Crash | Portfolio Yoga

Life is all about Trade-Offs

Most of our investing career is just built around 20 to 30 years. The initial part is spent figuring out oneself and the strategy that suits oneself. The last part is mostly reaping the benefits and moving to a safer and income driven strategy.

Depending on how much you can save, the 20 to 30 years can provide for very strong growth in your asset base. But the issue is that once every decade or so, you will face a situation which makes you question everything you know and believe in.

Regardless of what kind of investor you are, there are always trade-offs to be made. As a discretionary investor who studies companies, bottom-up, there is a limit on how many Industries you can study and learn enough to be able to bet significantly upon. A systematic investor on the other hand has to make choices when he is building his algorithm.

We make trade-offs all through our lives. When we finish our 10th Standard Exam, we need to take a decision that will have an impact all through our life – should we take up Science, Commerce or Arts being the monumental question we are faced.

For Science, the trade off continues as they finish 12th. Should I go for Medicine, Engineering or pure Sciences? Each decision has a certain pay-off – if it works, you congratulate yourself all through your life for a well made choice.

When it comes to investing, it’s not very different. Should you invest on your own or should you invest in a mutual fund. The choices don’t end there. If you wish to invest on your own, what philosophy should you choose – Value, Growth, Quality or Momentum or a mix of them. When it comes to Mutual Funds, every fund house has a dozen or so funds trying to provide for any segment you may wish to invest and there are 41 such folks.

For the last two years, being a large cap investor would have provided you much better returns than a Mid or Small cap investor. But pull back a bit more, say 7 years and it’s not so much clear for quite a few funds outside the large cap universe provided similar if not better returns.

Franklin in the debt fund space had made a name for itself by producing superior returns. But when the chickens came home to roost, some of the Alpha got wiped out. But that is the nature of return – higher return comes with certain caveats including risk of capital loss.

Asset Allocation is a trade off. When you choose a conservative model, you are letting go of the upside for more protection on the downside. Today, it feels awesome to have a draw-down in single digits, but that is the trade off you made by willing to not having a large equity exposure.

I track PMS returns every month since unlike mutual funds, there is no publicly available database I know of. Anyways, one recent addition to the list I track is a multi-cap pms but one which I was told was more small cap oriented. The return since its launch (2013), an awesome 26% as of end february. The negative, well, even before we hit Corona, the fund was down 50% from its peak. At its peak, the CAGR was an incredible 60%. While it’s normal for their clients to feel bad about the recent performance, for those who came in early, the return vs risk is still very much acceptable.

If you are getting into equities today, you have a trade-off to make. Should you choose the well known large cap firms or the beaten into nothingness small cap. Few days back, I ran a poll asking where people were investing. 2 days back, I saw a similar poll by a AMC head. In both polls, very few claimed to be investing in small cap with Large cap being the first choice. Once again, the Risk and Reward is different for both choices.

As a quant, we make choices when we build every model. The Asset Allocator model for instance is worried about taking risks, the Momentum Model on the other hand is 50% invested even today. Different goals, Different strategies.

In the United States, it’s said that there has been a flight to safety. Investors as usual are fearful, not just about markets but about future prospects as job losses climb to numbers never seen. It’s once again a choice between probable future gains in equity vs the pain of continuing losses especially if that comes in even as one is unemployed.

Choosing the trade-offs themselves is tricky. In good times what trade-off you may feel is acceptable may not seem like a good trade-off when the times turn around. Ask Softbank as it tries to recuse itself from buying 3 Billion Dollars of We Work shares it agreed upon when times were better than its today.

In hindsight, we often feel that there was no trade-off to be made and the choice was very easy to make, but the reality is that there is always one. How you play it and the results makes us look back and think differently on the choices we were offered.

The world today appears dark and bleak. It’s like a tornado has hit the town and we are in the dark in the Shelter. When we go back, things may not be the same, but human nature rarely chances in a matter of days let alone years. Investing should be driven by such constructs. The portfolio may not be “Antifragile”, but our behavior can be.

Staying the Course

In January of this year, I made a pretty massive investment for one of my family members in a mutual fund whose philosophy I strongly believe in. I had the option of investing in the Liquid and doing a Systematic Withdrawal Plan to invest in Equity or invest in lumpsum. My own testing has shown that its basically a coin toss on which is better and I opted for the Lump Sum.

Today, that investment is down 24% and it pains me that no end. But this investment was done not for any short term goals but a goal that is 18 years away at the minimum. While the bad start point will do doubt have an impact, I think that the investment based on my assumed return will still meet the goal.

I came across this tweet today and while I did pass a sarcastic joke, the fact remains that the best thing to do if you continue to believe in the fund and their philosophy is to just sit tight

https://twitter.com/_Mutual_Funds_/status/1246464026051141632

This is not to say that the fund will perform according to one’s expectation, but unless you are a professional, I can say with 80% confidence that over a long period of time, you will find it tough if not impossible to beat returns generated by the majority of funds while investing directly in stocks.

When we invest in stocks, we are not just managing a part of our money but need to act as our own fund managers. But we are in many ways handicapped – from our ability to research the companies we wish to invest in to our own behavioral biases which do not allow for acts like cutting the losses.

DSP Blackrock Micro Cap Fund in 2008/09 fell nearly 75% from the peak. Subsequently though, it rose from a NAV of 4.50 to a high of 73 in January 2018. This was accomplished I believe by not just sitting on the portfolio of 2008 but being active.

I don’t know when this bear market will end or how long it will take, but data shows that unless you are able to catch the absolute low, you are better off just staying the course. For instance, I checked the difference in one’s return if one invested 3 months before the final low and 3 months post take off when it became clear that the crisis had passed off. Being early was as damaging as being late. Since the 3 month prior and the low can be known only in hindsight, this is at best a theoretical exercise with no practical value.

Mutual Funds wish that you keep sipping to infinity regardless of the underlying markets. But if you were to be practicing any sort of asset allocation, you know that just the market returns alone can significantly boost your equity exposure. When times are good, it’s best to sip into debt and when times are bad, make the switch the other way.

The reason for every bear market is different and yet the final outcome is similar – the weak get punished, the strong survive and later thrive. As a theoretical exercise, it’s interesting to wonder if we could have exited before the big crash arrived, but if everyone thought the same, one needs to wonder if there would have been a market to sell.

Personally I practise a medium to long term form of momentum investing which means my exits are not quick enough in crashes such as these. But history has taught me that if I stick to my system and the signals, I will be able to generate a return that helps me in achieving my goal. To me, that is the final objective.

The Corona Virus doubtless will change a lot which means that a lot of companies will end up on the losing side of the battle. By buying an Index or a fund whose philosophy you strongly believe in, you should be rest assured that the winners will most probably be part of your portfolio while the losers are ousted. Finally, that is what matters between the Winning Portfolio and the Losing Portfolio.

A dislocation for the Ages

It was 1990 and as a citizen of Iraq, life was seemingly getting better. The long war with Iran was over and while GDP growth was nowhere close to what one would have loved to have and one they had seen before the war with Iran, at least the future it seemed was better. In August, Saddam Hussein decided to invade Kuwait and life has never been the same again.

Countries go through different kinds of dislocation – some temporary, some literally permanent and in between Millions live their lives. Since 1900, literally every country has gone through a period of short or long period of dislocation that has changed life as they knew it before.

When we look at such a large canvas, the current crisis concerning the Corona Virus and the month long lock down India will be enduring looks fairly small. Yet, the implications of shutting down much of the country for a month has a long lasting impact that we cannot fully visualize.

Replacing a one month of no activity can easily take a year or two and even that assuming that the firm is able to survive. The Financial Crisis of 2008 laid to rest the high flyers of the previous years – Infrastructure and Real Estate firms. This time, one wonders who will be the ones facing the firing squad.

But India will move on and that means at some point, Valuations become attractive enough to overlook the immediate risks. The recovery from the 2008 crisis was fairly fast, the recovery from the 2000 crisis took a few years, the recovery from the 1992 crisis took a decade and a bit more.

It’s hence important to reassess our goals and our time frames before jumping into the boiling pit solely because valuations are cheap. What matters more is our ability to sustain for long without support from the markets.

This time its’ No’ Different

Markets Falls are common though we had the uncommon pleasure of not falling big for nearly a decade. What differentiates this fall from others is the fear that the world may never be the same again.

Almost all falls of the past are those that were caused by financial stress or bubbles caused by easy money policies or scams. This is the first real crisis caused worldwide by something that couldn’t have been foreseen.

Personally, I got it Wrong. As the Corona Virus started to make news, I tried to update myself on as much as possible and try to decide the future course when it came to my portfolio. The only similarity I could see is the Spanish Flu.

The American Market was the only one with reliable data I could rely upon. This was the performance of the Dow between 1918 to 1920.

At the time of the start which could be categorized as late 1917, Dow Jones was on a decline. From its peak in November 1916, it had fallen by 26% by September 1917 and fell a bit more before it bottomed out in December 1917.

In fact, by the time it ended, Dow was actually in the positive zone. Maybe this was a wrong example to look out for or maybe the impact then was smaller than its today, whatever it is, markets today are looking worse for the wear.

Yesterday, I popped this question on Twitter

https://twitter.com/Prashanth_Krish/status/1241242995300564993

Thanks for all those who responded.

One difference or this may be due to the nature of the media is that most people are not selling out in panic with most wishing to add more given the opportunity they feel this market reaction is providing them.

What the market does is not something in our hands, but our actions are entirely in our hands. Personally, I regret being unable to exit completely at the start or even post the first gap down. Then again, I was sticking to what my System was telling me and even today, the system has not gone fully into Cash.

Recently, I was reading Stocks for the Long Run by Jeremy Siegel. In it, he narrates a interesting episode which I quote,

In the summer of 1929, a journalist named Samuel Crowther interviewed John. J. Raskob a senior financial executive at General Motors on how the typical individual could build wealth by investing in stocks.
Raskob’s idea or plan for the retail investor was that by investing just $15 a month into common good stocks, an investor could expect to grow their wealth to $80,000.

A 24% return then as is now seemed ridiculous, but then again in the decade of 1920 to 1929, Dow had risen from a low of 64 to a high (set a few weeks after the interview) of 383. That is a compounded return of 25% per annum over 9 years.

But like the Magazine Effect, the Interview came close to the top, a top that was not breached for 25 Years. Yet, for some one who started investing systematically based on his interview was better off than a Bond Investor in just under 4 years. What did not happen though was reaching the 60K target, it ended at 9K.

The key to reaching our goals depends on two key factors. The amount of savings we can mobilize and invest and the returns that the said investment can generate. Equities is a preferred route for those who understand the risks over the long term, they have generally and I use the term generally because it also showcases that equities don’t work all the time, they have provided a higher return.

But when we say long term, it doesn’t mean the taxman’s definition of 1 year or even teh 3 to 5 year period used by most fund houses to sell their funds. Instead, one needs to be invested for a minimum of 10 to 15 years to reap the benefits.

Asset Allocation has to be the key decision for a mistake here has as much an impact as picking up a lousy fund or stock. The maximum pain point you can afford to bear is not something that is easy to locate in good times, it’s only in bad times you come to know what level of exposure was okay and what was not.

If we can agree that when this all ends, we will not end up in a dystopian society or become zombies, at some point the market will settle and then bounce back. No one knows which that level is which means that all predictions are just that, predictions without any greater chance than one you can come up with using a random approach.

As I wrote in my previous post, historically markets have bottomed even before the end of the bad news. Same would be the case here too. Stick to your method, there is no better alternative as long as the method has been tested and found to be something you can come to bear.

Mayhem in Markets. Will it End

Every Bull and Bear market is different yet when the dust is settled, it’s all the same. What is different is the way the market behaves and the speed at which it acts.

India has seen three major busts till date – 1992, 2000 and 2008. We hear those since they were related to either major scams or global market meltdowns. But those aren’t the only times markets have fallen.

In 1991, with India on the verge of political instability (the then Chandrasekhar government could not pass the budget in February 1991) and a serious economic crisis. Foreign Exchange Reserves were declining to the extent that India in January 1991 borrowed $777 million from the IMF.

But markets had peaked in October 1990 and by the end January was down by 41%. But right when it should have crashed and burned, markets started to rise even though Foreign exchange reserves dropped to an all-time low of $1.1 billion in June 1991, barely sufficient for two weeks of imports. But the October 1990 high was taken out by July of 1991.

{Source of Fx Data: Montek Singh Ahluwalia. BACKSTAGE: The Story behind India’s High Growth Years}

Between 1986 to 1988, again a period of government instability, markets fell 40% before recovering all by October of 1988.

Let’s look at some International Evidence

First, the London Market during World War II. The pics below is from the book Wealth, War and Wisdom by Barton Biggs.

Japanese Market during World War II and later the Korean War (Peak and Trough)

Biggs concludes with the following

Is Corona Virus the Black Swan that will result in a total breakdown of financial and social infrastructure as we know it? I don’t know but I think the odds are pretty low even though as country after country closes their gates to outsiders, it surely feels as such.

In the last leg of a bull market, the seller is staying away hoping for a better price tomorrow while the buyer is willing to pay whatever the market asks today. Today, we are seeing the opposite of it with the buyer staying away hoping for a cheaper price tomorrow while the seller is willing to sell it at whatever price it can get.

Which reminds of this famous pic from the Great Depression

Let’s look at the broader picture to understand where we stand today. First off the 10 year return.

If you had invested in Sensex 10 years ago, your compounded return today would stand at 5.02%. The previous time you had seen this kind of low return in this Century was if you had invested in 2007 just before the financial crisis brought the world’s banks to its knees. Most of the other instances are for investors who invested in the period between 1991 to 1994 (ending period being 2001 to 2004).

The Sensex is currently 26.50% below the 200 day MA.

Red Horizontal Line is where we are today

While it has come here couple of times in 1992 and 2002, the only other time it was comprehensively down was in 2008.

Nexg, a look at one of my favorite breadth indicators. Percentage of stocks that are trading above their 200 day EMA’s

We have briefly went below in the past but other than in 2008, rarely stayed there for more than a few days at best.

Number of Stocks with Positive Momentum

Basically this is closing in onto the lows of 2008 (which came nearly 8 months after the crisis started versus being in the very first month this time around)

New 52 Week Lows

On Friday, 1000+ stocks registered a new 52 Week Low. With 2500 stocks being in the database, this means that 40% of the market was hitting new 52 week lows that day. A record with exception of 2 such days in October 2008.

Relative Strength Index {RSI}

Relative Strength Indicator is an indicator used to measure the strength or weakness of a stock or market based on the closing prices of a recent trading period. As of today’s close, 1400+ stocks are in oversold zone

30 Day Volatility

Enough Said.

A Interesting Twitter Thread

1/N We often hear- what crashes in a bear market takes decades to recover and what stays strong is 1st one to bounce. I am a believe of check it before believe it and ran a simple 1 hour analysis. A simple heatmap table worth 1000 works. Attached is chart and thread of insights pic.twitter.com/PcKl4SvEVA
— kumar saurabh (@suru27) March 17, 2020

Compared to other falls where disruption was caused due to economic reasons, this time around the fall has very little to do in terms of direct economic or bank / credit related reasons. Banks are very much in business, there is no credit freeze or houses and jobs being lost, at least not yet.

Weak businesses need very little reason to fail and Cornavirus may be instrumental in taking them out of the works. Non Performing Assets may rise but given what we have already seen, the rise may not be as catastrophic as we assume.

The darkest hour is just before dawn. I don’t know if we can go darker for there is plenty of space to go lower, but the odds are already in favor of investing if one can hold onto it for a few years.

In recent years, company growth has been ispid but still very much in positive territory. While future earnings will definitely be impacted by the current situation, the question is how much and how much of it has already been discounted.

Drawdown from Peak

On the NSE, just around 27 stocks have a draw-down from peak lower than 20%.

There is no magic strategy that can avoid draw-downs. Be it Passive or Active, Be it Value or Growth or Momentum or Quality, you shall be hit with draw-downs some time or the other. Going to cash seems an optimal way but this generally comes at the cost of returns. One cannot regularly keep going into Cash and still out-perform the market.

Dow as I write this is down another 2000 points and now close to breaking the 19,000 levels, a level from which it broke out in 2017. On the other hand, our Small Cap Index is pretty close to where it opened in 2010 (and was where it was in late 2007 as well) while the Nifty Mid Cap and Nifty 50 Index are where they were last found in 2015.

Stick to your strategy. That is the best hope for now and forever.

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New 52 Week Lows

Relative Strength Index {RSI}

30 Day Volatility

Drawdown from Peak

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