Opinion | Portfolio Yoga

Reminiscences of the Past

When I first came into the Industry, I wasn’t sure of what I wanted to become. Within a year or two though, I knew that I wanted to be a stockbroker. The reason – money. I could see good brokerage firms earning a lakh or more per month. This at regional stock exchanges. Brokers of National Stock Exchange which had just started to gather momentum after being born a few years ago were multiples of this. A lakh today is small change but in the late 90’s, this was big.

Of course, there is no free money, and neither was the brokerage earned. In the days before dematerialization made transfer of shares not just simple but zero risk to the stockbroker, it was a circus out there. When a stock was sold, the seller in the transfer deed form would put his signature and along with the share certificate give it to the broker.

The broker then forwarded them to the clearing house of the stock exchange. He would then give this to the buyer who would by then have been debited the amount for the purchase. The purchase amount was routed to the broker who would pay the client. The whole process took 15 to 21 days.

The risk to the broker who sold the shares actually began now. The shares sold would need to be transferred to the buyer. But if the company did not close the books (aka Record Date), this could be further sold. The stock certificate with the transfer deed could hence be floating around with no one transferring. This could last as long as a year. Every company closed it books at least once (Dividend / Corporate Actions) at which time, the last buyer would send the same to the company for transfer.

Now, companies took their own sweet time. The best companies took a month, the worst, you would need to follow up to get back the shares. Most of the time, the company would send back the certificate with your name in the back showcasing that you are now the proud owner of the certificate. Once in a way, the company would send back the share certificate along with the transfer deed and an accompanying latter that said, Seller Signature doesn’t match.

When this happened, the stock certificate along with the transfer deed would be given back to the stock broker he had bought from. The stock broker inturn would submit the same to the stock exchange who would then send it to the broker whose name first appeared on the transfer deed.

This could as explained taken as much as 11 months from the time of selling between which the price could have gone anywhere. Now the broker after receiving the said bad delivery had to rectify it within 21 days. What this meant was to get back to the seller, have him sign again and this time have it validated by a Bank Manager and send the Stock Certificate with the new transfer deed back to the stock exchange who would then send it to the buyer.

Many brokers faced an issue here. What if you could not find the seller. Remember, he has already taken the money. Quite a few brokers lost their membership because of bad deliveries which they could not rectify. All for around 1.5% of the selling price value.

If a broker failed to rectify the shares, the stock exchange would buy the same in an auction and debit the broker who had sold. For the broker who had already given the money to the client, he would then find himself holding a worthless certificate while being debited twice for it.

Brokers got caught on the wrong foot during bubbles like Harshad Mehta and the Dot Com bubble. Shares sold for a few rupees were suddenly worth a few thousand. One bad delivery that they could not rectify would lead to huge losses.

In many ways, it’s amazing how far we have come. While brokers are very safe, it has come at a price. Where once there were multitudes of exchanges throughout India and hundreds of thousands of brokers, 80% of today’s business I guess is concentrated among the top 25 brokers. NSE prevailed over everyone. While BSE survived, they aren’t thriving.

Brokers of the past also acted as advisors to their clients. While there have always been bad apples, there were a lot of excellent brokers who helped their clients to invest better. Today, it’s each investor to himself. Strict rules by SEBI have meant that there are hardly a few advisors who shall lend a ear.

Everywhere I see consolidation. It started with stock exchanges, moved to brokers. Advisors who survive will be far and fewer than even the few who are around today. With more transparency and costs that can be charged to investors being curtailed for Mutual Fund houses, smaller firms will have an issue sooner or later and once again, consolidation is bound to happen.

Only bright spark for now seems to be in the arena of Portfolio Management and Alternative Investment funds. Interesting times ahead

External Validations

Something I have observed and one I wonder if the one thing that is unique to the stock markets is the need for external validation. If you ask a small businessman how business is, more times than not, he will have a list of complaints and how it’s getting tougher. An investor / trader on the other hand mostly cannot stop himself. He may have 9 stocks that are under water but his focus and happiness comes from the one above. Look how I was able to pick this stock up at X. This kind of validation adds little value than making oneself seem superior.

On Twitter, this is more pronounced. Fund managers who have been successful managing tens of thousands of crores barely have much followers or speak about their achievements. On the other hand, you find guys who have bought bluetick (to seem to showcase themselves better than the cattle class) whose timeline is filled with how great they have been.

External Validation has its uses. Guys posting their Profit / Loss on Twitter are seeking to show that they have been able to crack a system that is very hard to crack. This approval can then be converted to money by conducting webinars or simply managing money of others. The top financial influencers I assume earn more than what even a fund manager with a couple of hundreds crores would make.

From the time I remember, one of the first things to arrive on the doorstep of our house was the newspaper. In some ways, reading newspapers also inoculated me to reading (though unfortunately it did not help me with my actual educational reading). While much of the newspaper is written by journalists, there is this small column “Letters to Editor” which posted letters written by readers. I wished I could have my opinion published too so I could showcase I too knew something.

Arrival of the Internet and Social Media meant that we did not have to depend on a gatekeeper to get our views out. We were our own newspapers in a way. But when a billion people start writing, curation goes out of the window and noise easily overwhelms the signals.

Not all validation is wrong either. If you have thought that you have developed a strategy that seems to be interesting, sharing it with others provides feedback that helps overcome one’s own blind spots. Most traders though think themselves more in line with Jim Simons and feel that spilling out the secret would doom the prospects itself.

The other day, I was with an acquaintance who claimed he had developed a strategy that showed gains of 200%+ in a year and without any deep drawdowns. When asked for details, he said “Proprietary”. A couple of years back, a leading advisor launched a positional trading strategy that showed massive outperformance. Details again were “proprietary”. Few months down the lane, it had lost so much money for his clients that it was shut down.

In programs like Amibroker, optimization is just a one click process. This is pure data mining with very few indications that this would work in the future

https://twitter.com/jsblokland/status/730380403429810176?lang=en

Of course, if you are a believer in Jim Simons, you then would also know that many of their strategies are based on correlation that makes little sense. If I can predict with say a 60% accuracy, if Nifty will close positive or negative tomorrow based on the weather in Bangalore today, why not make use of it till it works?

Compared to technical / momentum guys, I find value guys more open. The feedback loop helps them figure out things they are missing. The Valuepickr forum has allowed access to the best ideas as well as deeper views on companies they feel is a worthwhile buy. The ability to meet greet and discuss with the best is absolutely priceless

https://twitter.com/Sanjay__Bakshi/status/756851090197475328

When I started off with Momentum, I shared the details of the strategy with my friend, collaborator and guide @jace48 who helped me a great deal in refining the same. One year later, I more or less posted the strategy on the blog Momentum Investing – An Experiment with Real Money | Portfolio Yoga. Rather than harm, it has proved very beneficial.

As I write this, I am reminded of this tweet

https://twitter.com/LazyTRaider/status/553179829407731712

Generating Alpha is tough for Individual investors with limited time and resources. Feedback loops hence become very useful. Having someone whom you feel has the same thought process as you can be very helpful in providing feedback. The hard thing though is sharing the idea fully as well as being able to appreciate the pro’s and con’s of the advice received.

As I wrote in my previous post, choose your companions with care.

Symmetry in Thinking

When I first started going to the stock brokers office, my idea of investing was closer to value investing. But at the brokers office, all I encountered were people who were trading. In due course of time, that is where I ended up as well.

Trading regardless of whether you are profitable or not can be very addictive. The ability to see gains coming in based on a simple positioning one has taken is seductive. More so when one’s capital is small and limited. Yes, it’s nice to think that with compounding, even a small sum of money can end up being a significant sum in the long term, but one wants it today not tomorrow.

Data suggests that most trading is a negative sum game. Add taxes and it becomes a deeply negative sum game. Ed Thorp won money on a consistent basis in the Casino, but the Casino owner knows that at the end of the day, the house always wins.

Most of us wish to be rich and yet very few actually achieve it. When you study the ones who have achieved success, there are virtually none who have achieved from speculating. But speculating is as old as the hills and it keeps beckoning.

Children learn the most from their parents because their parents are with whom they spend the majority of time. In stock markets, I feel that the best ideas come when surrounded by people who are not only as knowledgeable as you but also as curious about the world as you.

I have been around folks in the investment business from around 1996 onwards. But when I look back, the period when I learn the most comes down to just 4.5 years. This mostly due to 2 friends who have helped and influenced me a lot. Surprisingly both are not full time market professionals.

When one looks back on the career of Warren Buffett, the few things that really stand out are the company he kept. Before starting his partnerships, he worked under Benjamin Graham. Then at more or less the right time, he came in touch with Charlie Munger. Oh, he is also friends with Bill Gates.

Luck and Serendipity I think plays a large role in one’s career. Also, being open to change. This I think is different from thinking oneself as open minded. People claim to be open minded but only open to spilling out ideas for others and never accepting that any other way can exist. Tough to learn from those.

On Finance Twitter, Influencers with their mindless ideas make the most noise. That noise in many ways overwhelms the excellent views expressed by others who may not be as articulate but know their stuff. Whom you spend time with matters a lot in the long term. Choose Wisely 🙂

The True Contrarian Strategy – Momentum

Contrarian investing is described as buying when no one wants to buy and selling when no one wants to sell. Much of value investing in many ways is contrarian investing.

In the book, Contrarian Investing, the Authors say that any stock that fulfills 2 out of the following 4 criteria can be considered as a buy

A PE Ratio less than12
A Price to Free Cash Flow ratio less than 10
A Price to Sales ratio of less than 1
A price to book value ratio less than 1

Not too different from a Value Investors screener for choosing stocks. When you search for Mutual Funds whose fund names have “Contra”, on ValueResearch, they are bundled with Value Funds.

Talking about the Berkshire Annual General Meeting, Morgan Housel wrote this,

It’s 40,000 people, all of whom consider themselves contrarians. People show up at 4 am to wait in line with thousands of other people to tell each other about their lifelong commitment to not following the crowd. Pluralistic ignorance at its finest.

Being contrarian is doing something that goes against the grain of logical thinking. Much of investing is not really contrarian. This is not to say Contrarian investing is not possible. Investing in a sector when it’s facing bad times for instance is often seen as contrarian investing.

I myself have done this more than a couple of times, the last being

https://twitter.com/Prashanth_Krish/status/1396742870321664000

I think investing against the herd gives off the zing that doesn’t come with normal investing. Here is the comparison chart of Nifty Realty with Nifty 50 and my own personal Momentum PF.

Lot of times, Contra Investing can also overlap with Distress investing. Wanna buy Pakistan Bonds?

https://twitter.com/AAHSoomro/status/1624677330575654912

The biggest issue with Contrarian investing is position sizing. Bet too small and even if right, it may not move the needle. Bet too much and if things go wrong, your returns shall never make it to the benchmark for years.

But there is a certain fascination / ego to say one is a contrarian for it suggests that one is better than the herd. But we are in more ways than one always part of the herd.

Recently I finished reading “Samurai William: The Adventurer Who Unlocked Japan”. It’s an impressive book that looks at the first Europeans who landed in Japan. But what the discovery (for Europeans for Asians had trade relations with the country going back centuries) was the fact that this was financed by risk talking gentlemen sitting in London.

In a similar vein, I think in today’s world, the true contrarian investors are “Angel Investors”. Unlike PE funds or VC funds, Angel Investors are risking their own money in investments most of which they very well know shall fail.

In the secondary market, I think one of the most hated strategies has to be Momentum. BAAP takes the limelight because of just one fund manager there to be bashed.

When one speaks about Momentum, most confuse Discretionary Momentum Trading and Systematic Momentum Investing. While both try to buy stocks that are going up, the key difference is in risk management. Systematic has a set of rules to ensure that when things don’t work out, and they don’t 50% of the time, we have an exit to end the agony.

In discretion, we are left to our own devices and given our behavioral biases and heuristics, the probability of cutting down when things aren’t working out is much tougher. Many traders for instance have a concept called “Mental Stop Loss”. Rather than placing the order on the terminal, the idea is to have the same in the mind and execute when it’s triggered.

Most of the time, stop loss means that the trade is already at a loss. The probability that the trader will actually go ahead with the trade is less than 100%. Most of the time this leads to bigger losses but once in a while, the trade rebounds to profit and the mind registers this as a reason to not place the order.

At the end of March 2020, my portfolio had been devastated by the markets. On 1st April, my strategy told me to sell 25 of the 30 stocks I held and buy 10 as replacement (50% went to Cash due to paucity of stocks to buy).

Despite practicing Systematic Investing for nearly 3 years and Systematic Trading for more than a decade by then, my first instinct was to override. Why not hold onto the stocks given my view that the worst could be over. Being overweight in financials, a few of my investments were down 40% and more – not easy to book losses of that nature especially when the holding period was just a month or two for many.

Thankfully I choose to follow the system. Thankful because as I wrote in my previous post, The Itch”, the cost isn’t just about money. In this case, in hindsight, sticking to the system gave a better return than if I had just stuck with the stocks even though many did recover in time.

The toughest issue with Momentum Investing is not just behavioral. Buying at highs and selling many a time at what seems to be the low point is tough. Tougher is the lack of a convincing argument on why the action needs to be performed.

Jim Simons had started to taste success in his fund. But that did not stop him from trying to influence what trades to make. Thanks to his team, he was not allowed to mess up the system.

Snapshot from the book, The Man who Solved the Market by Gregory Zukerman.

There is this misconception that systematic trading or investing is easy when in my own experience it’s not. The reason is that a system asks you to jettison all your own thoughts, views and just follow the machine. But we are not machines.

Systematic strategies are easy to follow when the going is good. The utopia of making money, even if it’s inline with the market allows the mind to feel it’s in control. But the trouble starts when one has a losing streak and regardless of systems, every system shall have its downtime.

Mulvaney Capital runs a systematic trend following program. It has had a blockbuster 2022 with a return of 89% for the year. Since its inception in 1999, it has generated a CAGR of 14% vs 4.50% for S&P 500. A fabulous outperformance indeed.

But long term returns can hide short term pains and it’s the same here too. The fund had a fantastic 10 years since its inception. 2000 to 2010, it generated a CAGR of 19% vs a negative return of 1.4% by the S&P 500.

But in the next 10 years (2011 Jan to December 2020) yielded a CAGR of just 2.88% vs a return by S&P 500 of 11.55%. Talk about underperformance. Two short years later, the CAGR since 2011 Jan is now greater than S&P 500.

Most CTA’s have low assets under management with the management most of the time having their own money greater than the rest of clients combined. The pressure the fund manager faces during those trying times is unmeasurable.

Momentum strategies will have similar periods of no returns too. In the back-test, we saw that the 2008 peak was not comprehensively taken out till late 2013. The returns were inline with Nifty 50 but that is of little help to someone who has to keep managing the portfolio (Weekly / Monthly as the model maybe).

As a contrarian fund manager says in the book, Contrarian Investing,

Compatibility between investor and investment style is one of the most overlooked concepts in the investing field. What works very well for one investor may be disastrous for another. I think that’s why a lot of investors fail. They may have a good investment strategy or technique, but they’re not comfortable with it because it’s not compatible with their natures. The result: they don’t stick with it.

Much better to temper enthusiasm when things are good and develop enthusiasm when things look bleak. This is what contrarians do and it helps them stay the course.

All good investing is Value Investing, says Charlie Munger. I would add that all good investing is Contrarian in nature.

PS: As I was writing this post, I was also listening to songs from the Telugu Movie Shankarabharanam. In many ways, the movie was a contrarian. It featured a debutant for the key role while also allowing a newbie singer, SPB, to sing the fabulous songs. The movie broke records and is seen as one of the best Telugu movies ever. Risk many a time can pay off very well.

The Itch

So, there I was yesterday sitting at a hotel waiting for friends to arrive. One good thing about waiting these days is that you no longer are bored because there is always something on social media to read about. I on the other hand was checking not social media but Kite (Zerodha App) to see what Adani was doing.

After making a low of 1494, the stock was trading around 1620. Is the worst over? I wondered. If that is the case, maybe I should try to dip my toes with a small position. And based on that nudge, I placed an order size which is 25% of what I normally buy in any stock. Kite instantly rejected my order saying, No funds available.

The itch was now over, friends came and we had a good Maddur Vada with Coffee. But on the way back in the evening, this made me think. The buy (it would not have got executed since price did not get back to 1500) would not have really changed anything for me. The small position size meant that even if I made 10% profit, it would have barely budged my bottomline.

Succumbing to the itch though would have meant breaking my current disposition to not doing something randomly no matter how much the appeal.

I have seen various financial advisers say that you should maybe set aside 10% of your capital for these itches. The idea here being that any damage will be limited to 10% which will not ruin the goals much of the capital is being saved for. I, on the other hand, think that is a very bad idea.

Human minds are weak. Most of us are looking for excuses to justify our mistakes. Discipline is tough to enforce. Yesterday when visiting a Doctor, he advised me to sleep early. It’s not just the hours one sleeps that counts but also the time and the quality he maintains. But with so many movies available, it takes a lot of determination, determination I lack, to sacrifice Television for Sleep.

Netflix CEO Reed Hastings once said, Sleep Is Our Competition. It indeed is and the model they developed for weaklings like me was to provide not one episode per week but put all the episodes out there to watch at a single time. So, earlier while one would have seen a hour of a teleseries and then went back to sleep, binge watching has changed all that. Why stop at one when you can finish the entire series by the time the Sun breaks the horizon.

If social media had listings of say 10 tweets or photos before requiring the user to click the next page, the amount of time spent would not have been as high as it is today when you can scroll to infinity and beyond.

Much of these is said to be the effect of Dopamine. From the stock market to social media and beyond, we are always looking for the things that give us instantaneous pleasure even if there is a cost to pay.

Compared to the 90’s when I entered the markets, today there is an explosion of information and knowledge. What earlier was possible to be known only to a select few is today known by everyone in a very short time span. Newspapers carried the latest information then while today they are old by the time they get printed, almost all the news items that merit attention have been discussed threadbare.

But has better access to information, especially in the world of stock markets, made for better investors. The data that one sees seems to show that it has actually made things worse.

In the good old days, I would not have been able to know the price let alone buy something sitting at a hotel waiting for a friend. The ability to execute with a simple click of a button has converted investors into traders and traders into junkies.

There is a well-known Greek aphorism, “know thyself”. In the world of investing, knowing one’s own weakness and threats that may arise is paramount to survival. Survival, not success is the key for unless one survives, there is no likelihood of Success.

Market View for 2023 & beyond

We are close to ending 2022 and at this juncture it seems that the markets will close in the positive for the 7th consecutive year. The last time we saw a similar 7 year consecutive gain was between 1988 to 1994.

The high of 1994 was next broken only in 1999. I hope that we won’t see a repeat of that but who knows how the future shall unfold. Politically 94 was the peak of strong governance and the period following that was one of political instability not to mention international financial crises such as the 1997 Asean Financial crisis.

At the current juncture, it seems that political stability will be there for at least the next few years and while there are countries which have been brutally hammered by Covid and are facing financial strain, the impact on the world economy at large should be moderate.

To understand the future trajectory of the economy, one way is to study the economic trajectory of other countries which have similarities in India.

Let’s start with next door, Pakistan and China. First a comparison with Pakistan. GDP per Capita is a data point that can be easily compared across countries, large or small. Here is the one comparing India’s GDP per capita with Pakistan’s GDP per capita.

The surprising part of this chart – Pakistan till 2017 had more or less consistently had a higher GDP per capita than India. Today, India’s is 48% higher and based on data, it seems it can only become wider.

Another country that India can and should be compared is with China. I had to use log chart here just to ensure that the Indian line was visible enough, such has been the growth of China.

The surprising aspect of this chart is that China was lower than India till 1991. Given India was lower than Pakistan, China seems to have been even worse. Then it took off. Today, China is 450% higher than India. India today is at the same place where China was way back in 2004 / 2005.

But Indian trajectory of growth vs Pakistan did not start in 2007. It was the result of all the reforms carried out since 1991. Same for China, China’s crossover in 1991 over India happened due to more than a decade of even stronger reforms and one that for now continues to bear fruit.

While I barely read Indian newspapers, I make it a point to try and read Pakistan’s (especially the Open-Ed columns). The optimist I am, I think the Indian path will mirror China’s (even though we may never grow as fast and as long as them) but the realist also wonders, what if we slip up.

In one of my previous blog posts, I wrote this

“Assume you were a rich Pakistani. You understand that inflation is high, real Interest rates are negative and hence investing in the stock markets is a better way. At the beginning of 2018, the KSE Index was at 41,000 and One USD cost 112 Pakistan Rupees. Today, the Index is at similar levels, one USD is now available 220. Basically in USD terms, the wealth has halved over a period of just 5 years”

Since 2004, Nifty 50 has gone up by 840% whereas the same Nifty 50 denominated in USD has gone up by just around 415%. A 50% decline in returns.

Why worry about USD returns when our earnings and spending is all in Rupees you may wonder. The reason is simple, Energy cost is calculated in USD and as the base accounts for much of the price rise in every product.

While India may never become the manufacturing powerhouse that China / Germany are today, Manufacturing shall drive growth in addition to the growth powered by Services. United Nations Industrial Development Organization ranks India at 40 with most trends seeing a accelerating trend since the 1990’s when the data starts

Countries make mistakes, mistakes that may not be noticeable immediately but have profound impact in the years to come. I believe Europe has made some really bad calls and the price will be paid by their citizens over the coming years and even decades. Nothing goes away scott free.

I am not in the game of prediction and yet, I predict. Prediction to me is important to have an understanding of the future to decide what course of action is best suited to allow me to live the quality of life I wish to lead.

India today I think is at a very sweet spot. Yes, there are risks especially from the North but given the recent experience of Russia with Ukraine, I feel the situation will not go down the tubes anytime soon.

The US markets have seen pretty tough days with S&P 500 giving away nearly all the gains made in 2021. Nasdaq has gone even further giving up not just the returns of 2021 but nearly half of the gains made in 2020. A bit more decline and we could see the Index being close to where it was pre-corona.

Take a look at the ratio chart of S&P 500 vs Nifty 50 in USD

India underperformed big time vs US from 1994 to 1998. From there to the end of 2007, it was one way of outperformance. This even though both the Indian and US markets took a hit when the dotcom bubble melted.

Since 2013, Indian Markets and US have been in tune in US Dollar terms. Measured in local currency terms, S&P 500 is up by 131% vs 231% for Nifty 50. Kind of shows the impact of the depreciation of the Rupee vs the Dollar

The continued rise in Interest rates in the US has hit most countries with even the Euro and the British Pound unable to stem the tide of depreciated currency. Japan’s Yen has depreciated by more than 20% this year alone.

From 1973 to 2000, the Indian Rupee saw a CAGR depreciation of 6.67% to the USD. From 2000 to 2010, the Indian Rupee barely moved. From 2010 to today, its annual depreciation is to the tune of 5.24%. 2022 seems to be in line to be the 11th worst since 1973. Unless India can get to a situation where we have a trade surplus, this depreciation is bound to continue

In the last few months, there have been hundreds of reports of the coming decades and even maybe the century. I am an optimist and really wish for that to happen but unlike China which was in the right place at the right time, it will be tough for India to replicate the act.

Globalization which used to be promoted by the West is now being seen as a negative given how dependent they have come to be on China and the hollowing out of manufacturing. While global trade will continue to grow, the competition is really hot.

The biggest advantage for India vs other countries lies in the large population which provides for a huge local market. But the local market size has been trumpeted for nearly 20 years now but when it comes to consumption, we are still a pygmy.

Currently more than 50% of stocks listed on the NSE are outperforming Nifty 50. While this is not on the higher side, if historical data is any evidence, this also rules out another bull market starting anytime soon

Same is the case with the % of stocks trading above the 200 EMA

This year, the Nifty Small Cap Index saw a decent correction. But unlike say 2018 or going back, 2011, this isn’t deep enough to provide a platform for the next jump.

When we talk about correction, we always assume price correction for in majority of the cases, its price correction that sets the base for the next leg of the rally. This induces a fear that the next big correction is on the cards. What we seem to be seeing in the current instance though is more of time correction.

From India’s perspective, the Russia-Ukraine war has not had a major negative impact on the economy. While we did face some tumultuous times due to oil spiking up, today with oil trading well below $80, it has become more comfortable to manage. Same cannot be said for a host of other countries.

Based on trailing four quarter earnings, Valuations are neither cheap nor expensive. Kind of no man’s land for now.

Reasons for the 2000 crash or the 2008 crash did not originate in India. If the world catches a cold, it’s unlikely that we can stay insulated. The low interest rate prodded rallies in both Private Equity and Crypto are beginning to peter out. Will the massive reset and losses have no impact on the public equities? Only time can give the answer.

Prediction for 2023

While there are still two weeks to go, markets weren’t kind to the prediction that was evolving at the end of 2021. Here is the comparison with what really happened. As can be seen, the prediction really did not counter the deep cut we saw in the middle of this year and unless we see a decent rally in the coming two weeks, it is unlikely to close near the predicted levels.

Based on my understanding and analysis of cycle theory, this is how I assume 2023 will evolve.

The Drift

The other day I was talking to an acquaintance who was looking at building a portfolio of stocks. Nothing wrong perse but he neither had interest in understanding the markets nor had the time to devote to the subject (there is a reason all the big investors have been full time investors from long time). I explained that I felt that the best investment for him would be Index funds.

Index funds are unloved. My suggestion more or less ended the conversation. I was reminded of this conversation thanks to this tweet

https://twitter.com/itsAdityaT/status/1601796809902665728

Rich in itself has no definition. Is someone with a crore of rupees rich or someone with a hundred crore of rupees rich? Morningstar says someone with 5 Crores in Investment can be defined as rich in India. On the other hand, if you have wealth greater than 65 Lakhs, you are in the top 10% of Indians and that definitely counts for something.

I myself wrote something on this subject

Getting Rich vs Getting Wealthy – March 2022 Newsletter | Portfolio Yoga

On Twitter, much of the talk (outside of making billions in options trading) revolves around individual stocks. This is because of the fact that unlike funds (which are a portfolio of stocks), a single stock can go up 1000% in a year or less (on the NSE over the last one year, M K Proteins, a SME has shot up by 1500%+) and these kinds of moves provide opportunities for showcasing the greatness of the investor in having been able to identity such a stock.

It’s another matter that very few actually would have invested anything substantial (as % of their net worth) but it’s not money made that is the criteria.

When a new investor looks at tweets and especially by those who have a huge following (numbers boosted mostly as a result of seeming to be invested in every moving stock out there), the assumption is that investing is easy and a portfolio of such stocks should easily beat the measly returns of the Index.

Majority of Mutual Funds and PMS don’t beat the measly Index returns and even those that beat don’t beat them consistently. This despite having a deep research team on which hundreds of crores are spent annually. Yet, the fact that even with low odds, there is always a possibility of beating the markets and this attracts investors like an ant to honey.

While I have not come across any study (pretty sure one would be there somewhere), my assumption is that the majority of investors lose money, let alone beat Nifty returns. This is due to the fact that very few stocks actually create wealth in the long term.

A paper by Hendrik Bessembinder showcased that in the US, the best-performing four percent of listed companies explain the net gain for the entire U.S. stock market since 1926.

One of the surprising trends that I observe in the Indian markets is the persistent decline in the Advances-Decline Ratio.

While I have no exact reason to offer for the decline even as the markets themselves have delivered big time, I wonder if the reason for this is because of the fact that Indian markets have way more small companies than large.

Just 17% of listed companies in India had market capitalization greater than 2500 Crores. Small companies, while attractive to investors for the chance to get onto the train before the long journey starts, have a very high failure rate. The attraction towards these smallcaps though is massive like in a lottery, there will always be a few winners and stories of how someone made it rich keep others in the fray.

Since 2005 to date, Nifty has closed in the positive zone 54% of the days. On the other hand, breadth has been positive (more advances than declines) just 46% of the time.

Outperformance of stocks vs Nifty is lumpy. Here for example is a chart showcasing the percentage of stocks whose 3 year (rolling) returns were greater than Nifty. Do note the date on the X-axis is the end date.

But the above chart has an issue. Dead stocks get eliminated (once they stop trading). For example, if in a single month 100 stocks which were underperforming stop trading, the next data point with all things being the same would show a higher percentage of stocks as beating Nifty.

A better way would be to maybe look at the CAGR outperformance vs Nifty of each stock since their listing (or the first available trading date, whichever is later). Stocks with data less than one year have been ignored.

The scatterplot above plots stocks with the longest period of being listed to the least (0 to 1000 on the X Axis).

Nearly 70% of stocks have not been able to beat Nifty returns (Dividends not included). The Median outperformance of the stocks that did beat Nifty came at 9% while the Median of those that underperformed was at 16%

Here is how the distribution shows up

Before you get too excited about the 45 Stocks that are at the right end of the tail, few of them are delisted and of the 26 still listed, save for Adani Green and Adani Total Gas, rest of the stocks were listed March 2020 or later. Equippp Social Impact Technologies Ltd which listed on 20th May 2021 at 1.45 and today even after a 78% drawdown from the peak has outperformed Nifty by 737% and is the biggest gainer.

74 Stocks have data from November 1994 and continue to be listed today. 46 of them have underperformed Nifty while 28 have outperformed the Index (biggest outperformer benign Infosys).

Another way to break down this data is to look at the stocks by year of listing. Save for 2019 and 2020, in no year has there been more stocks that outperformed the Index.

Stock picking is ridiculously difficult and yet social media and business channels make it seem like a cakewalk. Very few succeed to beat the Nifty in the long term but the fascination to make the cut remains.

Beating Nifty in itself doesn’t have to be the criteria to judge but if one is not fascinated by the process of investing, one should question the merit of trying to pick stocks in the hope that one will strike lucky and become incredibly rich.

In many ways, this study can be seen as biased in favor of investing for the odds of long term success appears unusually high. I assume one reason for that is that it’s only now that Institutional money is starting to dominate. At the beginning of this Century, Retail Ownership of listed companies (NSE listed) was to the tune of 18% and one which stands today at less than 10%.

Going further, I sense that this will only go down as equity participation via vehicles such as Mutual Funds and PMS increase over time. Ownership by portfolio management companies today is not classified separately since it’s held by the clients directly in their own accounts. This in a way means that even that 10% may be wrong and the real number much lower.

I wish there was a way to calculate how much of the wealth that is being created was getting spread between the various participants. While Mutual funds are panned for not beating the Index, they have (at least based on the data I have) not lost money (when markets themselves have been up big time). Same I doubt can be said for retail investors.

When Warren Buffett started his career, there was very less competition to speak about. Every “Next Warren Buffett” has got blown over today because the risks required to be taken to become the next Warren Buffett have become incredibly high and that risk generally tends to mean that the chances of blowing up is higher.

In Lewis Carroll’s Through the Looking-Glass the Red Queen famously states to Alice ‘it takes all the running you can do, to keep in the same place. For the retail investor, the overall drift appears to go against him. To just ensure capital is not lost requires a lot of work. The question given that time is limited, is that effort worth it?

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Prediction for 2023

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