Portfolio Yoga - Part 24

In God we Trust, Rest bring Data

The position of the RBI Governor is one of Prestige than Comforts. While the RBI Governor draws a Basic Salary of 2.5 Lakhs per month, the CEO of HDFC Bank, the premier most private sector bank in India draws a Salary of 80 Lakhs per month in addition to perks such as ESOP’s which can add a lot to the tally.

Allan Greenspan will be known by millions of people more than those who knew who the head of Citibank was during his tenure. Same is the case with RBI, the Governor’s are those willing to sacrifice a nice salary that could be obtained for being in charge of driving the decision making process at the RBI.

One of the perks of being the head of the Central Bank in most countries is that while they are answerable to the government of the day, they enjoy a very high degree of freedom in exercise of powers that accompany the office.

Yet, clashes between the Central Bank Chief’s and the Elected governments aren’t rare. Just last week when State Bank of Pakistan hiked Interest Rates, the Prime Minister expressed surprise and while talking about maintaining autonomy of State Bank of Pakistan (which is the Central Bank of Pakistan), he asked that in future no such decision be taken without taking the government into confidence first.

Recently, Trump accused Federal Reserve Chairman Jerome Powell of endangering the U.S. economy by raising interest rates.

Politicians around the world are the same. They wish that they have a Central Bank that is Autonomous to the outside world and yet follows the dikkat of the government. From Modi to Imran to Trump, all of them want their Central Banks to lower Interest Rates.

The biggest borrower in all countries remains the Government and a high interest rate means that much of the government budget gets eaten away by interest payments. Lower the interest rate, better the ability of the government to borrow more without feeling the pinch.

For a moment assume India to be a Company and RBI to be the Auditor. If you are long stock of India and the Auditor after fighting the management for some time resigns due to “personal reasons”, how trustworthy do you think the accounts are – especially since a recent growth number brought out by the company was riddled with deficiencies.

Resignation of the governor of RBI is not the end of the world, yet it’s an important pivot and one that could well define how India fared.

The reason fiat money works is because of Trust – you remove or even start questioning the Trust and the Fiat currently starts looking more like an ordinary paper than a value of exchange. The last time an RBI governor quit in protest due to “differences with the finance minister” was in the 1960’s when we were a much smaller and closed economy.

Emerging economies including India have had a great time in recent years thanks to the low interest rate and ballooning balance sheets of the Central Banks of US and Europe. But that easy money supply has more or less ended. US Fed is already well on course to contract the size of its Balance Sheet by removing 50 Billion from its Balance Sheet every month. ECB too will be starting the process most likely at the meeting to be held 3 days from now (December 13). With easy money on the way out, attracting FDI / FII money will become tougher for India is not the only emerging economy that is seen as attractive.

When a company loses the confidence of the investors, its tough but bearable to a extent. But when it loses the trust and confidence of the Bankers, it can be a death knell, especially if the company requires outside finance for growth.

India is at a stage where we require tremendous amount of foreign capital to enable the country to life itself from the emerging nations to the developed nation state. This money though doesn’t come easy and instances like these will have people questioning the Risk Reward characteristics of investing in India in the first place.

“This too shall Pass” is a favourite phrase used by many to describe events that seem big at that juncture but will be all forgotten in time – anyone remember the Greek / Cyprus crisis that was supposed to doom the Global markets for instance? Yet, the markets don’t simply sail over such events – there is a opportunity for those willing to take the risk and threat to those who are already overexposed to the risk.

Markets will go through a tough period – weak hands will be thrown to the wolves while the strong hands will endure the pain to see the light of the new day. As long as you can sustain the pain and have invested in stocks that themselves can survive the oncoming tsunami, All izz Well.

But day’s like this aren’t forgotten for the lessons that could be learnt are too important and timeless to be overlooked by future historians. For Investors, the ride is about to get a lot more volatile.

Saying No to Yes

Yes Bank has been in all kinds of bad news in recent times and that has shown up in its stock price % with the stock falling 60% from its peak in a matter of months. From being one of the most expensive Private Sector Banks it’s now one of the cheapest around – and all this without a sniff of a scandal of the sort that bring down companies.

Yes, there is the issue of deviation in NPA recognized by the Bank versus what RBI thinks is the right number, but this has been known for quite some time now. Yes, Rana Kapoor not being given an extension which was the first negative trigger in the current episode is negative for the bank for he was a key guy in the Bank’s growth.

But that doesn’t mean end of the story. Yes Bank is a fairly large bank with a good second line of leadership that can take up the mantle and grow the bank.

The fact that the one of the promoter has pledged in an indirect way their shareholding is wrong for it asks the question of what more is hidden. But in terms of risk, this is negligible since the risk lies with the lender who has no recourse to the asset on which the lending has been carried out.

Retail Investors love fallen angels and Yes is no different. Since 1st September of this year, 93 Crore of Equity has changed hands in NSE alone. Assuming that the promoters haven’t sold anything, that is equivalent to 50% of Yes Bank shares changing hands.

It will be quite a while before we know who bought and sold during this period, but I would assume that Retail holding would have bumped up quite a bit from the 11.19% stake they held at end of September 30. This itself was a bump up from 8.83% retail shareholders held at the end of June 2018. Given that the stock saw a huge fall in September, this isn’t surprising.

Every company operates on the basis of Trust, break that Trust and it’s easy to bring down a company faster than any other event ever can. When it comes to finance, the Trust factor is even higher for a small spark can set alight a raging fire that destroys the company in no time.

Long back, I had analysed stocks that fell a large percentage in a single session / short time frame. Most of the stocks never recovered its earlier glory. But then again, there are stocks like Satyam where investors who bought it on the final low double or tripled their money in no time.

Betting on stocks that fall down is not Value Investing even though the company may seem to be valuable when looked at using historical numbers. While there is no change fundamentally, Rating Agencies have now downgraded the Bank.

Unlike other companies, I would be surprised if the government or RBI didn’t swing into action at some point of time if this continues. After all, which government will wish to go into Elections with a Bank going down taking investors’ money with it.

“What you find is there’s never just one cockroach in the kitchen when you start looking around,” said Warren Buffett on Wells Fargo when the Bank was beset with issues, many of it its own making. Well Fargo has survived and thrived, so that may have been one hell of a opportunity

Yes Bank may recover and prosper from here, but unless you know better that anyone else on the street, it makes no sense to bet big on it at the current juncture. Better for more clarity to come and while you may miss catching the bottom, better evidence lets you bet bigger since there is a higher factor of comfort.

Or if you are technically inclined, I would suggest waiting for it to cross the 200 day EMA and if that is too much of a wait, at least wait for a higher high, higher low formation. Let the markets show the path rather than one speculating on the path before its formed.

Then again, I may be biased since I myself so thoroughly believed in Global Trust Bank that even today I hold its worthless share. Once burnt, Twice Shy as the saying goes.

What is your Philosophy when it comes to Investing?

For a long time, I was a drifter when it came to investing philosophy. Value today, Quality tomorrow and Momentum the third day. The disadvantage of being a drifter is that one never is able to convince himself that when the chips are down, the strategy is still as valid today as it was yesterday.

Out goes the baby with the bathwater in search of a new medicine that can soothe these wounds and seem to be the perfect match until it hits its own roadblock that makes one once again shift gears.

We understand that everyone cannot be an expert on everything and yet somehow exclude ourselves from that limitation with the belief that we can somehow traverse the diverse fields with the agility that can lay Usain Bolt to shame.

When investors select mutual funds to invest into, the key criteria many look for is the short term returns of the fund. Higher returns from known funds have generally meant an enhanced flow of funds.

Higher the amount under management, higher the incentives for those at the top and that itself is generally enough to motivate fund managers to switch philosophies based on the flavour of the day. While this in itself isn’t wrong, what it means that the investor has nothing other than performance to back-up his investments rationale.

Churn is a factor that is dependent on the strategy being deployed. My own momentum strategy requires a much higher churn than a value strategy where churns are much lower. But when you look at the mutual fund turnover ratio’s, they tell a different story altogether.

While some funds do have a very low churn ratio, many a fund which either in name or through brochures and advertisement claim to be followers of one sort of philosophy have a turnover that is replica of another.

It hence isn’t surprising to see that investors keep getting returns lower than the fund returns for the whole logic of investment was based on returns and when returns fail, they are unable to understand the reasoning and would rather abandon ship than take the risk of sailing through the stormy seas.

Momentum, Value, Quality and Size are well known factors with tons of documentary evidence that point out to its longevity. But in such long periods are periods where the strategy under-performs other strategies and the market as a whole.

Small Cap stocks have been under the weather in India for nearly 10 months now. While last Diwali picks by experts were more in the Small and Micro cap space, this time around, most of the recommendations are in the large cap space.

But has Small Cap really been a disaster like everyone loves to point out. Here is a relative comparison chart that compares Nifty 50, the large cap Index with Nifty Small Cap 100, the small cap Index.

As you can see, from the chart, while the path has been varied, the results have been the same. A small investor would have been the object of envy of the large cap investor for a long time but once the crack came in, the large cap investor feels vindicated that his style was the better choice.

Momentum Strategy can be applied on any subset of the market. For my personal investment, I am agnostic to market capitalization which means that the choice of stocks is based on the flavour of the moment. Yet, despite the churn, the portfolio has seen a draw-down – one that will be a long time from getting back to all time high.

In earlier days, like the experts of today, I would have loved to shift to a strategy that offered more robustness in these times. Maybe Quality for the Nifty Quality Index is still making new highs even as the rest of the market seems to be immersed in its own poo.

But many a Quality stock is even today more expensive that it ever has been historically been. This means that while they could be resilient for now, their future returns will not be in-line with others as and when the market recovers – and the market always recovers.

Success in markets doesn’t require one to follow the herd when it comes to the most popular style or strategy. Success instead comes when we are able to stay the course even as the airplane hits a air pocket and there is turbulence all around.

If the current market behaviour is making you clamour to change your path, my humble advise would be to step back and see your portfolio for what it aims to be rather than what you want it to be.

Stocks, Sectors, Industries, Countries all move in cycles – sometimes in favour, sometimes out of favour. As long as you understand that, investing becomes much easier since changes are not driven by the heat of the moment but an in depth understanding of the strategy itself.

Whatever you do, Wishing you all the Success in the coming year. Wishing you a Happy & Prosperous year ahead. Happy Deepavali.

Run with the Herd or Go against the Tide

Most of us make millions of decisions, small and big over our lifetime. As much as we believe in being individualistic, most of the decisions aren’t really different from decisions taken by the vast majority who are facing similar questions.

We hate to be told that we are following the herd when the reality is that we are part of the herd. Once in a way, some of the decisions one makes can go against the herd but unless the outcome is better, the decision is held up as the reason for not to sway away from the path taken by the majority.

But being part of the herd itself is not wrong by a long way. While Billionaire’s who dropped out of college are celebrated, not everyone who drops out of college actually succeeds by any distance let alone become a noted celebrity.

Being part of the herd also means that when one fails, one fails with the majority. Fund Managers for instance don’t want to go down the rocky path for what-if the path meets a dead-end. Career Risk means that most are more than happy to follow the path laid down by others for if there is a failure, he isn’t the only one caught in the storm.

Unfortunately the reason for such mockery for those who follow an alternative path is because it can be a long time to be seen as right. Warren Buffett was ridiculed for being old and unable to understand technology which would the driver of everything and was hot during the dot com bubble. Once the bubble popped, he of course was celebrated for being right.

But was he really right. 18 years post the dot com bubble, Infotech stocks are the leaders when it comes to the US Markets. Buffett missed them out before the bubble, during the bubble and post the crash as well.

Raghuram Rajan is celebrated for calling out the risks being taken by Banks and Insurance firms in the housing bubble. But it was 2 years before the issues he posed started to become a reality and nearly 4 before the world understood the implications of the risk he had laid out in his paper.

Timing the Top isn’t tough, it’s nearly impossible. The top happens due to a plethora of factors including sentiment and money flow that cannot easily be foretold. In fact, there is a saying that the bull market ends when the last bear gives it up while the bear market ends when the last bull throws in the towel.

There are people who are wrong some of the time, most of the times they being just early – being too early is as bad as being too late and there are another set of people who are consistently wrong.

One famous US bear is John P Hussman who has been bearish on the US Market since 2009. Everytime US markets go through a short term correction, his timeline becomes hyperactive as he tries to showcase how large this current bubble is and how based on earlier history, this is clearly not sustainable.

His charts aren’t the average technical charts for they are deeply interesting. But the reason they don’t work is that many of them are nothing more than curve-fitted and hence more liable to be wrong than right.

Earlier this month, he posted a chart which used a signal derived from 5 conditions. Since 1992, the chart showed 3 Signals – one at the peak of 2000, one at the peak of 2008 and the final one just before the intermediate peak of 2015. The final signal was now (October 2018).

Anyone looking at the chart and the accompanying narrative would be hard pressed not to agree with Hussman. Finally here is a indicator which has had great success in the past, has a logic that is tough to disagree with.

Yet, once again it was a curve fit chart. Someone who is a very well-known used the same conditions to test for a longer period – from 1932 to date and guess what, these were the only signals that you could find.

John Hussman not just preaches but practices what he preaches and the results aren’t surprising. He runs 3 funds targeted towards Equity and their 10 year returns are -7.27% and -7.60% even as S&P 500 ten year returns has been to the tune of 11.60%. Do note that S&P 500 returns are positive while the fund returns are negative – there is not even am iota of resemblance in between those returns.

Bad fund managers destroy capital. They seek out to be different from the herd but fail to recognize that in their pursuit to be different, they can also be wrong for so long that even if they are finally proven right, it makes very little difference for no one has the time frame or the ability to hold onto their investments for so long.

Hussman is an exception like none other. Most fund managers who end up losing money for their clients aren’t as consistently bad as Hussman. Some of them deliver incredible returns over a period of time but get carried away and end up destroying a large part of their client’s funds when the tide goes out.

The last few years have been a period of high tide and high returns for the vast majority. 2018 has turned out to be vastly different for those who mistook the tide for the sea for the sea never goes out, only tide does.

Caught in the draw-down of a nature many have only experienced only in charts and books, it’s interesting how every small straw is being clutched at, the government pleaded to act and those who were right (even if wrong for a long time) ridiculed.

Saurabh Mukherjea who came to fame in India during his stint with Ambit Capital is some- one who seems to be abhorred by the bulls. He is famed for his Sell call on BFSI (banking, finance and insurance) segment and even though he may claim to be right as BFSI’s stock keep tumbling, the fact remains that most of the stocks he disliked are still way way higher than where he gave out a sell call.

But that is not his only contribution. He was also instrumental in bringing the Coffee Can Approach to the retail audience. While he is no longer part of Ambit, the very fact that Ambit has chosen to use Coffee Can as a PMS product goes out to show the worthiness of the idea.

In his recent newsletter, he talks about Non Banking Financial Firms which are facing headwinds and claims that Investing in them is like playing the European Roulette because their basic model is leverage and they go bust once in a decade (historically).

If one were to talk to any Bitcoin fanatic, I am sure he has the same thing to say about the whole money supply system – the fiat money is a farce and is unsustainable. I don’t know how this NBFC crisis will play out but one thing is for sure, the best of the companies will be able to wade through the crisis and emerge stronger.

The Dot com bubble killed many a me-too dot com firm but Amazon came out stronger. The Housing bubble nearly killed the Banking system but Goldman, JP Morgan among a couple of others came out stronger.

Closer home, the 2000 bull-run ended the life of many an Infotech company but Infosys came out stronger and better. Wipro the golden boy of those days survived but has never thrived (even today 18 years later, it’s still well below its all-time high set in 2000).

When bubbles burst, it provides a opportunity to pick dollars for nickels. But of course assumes you have the ability to differentiate between a Zimbabwe Dollar and a United States Dollar. It’s not even worth spending nickels on the former while it’s a great opportunity in case of the later.

If you have such expertise, now is the time to start digging for the proverbial pot of gold. If you don’t, you would save a ton of money not to speak about sleepless nights by waiting for the dust to settle and pick the winners.

The goal of investing isn’t to come first in a 100 meter race, it’s to finish (not win though everyone tries and wishes to win) the Marathon. That in itself is an achievement that very few can claim to achieve.

Discipline through Shorting

I admire Elon Musk. I believe he is one of the greatest Entrepreneurs of the 21^st Century, no doubt about that. Yet, he can be devastatingly wrong – for like when he recently railed against Shorts and called them to be made Illegal.

Shorts for all their claims and prophecies aren’t gods descended from heaven who have the ability to make or break companies. While they do push those companies on the edge to the other side, the companies that aren’t so precariously positioned have been able to devastate the careers of more than one such bear.

In India, shorting stocks other than those in the Futures and Options list is next to impossible. There is no easy way to borrow stocks to sell short with the intention of covering later. Yet, way back when derivative market in India was well in its infancy, it was Shorts who short circuited the market and the career of Ketan Parekh and his friends.

Mathematician Carl Jacobi came up with the term “Invert, always Invert” but it was Charlie Munger who popularized the same when it comes to the market. At its root lies the thought that if you are bullish on a stock, you should also be able to argue on the bearish side for this shows that not only have you worked on the positive side but also have the understanding of the risks that the investment can bring forth.

New age bulls while chanting the mantra’s of Warren and Charlie though seem to have forgotten that it’s more than just a theory, it’s the reality. Not surprisingly, as markets kept seeking lower lows, we have had bulls railing against everyone who they believe are responsible for the current situation – the government to RBI to Media to those who Short.

The other day, a recently famous option expert commented that Put option buyers want India to be destroyed just because they want to make some money. Not very different from saying that Life Insurance policies are being bought to bankrupt the Insurance company.

Shorting is not a piece of cake for even the most accomplished of fund managers – Jim Chanos the supposed King of Short Selling was revealed in a recent long form article that appeared in the Institutional Investor to have lost around 0.7% in his Short only fund since Inception which was in 1985.

Yet, his long short fund has generated a net annualized gain of 28.6% since launch in October 1985, more than double the S&P 500. As a fellow hedge fund manager commented, if the numbers are true, “It’s one of the greatest records ever”.

As investors, we abhor the short side. The long side gives us plenty of comfort since we know that the worst we can lose is only our capital already employed in the trade. A short on the other hand can lose an unlimited sum for a stock can theoretically go to Infinity and beyond.

Its isn’t easy for the small investor to create a Long Short model either for the capital requirements for a short are much higher and demanding. But the shorts don’t just demand money – they demand attention and continuously question our beliefs and methods.

We are optimists by nature and yet when the market turns against us, we become the worst pessimist – from wondering whether we went wrong to whether the whole world was loaded against us.

In markets, most of us aren’t optimists in the first place and therein lies the problem. We are at best opportunists who think we can piggy back on the market for some easy money. But when thing goes south, we find ourselves wondering if optimism is over-rated. Technical Analysis works on the fact that human psychology doesn’t change & every cycle proves the same.

Investors these days are better informed than those of us who started out in the pre-internet era. They have a better understanding of allocation, behaviour biases, market psychology among others and yet, I find them not immune to excesses and when things go sour, most seem to follow the path of those who haven’t studied history or human behaviour or cycles – rail against the system first and throw the towel at the worst possible time.

As much as it’s important to read more – especially financial history and human psychology, I am beginning to believe that portfolio construct needs to form the basic foundation. A good portfolio needn’t be made up of longs only for shorts do have their own space.

One doesn’t need to have a short position as big as the long position, but even a small short position keeps the investor on his toes and asks him to take the tough calls. A short challenges ideas and views like no longs can ever do.

The other day, I heard Safir Anand claim that 90% of investors lose money – by lose money I don’t think he meant that they actually lose money but many lose by missing out on opportunities or missing out on getting market returns.

But in the age of everyone being above average, it wouldn’t be surprising if the percentage of investors who despite the best efforts not just underperformed the markets but actually lost money by buying high and selling low – the exact opposite of what they wanted to achieve is 80% or so {Pareto Principle}.

I incidentally run a Long Short Portfolio on my personal books – the short position being placed not by way of understanding, intent or thought but by accident. Yet, when markets were booming and the short was losing money, it kept me thinking about the range of possibilities and where and how far I could go wrong and the likely remedies for soothing the pain.

While the initial thought was to close out the short as soon as got back to my Anchor bias level, deeper or 2^nd line of thinking now seems to suggest to me that shorts can be a very effective instrument against one’s own biases going off tangent.

As Jim Chanos has experienced, the shorts may not actually make money for you but can be an efficient risk management tool that helps manage your Risk at a level that ensures survival in the deepest of bear markets.

Shorting is Risky, no doubts about that – yet, Investors, many of whom are down 40 to 50% in the current down cycle didn’t really anticipate such risks when they came into the market. We accept risk ex-post, why not accept it ex-ante.

Panics, Strategy, Tactics and Momentum

The headlong Fools Plunge into South Sea Water

But the sly Long-heads Wade with Caution a’ter

The First are Drowning but the Wiser

Last/ Venture no Deeper than the Knees or Wast

Someone the other day sent me a Video of the Alexandra Waterfall. Alexandra Waterfall is a small waterfall that flows normally for nearly 6 months of winter. But this isn’t what is amazing about this waterfall.

For much of the winter, the flow of water is constrained to a small area which is kind of a pressure release and ensures that there isn’t much water build up behind the ice. But as summer approaches, an Ice Armada approaches the water fall with a huge amount of ice. The pressure on the ice wall that is holding up much of the length of the waterfall holds back for a long time until it gives way in one single swoop.

Something of a similar nature took place in the markets. For nearly 9 months now, investors have seen mid and small caps being crushed even as the market itself ignored the destruction and kept making new highs.

In the space of just about a month, the wall has been broken causing a stampede of proportion not seen in recent times. Stocks have crumbled regardless of whether they had gone up in the earlier march or not.

Markets all about sentiments and when sentiments take a turn for the worse, even the best of news isn’t good enough to stop the carriage from rolling over. When going up, stocks go up for a variety of reasons – some individualistic, others not. But when falling, it really doesn’t matter whether the stock is a Blue Chip or a Coconut Chip, everyone falls like nine pins.

The difference though is both in terms of the depth of the fall and the reversal one sees at the end. The blue chips fall shallower than the coconut chips and are also faster when it comes to recovering those losses.

On Social Media, I see those who didn’t participate in the rally now mocking those who participated and are now getting burnt as the pull back is in full swing. But there is an issue with not being invested either.

Let’s take asset allocation for example. The one I publish here is one which goes gradually from 0 to 100. It is the contrarian way of allocation since it asks one to reduce as markets keep going up and adding more allocation as markets keep going down. It takes a real lot of faith to be out of the market when its going up and keep adding more money when it seems the world is ending.

But there are ways of asset allocation where its more binary. You are either all in equities or all out. Meb Faber’s timing model which is based on where the market is with respect to its 10 month moving average.

If you were using the Meb model, you would have been long on Nifty since January of 2017 and would now be looking at exit given that its currently below the 10 month MA though the trigger will be when the close happens.

On the other hand, my own Asset Allocator started off in January 2017 at 75% but quickly went down and 30 to 40 would be long term average. Given how markets exploded this looks like a missed opportunity.

But the problem with binary rules is the problem of whipsaws. For example, the same model has whipsawed quite a bit over time. Chart with arrows depicting when the Signal went into a Buy mode and when it went into Sell mode.

While it has over time captured long trends, the final result is that the cost of whips means that we don’t capture all. Instead, we end up capturing 90% of the gains (2003 to 2018) while suffering half the draw-down Nifty suffered (during 2008). Not a bad deal, eh?

The logic behind both is similar – not to be exposed totally at the worst possible time and they achieve the same in different ways. But the key to success in both is sticking to it and that’s where the problem lies.

Markets are falling currently and if you were to be following the model of adding more at every fall, this is the time to add to equities. If you were to be following the second model, this is the time to exit everything and shift to safer assets.

While selling after markets have fallen is tough, tougher is to actually go per plan and add more money at this juncture. Fear envelops the best of mind as we argue whether this is the time or is there still more pain-down the road.

In hindsight, Panics have been the best times to invest, but when one is a participant in such a panic time, forget investing, it’s tough to stay put with current investments.

Take Momentum Investing. If you are a momentum investor, should you be invested in the market, let alone add to your holdings. Logic says that when markets are going down, Momentum is the worst strategy to be invested in. But is that supported by data?

Momentum investing is very similar to Value Investing or investing in Quality companies. It’s a strategy like any other with the only difference being in the way stocks are picked. In strong bull markets, Value investors find it tough to get enough companies to invest into, but even in the strongest of bull markets, there are generally section of markets that appear fairly or cheaply valued enough into.

During the last year or so, much of the market was in the grip of a strong bull market and yet, if you were a Value investor, you could have found pockets of value in areas such as Information Technology and Pharma.

Markets are currently weak, but that doesn’t mean lack of stocks with positive momentum. Like in Value, we can differ on what exactly is positive momentum. The list of stocks with positive momentum has seen a decline in recent months, but even after applying filters to eliminate stocks that don’t have enough liquidity, I can still find 70+ stocks available to invest into.

Friends of mine who run advisories based on quantitative momentum offer dynamic asset allocation based momentum strategy which goes into cash when markets are weak and boosts up the portfolio holdings when momentum is back.

Similar to the asset allocation difference I wrote, tactical asset allocation mixed with momentum strategy, both styles come up with their own advantages and dis-advantage. The choice is left to the discretion of the investor based on what one is comfortable with.

My own choice has been to keep asset allocation outside of the system similar to how money management in trading systems is kept outside of the trading algorithm. This for me ensures that I can use strategies such as Value averaging to add more money to my portfolio whenever such opportunities arise while at the same time ensuing that I always know where I am in relation to the overall asset allocation.

Market falls like now can be an opportunity if you were to believe that we are closer to the bottom or a threat if one perceives that the bottom is still far away.

One way to look at is to see the breadth of the market and compare it to historical numbers. For example, the percentage of stocks that are trading above 200 EMA is now below the 20% mark. Historically, this has been seen when markets were closer to the bottom than closer to the high though the exception to the rule would be 2008 when the percentage went below 20% in March. If you invested at that point in time, by the time a year was up, the market itself was down another 50%.

But ignore the 2008-09 drama and the reality differs. Only once in all the instances (25 of them) did markets close in negative even a year after the event (Feb 2011 Entry). The Median return for buying when the percentage of stocks trading above 200 EMA went below 20 was a decent 23%.

Since my last post here, markets have deteriorated significantly in a very short span of time. Rather than a gradual time based correction, this has turned to be a strong price based correction.

Based on one’s risk appetite and liquidity position, I believe this is an opportunity to add. It’s not yet time to go over-board – for me that will be if Nifty tests the 9000 levels, but rather ensure that fresh money is deployed to return the allocation which would have suffered due to the current fall back to equilibrium.

When 9000 and not 7000 or 3500 as someone on Twitter tweeted out? 9200 is the 200 Weekly EMA and if you look at history, other than in recessions and 2008, this has been the point of bounce.

Secondly, 9000 also means a 20%+ correction from peak. Given the destruction we have already seen in the market, further fall is tough to see at the current juncture.

It doesn’t matter if you are a Value Investor or a Momentum or a Quality, given the breadth of the fall, you should be able to find good opportunities. They may become even better opportunities, but in the face of the fact that we don’t really know the future, not betting anything isn’t the best solution, especially if you are comfortable with both the liquidity and the asset allocation.

It’s not enough to just read about the great investors and traders, when the time comes, it’s the ability to stay the course and take the risk that differentiates (subject to surviving though) the professional from the amateur.

Alpha doesn’t come free because you wish to invest when everyone is doing the same, Alpha comes for being different and this is one such time.

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Not a time to be a Hero, but not a time to run away either

On 18^th July 1948, Havaldar Major Piru Singh laid down his life while attempting to eliminate the enemy during India’s first war with Pakistan in Kashmir. For his bravery and ultimate sacrifice, he was awarded the Param Vir Chakra, the 4^th such awardee in Independent India.

If there was an award for bravery in stock markets, I am sure most of us will qualify. But unfortunately our rewards are based on the results. If the act of bravery works out, you have some bragging power among friends and if the act falls flat on your face, the reaction is based on how much have rubbed them the wrong way when the times were good.

Last week saw stocks across the board falling like nine pins. Of the stocks that are traded on the NSE, nearly 92% of them closed in negative territory. Regardless of fundamentals, stocks have taken a beating like no other.

The trigger for the whole correction came from the default by IL&FS. Though the default was more of technical nature and one that would have had no direct repercussions on the market, it was a excuse that was not to be wasted.

Since 2014, thanks to inflow of money through mutual funds like they have never seen in the past, stocks had propelled higher regardless of whether it made sense to buy at such valuation or not. Selling by Foreign Institutional Investors, Political uncertainties, Rise in price of Crude and the widening deficit among other news that earlier would have torpedoed any rally were thrown to the sidewalk.

The fear of missing out on the action meant that investors jumped into the pool regardless of knowledge of depth or whether they actually knew to swim in the calm waters let alone troubled waters in the first place.

Crash in stocks like Yes Bank and Dewan Housing Finance has meant that there suddenly investors are wondering, which stock has the possibility to be drawn into question tomorrow. And then is Infibeam which fell 71% on Friday and in September alone has wiped out all the gains it had seen since its listing in April 2016. This is not the elevator coming down but the elevator crashing after the ropes have been cut.

Amidst all this, the US markets seem to be well on the way to another all-time high showing no sign of any weakness as the economy is growing at its fastest pace in a long time. But with easy money on the way out, the question is, how long this can last.

The US Federal Reserve has been tapering its balance sheet since quite some time now though that pace would fasten since the schedule of security reductions should see the Fed reducing their balance sheet by 50 Billion a month from October onwards, it was 40 Billion a month for the last few months.

“In order to rise from its own ashes, a Phoenix first must burn.” ― Octavia Butler

Every bull market is marked by excesses that is seldom understood or recognized during the phase of the market itself but once the bubble is burst, it’s easy to point out the same. This bull market has been led by financials – private banks, NBFC, Housing finance companies as such.

Of course, unlike the Infotech boom of the 2000, all sector booms have been growth led and this has been no different this time around. Low Interest Rate, Public Sector Banks going into a shell when it came to lending and aggressive sales meant that financial companies grew at a rapid pace.

While much of the banking sector is in a mess, Private Sector Banks were able to grow their books without getting caught in the kind of problems faced by Public Sector Banks. This isn’t the first time we have seen rise in NBFC’s though as they would say, “Its different this time around”

Good friend Vijay Sambrani has been in the markets for longer than I have and importantly has the ability to connect time lines across decades. His view on the current market conditions;

1994 REDUX ???. I have been having a recurring nightmare since the beginning of this year seeing the aggressive buying in mid caps and small caps since Demonetization. Was unable to recollect anytime in the past bull runs where the mid caps /small caps Indices’s P/E ratios were higher than that of the Nifty/Sensex .

Then I went back to my charts/notes/memories and remembered distinctly that this kind of scenario prevailed between Mid 1993 and Mid 1995. Then as of now the mid and small caps had a runaway rally , there were a slew of IPOs and retail which had been burnt by the 1992 HM scam came back with a vengeance .

I remember the NEPC Group, Tatia Group, Sterling Group and stand alone entities such as Balaji Steel, Femnor Minerals , Caplin Point etc etc which were the darlings of speculators/investors. And then came a host of NBFCs like ZEN Global, CRB etc and sprouting of Benefit Funds which funneled large parts of inflows into stocks which created a mini mania . And then one day , in September 1994 at the start of the month long NON-DELIVERY period the Sensex peaked after crossing the 1992 peak by a few points.

That market was led by a huge dose of liquidity which came in through by the newly formed Pvt Sector mutual funds and FIIs like Morgan Stanley. September 1994 peak coincided with the Peak Liquidity. Then the liquidity tap began to dry and slowly and steadily the market lost steam without any “apparent bad news”. In April 1995, the MS Shoes IPO failed and that led to a panic and no amount of assistance by MFs /FIIs could stem the downward spiral and slowly the NBFCs began to fail and the Sensex had dropped below 3000 in less than 8 months and bottomed out only in June 1996 .

Almost all the NBFCs failed , and most mid caps/ small caps also got delisted. The high flyers of this era lost 70- 90 5 of their value ultimately. I remember that one market maker on the Floor used to offer two way quoted for one of the most sought after scrip : Balaji Steel at Rs. 350 . Within the next 20 months it went to zero. Such was the carnage. And it all happened when there was no visible Major Bad News.

I distinctly remember I held significant holdings on my own and my clients behalf in Femnor Minerals, NEPC , Zen Global, Balalji Steel etc which have now become “junk”. All the profits I had made in the previous year vanished as I kept averaging on the downside. Time has made me more cautious , maybe more than necessary . So when I see many similarities between this bull run and that of 1994 , I shudder to think , whether History will repeat itself. I sincerely hope my thinking is WRONG.

I don’t have his experience or insight but what I do understand, I do hope that he is wrong for the emotional impact that kind of fall will have on investors who are just stepping into equity will be unprecedented.

Markets trade in cycles – we cycle higher and then we fall lower and then we climb higher once again.

In the movie Inception, there is a dialogue by Mal who herself is a imagination by Cobb, she says

“But Pain, Pain is in the Mind”

Right now, Investors are in a lot of pain. Just a few days back, I had a long conversation with my Chemist who has invested a significant sum of money for the first time in his life and is now seeing the value decrease day in and day out.

While the investment is significant, given his Networth from what I know of, this is a dip in the ocean. Yet, the pain haunts him making him wonder if he should just cut out the pain by redeeming the investment.

The recent bull run has meant that a lot of investors were herded into markets, some with basic idea of how the markets worked but most who had no clue other than that this will generate strong returns over time.

The panic we are seeing currently is from investors and traders who went overboard by building positions using margin. While leverage can help during bull markets and provide gains beyond what is accomplished by others, during bear phases it becomes a killer.

When markets fall as it has recently, the probability is very low of a V style recovery. The dust has to settle first before the next green sprouts seem to spring up. There is no reason to be aggressive in an attempt to maximize the opportunity for the opportunity maybe here for long.

What matters is where you are when it comes to your asset allocation and how confident are you about being able to hold out the pain in the event that his becomes an extended event. Bear markets are sharper and shallower than bull markets, but given that we had seen a multiyear bull market, any bear market will not be one that is over in a month or so.

If you are fearful, the best route out is to just stay put (assuming that your investments are in Mutual Funds where the churn from bad companies to good companies are taken care of by the fund manager). Add no more money for no amount of profits shall compensate for sleepless nights but withdrawing at a loss will be the worst possible way to deal with the situation.

If you are light on equities and are confident that going further markets will once again be better, this is the time to start adding again. We may very well fall further, but adding small amounts will provide you with a feeling of comfort that even in the unlikely case that markets recovery and take off from here on, you aren’t left behind.

On Twitter, everyone who doesn’t manage money seems to say, I told you so. They enjoy a luxury of being right despite being wrong for long enough to make the right inconsequential. The current fall is more of a correction of valuations than a fundamental change in the economy.

As long as you believe that the Indian economy will do good over time, it should not dissuade you from betting on the same. Betting on the Indian economy is best done by being a entrepreneur who takes advantage of the opportunities provided but since most of us aren’t good at that, the next best step is to piggy back on the entrepreneurs by buying their stock in the secondary markets.

Even though this is an opportunity, don’t over-invest for like leverage, your hand will be forced at the worst possible time. Stick to what is comfortable and allows you to sleep well at night. Reducing weight doesn’t really require selling off – you can reduce weight of your equity if you feel it’s too high by just not investing further.

Our family’s investment journey in markets started through a mutual fund we invested in 1996. By 1998, it had lost 50% of its value. Being new and fearful, I exited the fund in the heat of 2000. For some time, that looked like a fine decision. Today, that same fund has a NAV that is 12.5 times above where I sold.

The next couple of years should in hindsight provide for wonderful learning opportunities and opportunities. Being in constant fear will only make you miss out on those while not really doing anything to make the situation better.

Don’t be a Hero and try to buy stocks unless you really know what you are doing. That said, don’t be a coward and run away in fear for where opportunities lie, so does Risk. It’s two sides of the same coin.

Figure out your ideal asset allocation and stick to it. Sticking is the key, not identifying the ideal allocation for there is none.

Here at Portfolio Yoga, I have been publishing a simple asset allocation mix. Hope that gives you idea of where you should be.

The Gazette Notification awarding the Param Vir Chakra(Link)

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