Portfolio Yoga

August 2021 Newsletter – Keeping risk in Check – Optionality

August was the second time in 3 months, Portfolio Yoga Portfolio’s went through a change mid of the month. Stocks got removed without replacement. This has led to questions whether we are moving to a weekly rebalancing mode as is the case with everyone else. The answer to that question is a firm No.

The rebalancing will remain in monthly mode since we have enough data to showcase that monthly is better than weekly on multiple parameters.

Before I explain the reasoning behind the mid month change, let me talk about something that is happening in the world of Trend Following in India.

Before 2017 when I made a complete shift to Momentum Investing, I was a Systematic Trend Follower for a decade. I read everything that was available on Trend Following, heard multiple podcasts and learnt a lot about how to test ideas better and understand which models were flaky and which were antifragile.

Yet in 2017 when I got the first real opportunity to shift from trading to investing, I did that without the blink of an eye since I recognized the fallacies that prevented me from being a successful trader.

There are a lot of things that need to go right for the trader to be successful, but the one key and one that is constantly overlooked is the capital. I recognized that my capital was scarce to trade a diversified portfolio.

In 2012, I was working with Dr. C.K Narayan building and executing trading systems. We were trading on a broad set of stocks and Indices such as Nifty and Bank Nifty. While the strategy foundation itself was based on trend following, the way risk was managed was anything but trend following based.

We had for instance target profits, initial stop losses, trailing stops and reduction of position size as the trend went in favor of us. Literally everything you won’t find in a trend following book which generally always talks of Ride the trend till it ends.

The period we traded did not have great trends on either side and yet, thanks to the way we were able to build the strategy, we actually made money. Credit for most part belonged to my boss, CKN who had a much deeper experience than me and helped me shape the strategy in line with his experience.

Trend Following has a huge history and has been successful in what it professes to do. The strategy is not about beating the markets but about generating non correlated returns.

https://twitter.com/Prashanth_Krish/status/1426820407416430594

Since Clubhouse became available for Android, one room I try to be present in is the one hosted by Jerry Parker. Even though I myself am out of trading, I love to understand the intricacies of succeeding in a business like this. On his website, Jerry provides month by month returns going back to 1988.

What interested me was not the returns – 10% over the last 33 years but the smoothness of returns. In the first 23 years of running his fund, at the end of the year he barely had a draw-down and when he had it was in single digits. The last decade has been tougher, relatively speaking.

Way back in time, I ran a site called NiftyTiming.com. The advisory was to provide clients with the signals that got generated by a trend following system. It was a system I had coded and one that traded on the Nifty. The venture itself was short lived and I pulled the plug 3 months down the lane before anyone got hurt.

I realized I was missing something but wasn’t sure of what it was. It was only much later I understood that the risk I was taking by trading a single symbol even if it was an Index. Yet, I see advisors doing the same.

Last year was a very good one for trend following advisors who reaped the benefit of smooth trends and counter trends. 2021 even before the halfway stage was setting up for a disaster with draw-downs touching levels that would bankrupt any trader who was trading with leverage.

Unfortunately for most traders who subscribe to such strategies, they don’t have the data or the resources to ask the right questions. What this means is that the outcome is very much a subject of curve fitting.

When market doesn’t trend which is a large percentage of the time, trend following systems tend to get chopped. This is true as much for a 2 period moving average as it is to a 200 point moving average based system. The system itself doesn’t understand that the market is range bound in a tight range. But an analyst monitoring the system can definitely observe that.

I have observed one time too many the thought that one needs to stick with the system regardless of what one’s one observation is telling us to do. Yes, there is a risk of the observer getting the view wrong, the fact that one builds the system to ensure that one’s own opinions don’t mess up with the trade, the fact that this could be a slippery slope among others.

But what use is experience if one cannot at the least ensure that risk is reduced when it’s very much observable that the risk outweighs the rewards. Should one just hope the system will get lucky and we shall recover all our losses.

The biggest advantage of managing one’s own funds vs advising others comes from the fact that one’s actions are never questioned regardless of the results while the results dictate the questions when one is dealing with other people’s money (directly or indirectly).

Discretionary Advisors have it easy here. They understand the reason and while they may or may not turn out to be correct, they can provide a narrative to their actions and be done with. When it comes to systematic advisors, we are held to a higher standard.

Most Momentum advisors have gone with a Weekly rebalance schedule. I have tested hundreds of variations of momentum on weekly rebalancing and yet to come across strategies that have very low churn. Yet, somehow advisors seem to have much lower churn. Given that most of these models are “proprietary” in nature, maybe they have found a way to limit churn while still rebalancing on the weekly mode.

A system can be built to take into account everything that one wants to take into account when ranking a stock. But adding more parameters opens up risks of a nature that is not seen. Every additional parameter brings about its own issues of edge cases.

Talking about edge cases, let me provide an example of a Portfolio Stock – Linde India. Since it got into the portfolio, the stock had a one way move – down contrary to going up. Yet, the rank itself dependent on both volatility and one year returns did not budge below the cut off ranks. It finally did go below (slightly and hence an edge case) when we rebalanced for August.

I had two options then. Take the loss and move on or based on my reading of the stock, take a chance and wait it out for another month at least. Luckily it worked out fine. But this was not because I read a chart but more because I understood why ranks may move around despite having nothing to do with the performance of a stock.

What I have found for myself is that it’s better to have as few variables as possible and then add a bit of discretion when it comes to execution. The last two instances worked out fine and saved a bit, but this approach could also get it wrong.

The biggest risk of black box systems is that one doesn’t understand the deeper nuances of what goes into the system and how and why signals are generated. This results in a lower allocation than one that could be possible.

At Portfolio Yoga, I have constantly tried to be as transparent on how I rank (Sharpe Ratio slightly modified). The purpose of the advisory is not just about providing a set of stocks and signals thereof but to provide you with a framework which helps you make better decisions.

An Update on the Markets and what to Expect

The following is part of a note written to subscribers. Sharing the same here

It would not be an understatement to say this week was a tumultuous one for mid and small cap portfolios. While a small correction is not really something one should be worried about, the fact that the correction is coming after months of rise should make us pause and take a deeper look.

As I wrote in the Monthly Newsletter last week, our performance has been inline with the performance of the small-cap universe since the start of this rally in April 2020. Since the low in March 2020, Nifty Small Cap 250 has delivered a return of around 200% vs returns of 110% for the large cap universe.

This outperformance came with barely there volatility. But if history is any guide, this is going to change.

One of the philosophies followed by Technical Analysts is Elliott Wave Analysis. This theory posits that markets move about in waves. Bull markets are divided into 5 waves while bear markets are divided into 3.

The theory has its faults but in the broader sense it actually showcases how Fear and Greed combined with economic cycles are seen in markets. While pure ellioticians use the strategy to try and predict to a precise level where the index shall go, I use it to get an understanding of where we are in a cycle and how the future could unfold.

The Wave 1 of a new cycle is always sharp, mostly surprising and one that sees investors mostly itching to get out versus getting in. If we were to take the move from the lows of March 2020 to today, it fulfills the first couple of requirements. The strong move up was a surprise to the best of the analysts tracking the markets.

Let’s look at what to me are a couple of Wave 1 in action in the past. Do note that these may not match the purists who are more detailed, but my objective here is not to try and find where the markets shall end at but provide a context to the move and what we can expect in the forthcoming weeks / months.

The bust of the Dot Com bubble brought Nifty down 55% from the peak. While the Vaypayee led NDA government was in power, for the markets, it may well have been the Deve Gowda period – a period of absolute lacklusterness and low activity.

Starting in May 2003, the markets took off in a way that was reminiscent of the dot com bubble but was more broader than the previous avatar. From the low of 920, Nifty went up to cross the 2000 mark before the correction started.

The correction in itself was deep owing to the surprise fall of the NDA government with Nifty at the worst point being down 36% from the highs. The move up in the Indian markets wasn’t really independent. The S&P 500 Index too started to move from Mid March 2003 before topping out in February 2004.

While the Indian Markets saw a deep correction owing to local factors, S&P 500 went more or less sideways though the direction was on the upside.

The more recent move that can be categorized as Wave 1 in my view would be the one which started in March 2009. Was this as unlikely as that of 2003? You bet it was. The world was supposedly coming to an end and there was little that anyone could do.

From the low’s of 2009, Nifty Small Cap 250 rose by 235% over a period of nearly 1.9 years. To give a context, Nifty Small Cap 250 has risen by 223%.

2011 was a year of correction with Nifty dipping 30% from the highs while the Nifty Small Cap 250 dipped 45%.

Corrections are important for they ensure that valuations which tend to go way high during bull markets get smoothened out in either time or price based corrections and from every evidence we have, we could be at the start of one such correction.

The breadth of the markets continues to remain strong. That is not surprising since no broad indices have even breached the 10% draw-down from the high water point. While Nifty 50 has made a new all time high even today, since mid February 2021, Nifty has been flat – what we call as a time based correction and is up just around 7% while Nifty Small Cap 250 is up 30%.

This divergence is not sustainable and shall generally get closed out. But these could stretch too. The chart below plots the route differential between the Nifty 50 and Nifty Small Cap 150.

While the end result is the same, the path they took has been different.

Now let’s look at a time frame when the Small Cap for a while did better than Nifty 50, the correction in the Small Cap indices brought the returns to the same levels as Nifty 50 by mid 2018.

Now let’s look at the same comparison but much more recent

Most Momentum Multicap Portfolio’s tend to underperform when the broader markets are underperforming. We saw this between 2018 to around mid 2020 before the strong move from mid 2020 has more or less made Momentum the most chased strategy by retail investors today.

There is no easy way out. One way would be to shift from a multi-cap portfolio to a large cap portfolio. This will reduce the risk though if Nifty crashes, there is no avoiding the same. While even the Momentum strategy will move to more of a Large Cap over time, past experience has been that draw-downs should be expected.

Another way to reduce risk would be to cut down on the exposure to the markets. Asset Allocation is a wonderful way to reduce risk. But there is a trade-off. If the market continues to rise further, the pain of not participating fully can come back to haunt one to the extent that one makes mistakes at the first sign of opportunity.

Nifty continues to hit all time highs and the breadth remains extremely good. While wobbles such as the one we saw this week may suggest that we are closer to a top, it could also be an intermediate stop.

Overall Corporate Earnings have come at either expectations or have done better. This bodes well for the market in the short to medium term. The risk though as Barry Ritoltz emphasized in his blog could come from a resurgence of Corona in the US. He wrote,

If we do not radically improve our Vax rates ASAP, the entire economic recovery and precariously positioned, somewhat expensive market is put at risk of a 20-30% crash. This one will not have the trillion-dollar stimulus and rapid recovery of the 2020 edition, but rather, will be long, slow, and painful.
Ritholtz

This is not to say that the markets will react. The data for now suggests that it may continue to move higher. But the moves in the broader market is starting make one wary. Could be a false positive in which case, mea culpa in advance.

July 2021 Newsletter – Measuring Performance

Do-it-yourself (DIY) investing is all the rage. NSE data reports that retail now commands 45% of the total turnover on NSE

Turnover doesn’t equal ownership. Retail ownership has moved slightly higher versus its lows but even if the indirect ownership via Mutual Funds are included, it’s still very much below its all time highs.

One explanation for the fall in direct ownership over time would be the rise and growth in assets at Mutual Funds. Retail has slowly shifted away from owning Individual Stocks to owning Mutual Funds.

From both the tax point of view as well as the cost structure, owning a fund is generally cheaper. This is more so for the investor who looks at investing a large part of his net worth in stocks.

Indian Markets are very illiquid. What this has meant is that the majority of funds concentrate on the top 400 stocks at the most even though NSE alone sees daily trading in more than 1700 stocks. On the BSE, there are another couple of thousand stocks that are not even part of the ecosystem of most investors let alone Institutions

The above chart plots the number of new demat accounts that have been opened.

Now, you can look at it from both the bullish angle as well as the bearish. The bearish angle will claim that the retail rushing in is a clear signature of the top. After all, isn’t there a saying,

“Fools rush in where angels fear to tread”

The proverb is also apt given that despite all the positive news we keep hearing, FII’s have been sellers in the recent past.

I look at the data from the bullish angle. My view is that while there will always be excesses, the data of the past cannot be directly compared to the data of today. Context is the key.

For a long time stock market investing was equalized with gambling. This was due to many factors including very low compliance and rampant frauds – from the broker upwards. In recent years, compliance has really improved a lot.

While we even today have broker defaults, the hit for the investor is constrained thanks to better regulations and the backstop of the exchange guarantee funds.

Access to knowledge has improved by leaps and bounds mostly due to technology. This has meant a better understanding of the markets and how they operate in the long run. This doesn’t mean that investors as a whole will make money.

Rather, I feel that the Pareto Principle is as relevant here as it is elsewhere. 80% of the money will be made by 20% of investors. A study in the US shows that all the wealth ever made in the US Markets has been just 4% of stocks.

The entire report is worth reading, but here is the key conclusion

While the overall U.S. stock market has handily outperformed Treasury bills in the long run, most individual common stocks have not. Of the nearly 26,000 common stocks that have appeared on CRSP from 1926 to 2016, less than half generated a positive lifetime buy-and-hold return (inclusive of reinvested dividends), and only 42.6% have a lifetime buy-and-hold return greater than the one-month Treasury bill over the same time interval.
The positive performance of the overall market is attributable to large returns generated by relatively few stocks. Rates of underperformance are highest for small capitalization stocks and, as would be anticipated based on the evidence in Fama and French (2004), for stocks that have entered the database in recent decades.
When stated in terms of lifetime dollar wealth creation to shareholders in aggregate, approximately one third of one percent of the firms that issued common stocks contained in the CRSP database account for half of the net stock market gains, and slightly more than four percent of the firms account for all of the net stock market gains. The other ninety six percent of firms that issued stock collectively matched one-month Treasury bill returns over their lifetimes.
With odds as unfavorable as these, it’s not surprising that long term wealth creation by Do-it-yourself investors is a rarity. Yes, everyone has that stock that one bought at a low level and held till it was a multibagger, there are exceptional years such as the one we are presently in. But one swallow doesn’t make a summer

One of the most surprising things is the fact that very few investors actually take the trouble to measure their performance.

Sharmaji ka Beta is the benchmark for most parents. If that boy can do it, why can’t you achieve the same. This is also called Cross Sectional Momentum. The comparison is never against self but against the rest of the colony / class.

Yet when it comes to one’s own performance, there is very little clarity as to how we are doing. Measuring performance is akin to keeping a dairy. It helps understand how we are performing and compare and contrast with the opportunities that are available elsewhere.

Measuring helps understand whether we are doing the right thing or not. When I used to be a broker, I measured the performance of myself as well as a few friends who also happened to be clients. This helped in understanding how I was doing in the scheme of things and where I could do better.

In Measure what Matters by John Doerr, the author expands on OKR’s (which stand for Objectives, Key & Results). Once you get them right, all you then need is a checklist to ensure that execution is as good as the process.

Since I started investing based on the Momentum factor, I have kept detailed records not just of the transactions but the ranks the stocks were during the time of entry / exits. This is helpful in removing chinks that are part of my system.

The way to identify the chinks though comes with Performance Attribution and Performance Measurement.

In the 2017 bull run, I remember a fund manager who ran a small cap fund but compared his returns to the large cap index. This turned out to be a good way to sell, but reminded me of the famous quote by Richard Feynman

“The first principle is that you must not fool yourself, and you are the easiest person to fool”

What is the appropriate benchmark for a DIY Momentum you may ask.

I believe that comparing an active strategy such as Momentum with a passive index is doing a disservice. Yes, the outperformance is awesome, but the products are as different as chalk and cheese – this more so for the Multicap strategy.

Momentum has been awesome since April 2020, but if I were to plot the NAV of my own personal performance with Nifty Smallcap 250 Index and the Nifty Smallcap 100 Index, this is how it would look like

The above chart is useful to understand where the performance is being driven by. What this also provides is a framework of the risk such a high Beta strategy will face if the markets were to start rolling over.

Now to check against some Momentum Indices – primarily Nifty Alpha 50 and Nifty 200 Momentum 30

While Nifty Alpha 50 is not an investable index owing to no funds, it’s a pure Momentum strategy and hence a worthwhile opponent to compare against. Nifty 200 Momentum 30 on the other hand is more like a Nifty Plus strategy and not a pure momentum one given how lagging its rebalances are, but since it’s possible to invest, it’s another one which can be compared against.

Do note that a straightforward comparison in a way is wrong too. Unlike DIY, Mutual Funds gains are tax sheltered and in the long run that can really mean a huge world of difference. Not to mention the advantage of Buy and Forget in the world of Mutual Fund while having to be alert and tinker with the portfolio every week or month as the rebalance frequency tends to be.

The other day, I tweeted this

What is the difference between a Good Invsestor & a Great Investor?

Hint, its not Returns

Ans: Longevity
— Prashanth (@Prashanth_Krish) August 1, 2021

In my 25 years I have spent in the markets, I have seen a lot of people come and go. Some had exceptionally good returns for a while but mostly lost their way. I wish & try to meet people who are exceptions to that rule.

For a fund manager, beating the market is what he gets paid for. He can’t have a few lost years and a few great years. Even if the ultimate returns are better than the benchmarks, clients won’t stay {Exceptions alway exist}.

A Momentum or a Value or even a Quality factor will be unlikely to beat the markets every year. This means that one has to have the framework to allow oneself to be beaten by the markets once in a while (or maybe even a bit more).

Finally allocation is more important than returns. Allocation though comes with comfort in the strategy. As a Do it yourself investor, the key is to understand the source of the return and the failure points. It’s that which can help stay sane when the strategy is not working while also not getting hyped up over excess returns in one or two years.

The reason funds managers get rich has to do not only with the leverage provided by assets of the client as also their own confidence in their strategy that allows them to be 100% invested. As a DIY investor, we are our own fund managers. Its up to us to take the steps necessary to make sure that we are on the right path.

Choices, Noise & Investing

Finance is simple. Try to earn more than what you need to spend, save the difference as best as you can. That is what my Parents and their Parents before did. They earned, they saved a bit and invested into assets they were comfortable with.

I have never been to the United States, but I have read much about the choices available to a customer. A quote that got my attention,

A typical Costco store stocks 4,000 types of items, including, say, just four toothpaste brands, while a Wal-Mart typically stocks more than 100,000 types of items and may carry 60 sizes and brands of toothpaste.

Four vs Sixty. There is not even a sense of comparison on what is easy to pick and select. When it comes to finance, from the US to India, it’s moving closer to what we see with Walmart. In 2020 alone, the US saw 318 new ETFs being launched. In the first 7 months of this year we have seen 221 new ETF’s being introduced.

There is a plethora of Blogs, Podcasts, Youtube Interviews, Clubhouse Discussions, Substack that constantly pump out information – way more information that what we need or desire maybe. Choice is good to an extent after which it starts to actually hurt. More choices basically means more options which generally tends to create more confusion. Oh, I left out Television and Pink Papers.

Opinion Makers are dime a dozen. On Twitter, one interesting observation has been that those who tweet a lot get a lot more followers. This even though they may not even have a track record of their own. On the other hand we have Fund Managers and CEOs who have much lower followership.

Noise makes us question our beliefs. From April of last year, the best way for most investors would be to just be invested. But data – the one from Mutual Funds shows otherwise. From April 2020 to June 2021, investors have actually pulled out money and this after accounting for the huge inflow that SIP’s bring in every month.

Some actions may be due to need but the majority is mostly money that was scared out by the constant humming of those who feel that markets are ripe for a meltdown. After seeing one as recently as March 2020, it’s not surprising that those sitting on the edges would want to get out as soon as they saw some recovery from the bottom.

This is not to say that markets may not fall, that they shall fall is guaranteed. But the constant refrain of crash and the accompanying loss of one’s net worth impacts a great deal on one’s ability to handle the smallest of drawdowns.

On the other hand, because I am bullish, continuously pushing that narrative is wrong too for that sets the wrong expectations. The last year has seen a surge of new investors. In markets, these investors have been rewarded plenty.

Investing Now

Does it make sense to add money at the current juncture was a question I received from a subscriber. My standard reply has always been – it doesn’t matter when you invest, the first year of investment is when the risk is at the highest.

Markets since 1986 (when the Sensex started) have closed in positive one year ahead 70% of the time. This is the drift that has meant that a long term investor has a very low chance of losing.

This is not unique to India either. For the same time period, the FTSE Index and the German Dax had a positive return 68% of the time. S&P 500 has an even better record – positive 80% of the time. Since its own inception though, this falls to 74% of the time.

The only exception of course remains the Nikkei. Since 1950, the one year positive return percentage is around 65% and this falls to 55% if you were to start from 1986.

Longer the time period, greater the probability that you shall be positive. For most prominent indices, being invested for 15 years or more has more or less guaranteed positive returns (exceptions being the Dow due to the Great Depression and of course Nikkei).

The chart below from the book Stocks for the Long Run showcases how both risk and return from 10 year onwards to 30 year is similar.

In April, the one year return for Nifty 50 was 84%. Let me show the rolling one year return to see the previous instances have had such insane returns in such a short period of time.

From 1992 onwards, we had multiple times when we had a one year return > 80%. The next one year returns on an average was negative 8.41%. But if I move the starting point to post 2000, the average return has been positive 11%.

When experts provide data, do note that it’s easy to mess around the same to meet the objectives or the viewpoints of the said expert. If I intend to promote why markets would remain bullish, just using data from 2001 onwards (20 years is long enough, right) suffices.

In the long run, Nifty 50 has given a return of around 12% and going into the future, we should not expect any difference.

If one were to invest today, the expectation has to be low. But one should invest in my opinion for there is no guarantee of an opportunity that can arise and one that can be taken advantage of. Waiting for a correction is good in theory but mostly bad when it comes to practice.

In March 2020, when Indices were down 40% from the peaks reached in January, the inflow into Mutual Funds was the same as in February when we had no worries with respect to Corona. In April, when the same opportunity was available with more clarity, Mutual Fund investments actually fell by half (vs the previous month).

Invest when there is blood in the streets, says Warren Buffett, but most of the time the blood is our own and even if we have the money to invest, we don’t have the courage. What this means is that we should invest when we are comfortable to invest rather than waiting for the best opportunity to come by.

If you don’t have the courage to invest a lump sum, split it into monthly SIP’s but do invest for even though Lump sum may be a better way vs SIP, both are better than staying put waiting for a crash to happen.

June 2021 Newsletter – The Fear of a Crash

“Far more money has been lost by investors trying to anticipate corrections, than lost in the corrections themselves.”
Peter Lynch

The biggest question most people seem to have about markets today is not if a correction is going to happen but when. The list of reasons seems to keep growing. The US housing market for instance is posting the largest annual gains since 1980.

Both in India and the United States, Retail Investors are jumping into the action like never before. Millions of new accounts are giving a boost to the bottom lines of brokers. Look at the spike in trading numbers at Angel Broking, a discount broker.

While investors who have seen multiple cycles are exercising caution, the plethora of new investors whose only historical understanding is – Buying on Dip is the easiest way to make money is in the frontline of activity.

One of the biggest winners in the last year has been Saregama. Saregama has moved from 180 which was the low of March to 3480. Incidentally Saregama was a big winner in the Dot Com boom too, moving from a low of 12 in March 1998 to a high of 2310 in March 2000. Sometimes history doesn’t just rhyme but actually repeats.

Some disconcerting charts from the US Markets

I am not a great believer in surveys and yet this showcases how one sided market participants may have become in this rally.

Previous chart seems to go perfectly well with this chart. Buy Right and Sit Tight – who does that anyways.

Since April 2020, Nifty Small Cap 250 Index has seen a negative month just twice and even there, it was not greater than 2%. The index itself has risen 210%. This is a phenomenal return that we have not seen in the Index in such a short span of time.

Year to date on the National Stock Exchange, we have had 199 stocks that are below where they were at the beginning of the year and 1441 stocks that have gained. The average gain being 61% vs average loss of 14%.

When markets move too much too fast, it only brings bad memories to those who have seen a bear market or two. Is this the end one starts to question. This more so when one sees stocks that have been dead being rescued more by narratives than numbers.

Near the peak of the dot com bubble, we had an Initial Public Offer by a company called (I hope memory serves me right here) Computer Shoppee. The company was a new one and hoped to set up computer shops throughout the country. What was interesting about the issue was that the issue was at a face value of Rupee One. I don’t even remember if it was listed since the bubble burst soon after.

The Public Offer of Reliance Power which has become folklore. Cut to today and we will shortly see public issues by companies that have over time lost tons of money and even today have no clue about when it will eventually turn profitable.

One way to look at if markets are closer to a peak is to look at the percentage of stocks that have generated high returns in the last 3 to 5 years. The thought process here is that at peaks, most stocks would have gained tremendously. This is also a reason for the public to get attracted because it shows them that making money in markets is fairly easy.

The above graph denotes the percentage of stocks (Y Axis) that had the gains in the bracket. So, for example at the peak of 2008, 35% of stocks listed on the National Stock Exchange had 5 Year CAGR returns between 25% to 50%. Today this number stands at 26%, similar to what we saw at the end of 2017.

Since February of this year, we are seeing divergence in performance between the Large cap Index and the Small Cap Indices, This again foretells of a high probability of reversal on the cards though how long a divergence can remain is anyone’s guess.

While there are enough and more reasons to be bullish on India today, the fact remains that like Siamese twins joined at the hip, we are joined at the hip with behavior being dependent on how the markets of the United States behave.

Just take a look at the 10 year comparison between Dow Jones (in USD) and Nifty 50 (in INR). Where is the Modi magic one may wonder.

In 2008, India did not have a housing crisis or were its Banks in any sort of trouble. Earnings growth was strong and the future outlook remained strongly bullish. We even had a word for the short term divergence our markets saw with respect to US markets – decoupling.

The United States was not the first country to go for massive quantitative easing. That was Japan. Will the US go the Japan way as many bears seem to suggest? In the recent past I have been trying to read more about the macroeconomic situation in Japan both pre and post the fall and my guess is that the risk of the United States going that way is fairly low.

The Japanese tend to feel shame and disgrace upon a failure such as a bankruptcy. In the United States, bankruptcy is just a way to clean out the slate and start afresh. The ideological difference cannot be more stark.

While cheap money does lead to bubbles – the dot com bubble for instance is blamed upon the easy money policies instituted by the Federal Reserve post the 1987 crash, bubbles aren’t a one year phenomenon either.

For a while now, I have been strongly bullish on the markets and continue to believe in the same. Having said that, drawdowns are one of the ways markets tend to shed off excess weights. Here is a chart that plots the maximum drawdown seen every year since 1996

A 30% drawdown was a pretty normal occurrence in the markets pre-2008. Post 2008, it’s become a rare species. Drawdowns to me are opportunities.

How many days does it take the market to recover and move to a new high. The above chart tries to denote that. The year is when the markets hit a new high and the time spent (trading days) in the drawdown.

The recent experience in a fast recovery from a significant drawdown is not really rare. 1994 saw markets touch a new high just 2 years after the scam had broken out and the Index had plummeted more than 50% from the peaks.

Not everything is bad though. Writing in Economic Times, Aashish Somiah writes,

Nifty earnings grew by 14% in FY21, at its fastest pace in 10 years.

Also, in contrast to the trend of downgrades seen over the last few years, FY22 and FY23 earnings estimates continued to remain steady. In fact, if realised, the FY22 earnings growth estimates of 35% as per sell-side consensus would be its highest since FY04.

I look at market breadth for they tell the story way better than what is told by the large cap indices. Across the board, markets are bullish. This is as true for Large Caps as for Micro Caps. The divergence is building up.

In early 2008, the number of stocks that were hitting new 52 week / all time highs dried up even as the indices were kissing all time highs of their own. No such divergence this time around.

There is no real play book that provides a way to play out the current scenario. Advisers generally prefer caution and advice reducing exposure as a way to limit the risks. The trade off is that if markets continue to gain, the opportunity cost could be fairly high.

A secondary way to reduce equity exposure would be to wait for the market to begin its downward march before reducing exposure. The trade off is that one cannot exit at the peak but close to 20% away from it. The advantage being that one can stay until the music has been turned off.

Of course, historically the best way has been to stick with the system and the markets come rain or shine. But we all know that, ain’t we. You don’t need to read a 1300+ word drabble to know that the best returns are those who don’t try to time every aspect of investing.

I captured this image from a video on SpaceX but I think it closely resembles the actions of majority of investors. Wonder who can the Pied Piper of Investors in India.

Nostalgia of the Past

Do it yourself by investing while not exactly the flavor of the day has been gaining momentum. While smallcase and websites today offer a variety of portfolio’s to choose from, back in the good old days, Do it yourself meant Do it yourself. Starting from researching ideas to buying the stock and getting them transferred to your name, the investor of today has very little idea of the hassles faced during those times.

A weekly momentum strategy would have been unfathomable during those times. The delivery itself took 2 weeks if not more. Then you had book closures and record dates that required you to send the stocks to the company for transfer. If it was a great company, you would hopefully have them back in a month or so, with many others it was an ordeal following it up and finally getting it transferred.

Sometimes one was unlucky that the seller’s signature did not match with the company’s record. They would send back the certificate which you gave back to the broker who gave them to the exchange and who themselves handed the same to the originating broker. By the time you received the replacement share, remember not yet transferred to your name, it would be a month. Time really flew those days.

Markets for most part were sedate. Brokerage was high which led to a lower number of transactions and turnover. Information was scarce. With no Television to blast out the results the second they are out, everything came with a lag.

Times have changed though. The regional stock exchange where I wet my foot had at one time nearly 300 members. Today barely 50 are active and even among them very few actually having client business worth talking about.

Today, trading in markets has exploded, education democratized and retail itching to invest in stocks and securities. Oh, Zero Brokerage for delivery. Who would have ever dreamt of that couple of decades ago.

But human behavior hasn’t changed much. In 1999, we had a client who was a Chartered Accountant. Had some fantastic companies as his holdings. The IT boom was just taking off but he was not deeply interested. While one had no relative performance to compare on Social Media, one was relatively isolated from the happenings on the exchange floor.

As the rally continued, for active investors it very soon became tough to see clueless investors make tons of money while those who actually worked to identify good companies lagged. Starting in early 2000, he shifted his portfolio wholesale from the old economy companies to the new age. KLG System, Satyam are those that I remember buying for him.

What was interesting was not just the change in his portfolio but change in his viewpoint on why these companies were worth even after having rallied a lot in recent months. The narrative he spun was more or less the creation of the print media in which many investors took up lock, stock and barrel.

Once the dot com boom exploded, we lost touch. While I hope that he did well post that mishap, experiences of other folks who saw the boom and bust though doesn’t give me comfort. The 2000 bust followed a long and sedate period which lasted until April 2003.

Markets have never been the same. While the 2008 boom and bust is still new in the minds of many investors, the euphoria one saw in the dot com was something else. At the peak of the bubble, Bangalore Stock Exchange had almost 50 companies which were being traded. Very few exist today.

The dot com bubble in hindsight was brought about by the easy money policies of the fed. Has anything changed today one wonders.

Thanks to the actions of Central Banks, Fed Primarily, Investors have been protected from a deep and long draw-down recession for a decade now. Can they get it wrong – well, history shows the mistakes of Japan’s Central Bank created the bubble and later the mishandling of the bust. A more recent mistake would be the ECB with countries like Greece.

As this post was being written, the Fed policy came out with its views. The low interest rate seems to stay for a while. When we are in a bubble, it’s not easy to imagine that one is living in a bubble. Are we living in one? I guess only time will tell us to be sure.

Active Investing is Uncomforting

Investors for most part want returns that are higher than what the market offers. But Investors also hate doing things differently from the crowd. There is a certain comfort in being part of the crowd – when they are happy, the investor is happy, when they are sad, the investor is sad.

Owning a Value stock such as ITC is seen as a sin while owing an out and out Momentum stock such as Adani is seen as a Sin too. Between these two extremes lies the portfolio of most investors.

Market rewards investors for both doing things differently as well as doing things the same as the markets. To do something similar to the market is easy – buy an Index fund. To do things differently though is hard.

In the last one year, companies have gained in terms of market cap astronomically. Yet no group has gained as much as Adani. Motilal Oswal talks about 10x in 10 years. Most Adani companies achieved this in the span of just one year. Adani Enterprises, the parent company had a market cap of around 17 thousand crores last year. This year it’s worth 1.7 lakh crores.

A Momentum Investor is expected to hold such stocks. The risk though is when stocks fall off suddenly and ferociously as it happened with Adani on Monday. While how the investor reacts to such events may be different, the Momentum Investor should be mentally prepared for the same.

A Value Investor faces a different kind of pain – the pain of the market not recognizing the true value of the stock for a long period of time. Adani Enterprise adjusted for the spin-offs it has seen in the past has had its stock price go nowhere.

The stock was trading at 115 Rupees in 2010 and was available at 121 during the recent covid crash. The 10 year CAGR at the lows was below 5%. Today the 11 year CAGR is at 30%. One year has made all the difference to the investor who was able to stick with the company.

We can argue whether the stock is a value or not, but good stocks can go through a long period of doing nothing before doing something extraordinary in a short span of time. In the past we have seen Reliance, Hindustan Lever, Nestle among many companies with similar trends.

There is this famous Martin Zweig quote,

“It’s OK to be wrong; it’s unforgivable to stay wrong.”

When does one know it’s wrong? The views one forms is mostly a form of resulting. Writing in her book, Thinking in Bets she says, Resulting is our tendency to equate the quality of a decision with the quality of its outcome.

Momentum Portfolios for most part spent 2018, 2019 and half of 2020 without hitting the highs they saw in early 2018. How long does one give before deciding the strategy is wrong?

Relative Returns are how most fund managers get judged. This brings to mind the famous cartoon

Returns of every strategy gets benchmarked to the returns generated by a broad based Index. The Index represents the opportunity cost to the investor. An investor choosing a specific factor is not choosing the same to try and maximize returns. Instead he aims to maximize his ability to deploy as much capital as possible in the strategy.

Twitter for me is a window to the world. Yet Twitter can be many a time unnerving. Value Investors ridiculing investors who believe in Quality. Momentum folks ridiculing Value and so on and so forth.

Conviction cannot be built in a noisy atmosphere and yet there is no escaping the noise. Bull markets make it easy to build conviction. It’s the bear market that tests one’s conviction.

Lately I have been testing with a few microcap stocks. Truth be said, the exercise is uncomforting given the knowledge that once the music stops, there may be no easy exit. But it’s fascinating from the angle to crowd psychology and behavior to not just observe but to actually take part in the madness.

As Shane Parrish paraphrasing Charlie Munger wrote

If you want to improve your odds of success in life and business, then define the perimeter of your circle of competence, and operate inside. Over time, work to expand that circle but never fool yourself about where it stands today, and never be afraid to say “I don’t know.”

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Some disconcerting charts from the US Markets

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