enough, it was something that was missed in the last 24 days.
In a bull market, one is told that the best way to participate would be to buy on every dip. While it makes a lot of sense in theory, the question is how to apply it practically. After all, how does one know whether we have seen that dip or not.
Unlike most pundits on Twitter and Television, I do not have a crystal ball to say where one should Buy or Sell. On the other hand, with the help of some Statistics, its possible to compare contexts with how markets have behaved historically and come to a educated guess.
Lets first start with the most basic question. Have the markets gone up too much too fast? In the last one year, markets have gone up by around 60% and considering the circumstances in which this has happened (change of government, US markets in a strong bull market, economy seeming to show signs of bottoming out among others), this is something that is acceptable. After all, markets discounts the future and markets believe the future is pretty good compared to the immediate past.
The key difference between the current bull market and the one’s we have seen previously (2000, 2003, 2009) is that those rallies were born out of pessimism. Markets had become pretty cheap (when measured via trailing Nifty PE), we started off the rallies with Nifty PE being around 10 whereas in the current instance, markets started off without being too cheap (we never dropped below 15).
Today, Nifty 4 Quarters trailing (Standalone) PE stands at 21.09 and just a few days ago tested the 1 Standard Deviation. Coincidentally, this is the same level from which markets reacted in 2003 (chart below) and while the circumstances are hugely different, some reaction from this level maybe given as per this data.
Previous bubble burst’s have happened when Index was well over teh 2nd Standard Deviation (and pretty close to the 3rd), so in this instance, we can rule out the possibility that the current rally was a bubble and the hope that this may result in a straight line fall.
This rally has been different in a lot of ways, much of which I believe is due to the Quantitative Easing that has resulted in a flood of liquidity resulting in most markets seeing a very low historical volatility and a constant bullish undercurrent.
Take a look at the following chart for example
The lower pane shows the number of weeks since we saw a 5% cut (on weekly). Since 2010, we have had just 1 week where markets fell by more than 5% (week ending 18th November 2011).
Now check the following chart
Between 2003 and 2008, when Indian Markets saw their best bull markets ever, we had reactions coming in constantly. The longest period we spent without a week where we saw a 5% correction was 74 weeks (compare that to 148 weeks we are seeing currently).
As much as I believe that the future looks good, the best returns are found when we buy it cheap. The markets are not as cheap but not very expensive either which puts us in a dilemma. Take a look at the spreadsheet I had posted in July of this year
As you can see, above 21, the returns over the 3 year time frame get into negative territory. Of course, this being the average, you may see a +ve returns as well, but the probability goes lower as we go higher.
Technically speaking, we have not seen a good support range appear after we broke above the previous high of 6300. Interestingly that is also a level breaking which we are sure to get into a bear market.
A 20% reaction from the current high while may not appear to be in order, we have had a draw-down of 13% (Average), something we have not seen in 2014. So, even if we were to react 10% from the high, that would mean a test of 7300 levels.
For now, fresh investing can wait till we see a moderate correction at the very least.
Process vs Outcome
A lot of things in life are based on the concept of following the right process which ensures or is said to ensure the right outcome. Study hard parents say so that you can get into the best college – a direct relationship being there between marks scored and the fact that a high score shall get one into a top notch college.
A employee works hard hoping to claim his spot when a higher position opens up or to be able to claim a higher bonus. Again a direct relationship.
In the financial markets though, such a direct relationship is always difficult to establish. Buying a good company may decrease the probability of total loss of capital but never can guarantee a good return especially when its damm difficult to really say what is a good company and what is not. In 2007, I doubt if any Analyst openly said that Bear Stearns or Lehman were bad companies. After all, Lehman was a 150+ year old company that had survived through every crash and cycle that came about in those years. Bear Stearns was a 80+ year old company.
The thought for this blog came by this article – How we made nearly $1 million on Apple stock (Link).
The story is about how a couple bet (and not a big sum) on Apple and since they have sat on it for the last 16 years have now made a fortune (or sort of depending on what you call a fortune). Nice pleasing story especially since it deals with immigrants, their emphasis on buying a good company, etc, etc.
But is it a good lesson to learn for a ordinary investor? I guess not for not only does this story has its heuristic bias faults – Survivor Bias to start with but also the investors here did break major rules relating to investing. The fact that they came out good does not make the path something others should consider to the the path of the successful.
Lets start with the fact that even after overlooking things like Taxes, the guys have not made a Million (Realized + Un-realized). But since a Million bucks sounds nice, the copy editor maybe decided, this is how I attract more eyeballs.
Coming to the faults of the investment itself. The success is the outcome of breaking two golden rules of investment.
1. Never place all your eggs in a single basket. While the report does not detail whether they had invested in other shares as well, the gist seems to be that this is their only investment – Zero Diversification. In other words, they bet their money on a single stock and it turned out to be a great investment. If it had failed (as it has for hundreds of thousands of investors), they would have lost a small sum of money (that maybe not have been even significant enough to materially change their lives).
2. Not cutting one’s losses (Stop Loss). In the aftermath of the burst of the tech bubble in 2000, the stock of Apple fell by 65% and what did our savvy investors do? Nothing. The stock fell by 61% in 2008 / 09 and once again, our investors stayed put.
This also reminds me of a the following conversation between Barry Ritholtz and James O’Shaughnessy in Bloomberg Radio’s “Masters In Business” programme.
“O’Shaughnessy: “Fidelity had done a study as to which accounts had done the best at Fidelity. And what they found was…”
Ritholtz: “They were dead.”
O’Shaughnessy: “…No, that’s close though! They were the accounts people who forgot they had an account at Fidelity.”
So, is the moral of the story being not to act and hope that the stock will eventually bounce back? I say, lack of exit strategy is one of the biggest reasons that dud shares have only retail investors as their majority investors (even the promoters bail out after a certain period of time).
Is then Buying and Forgetting the right way to deal with the volatility that comes with investments? My limited experience in markets tells me that, this cannot be true. Yes, there will be occasional stories of such success, but then again, who would want to write a story about a guy who was disciplined enough to stay with a great company that just managed to go under when the economy tumbled.
Similar stories can be read about Entrepreneurs as well. The story generally starts with how the guy started out in a Garage and now has build his company to the current multi million / billion level. What is left unsaid that 9 out of 10 ventures fail.
Luck plays a great deal in a lot of our ventures including investments in the market. The following picture by Michael Mauboussin shows the same pretty nicely.
Hind-sight is always 20/20. While much of the world looks at the results, to me, the process is as much important too.
In the field of investment, if you do not have a process, the outcome will generally be one of failure unless you are that 1 in a Million who got Lucky 🙂