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Till date one place I have been highly unsuccessful is in the arena of entrepreneurship. Reasons are many but one of the foundational reasons as I understood very late is my inability to bear the pain of losses while continuing to be optimistic about the future prospects.
Very few enterprises start off making money right from the word go. Even not accounting for the founders own salary, many take years to break even. If one added the opportunity cost of the founder foregoing an income he would have been able to earn elsewhere for the skills he has, the breakeven period could be even longer.
Writing in his book, The Narrow Road, Felix Dennis chimes thus
Anyone in good health and reasonable intelligence, provided they utterly commit themselves to the journey, can succeed on the narrow road. Tunnel vision helps. Being a bit of a shit helps. A thick skin helps. Stamina is crucial, as is the capacity to work so hard that your best friends mock you, your lovers despair, and your rivals and acquaintances watch furtively, half in awe and half in contempt. Self Confidence helps, Tenacity is an absolute requirement, Luck helps.
When it comes to the market, the success rate is no different though experience tells me that it’s actually worse since what happens in years in a business can happen over a period of days in the market. The worst business can survive for a year blowing out his capital. The worst investor or trader would last a few weeks at best.
Behavior and Strategy are the two key ingredients for success. But good behavior alone cannot guarantee success since a bad strategy is guaranteed to blow up one’s capital though good behavior may ensure that one can hang around for a lot longer.
A good strategy in itself doesn’t guarantee success in the short term for there are always vagaries of nature but like compounding, in the long term, a good strategy can make a huge difference to the outcome.
The period from April 2020 to December 2021 was a rarity. In those 21 months, Nifty doubled in value. This is not something we haven’t seen earlier with the most recent of such instances being in November 2010 (21 month returns were to the tune of 112%, 10% better than this time around).
Correction in the markets was not a question of it but when. 2022 we seem to have started off as a year when some of the excess returns will be given back as markets self correct their earlier excesses.
Take a look at the chart below
Since 1980, Sensex has generated a long term return of 15.88%. But yearly returns on an average aren’t anywhere close to that. We have some very good years and some very bad years and some nothing years in between.
The chart plots out the differential between the return of the year and the long term return. Hence for 2021 when Sensex return was 22%, it shows up as 6% excess returns.
What is interesting to observe is the big bars we used to see pre-2009 on both sides have virtually disappeared. We don’t have extraordinary years (like 2003 when we went up 73%) nor are we seeing extraordinarily bad years (like the bunch we see in the mid 90’s – do note though that the market wasn’t that bad. It’s just looks had when you subtract 15% from the years already bad return)
In 1998, Sensex trailing PE ratio went below the 10 mark. Interest Rates were high, Inflation was high and Markets were cheap. The probability that we shall see a similar opportunity while can never be ruled out, the odds are pretty slim.
It never rains but pours is a proverb that is most suited for bear markets.
Right now, there is plenty of bad news going around.
The Russian Invasion, the sharp hike in Crude which may push up Inflation forcing RBI / Fed to hike will all be just excuses for what we have seen happen in the markets time and again.
Crude prices were high even before the US had enforced sanctions on Russia but are now on a tear. While every country will be impacted with the high price of Oil, the impact will be felt more in emerging countries like India.
Price of Nickel shot up so much that the London Metal Exchange had to shut down the market for the day to allow for those caught on the wrong side enough time to refill their margins. Poland has broken ranks and raised interest rates by 0.75% to 3.5%. Sri Lanka has had to devalue their currency by 15% to ensure that they can apply to the IMF for loans
But only when there is bad news enough to frighten the life out of someone will he be willing to sell things that once were seen as great opportunities at throw away prices. We aren’t at throw away prices currently but waiting for those isn’t a strategy.
Drawdowns are a pain, but once accustomed, it becomes easier to navigate through the bad times for the good times are generally right at the corner where the bad time ends. There has been enough written on it yet to be a successful investor, the ability to bear the pain when markets trends down is important.
Right now, the trend is weak. There is no denying that as is the case that there is no escaping such without trade off’s of one kind or the other. Momentum Portfolios as I have long argued are no better or worse than any other factor based strategy. While many got lucky during covid, it seems such luck is missing with respect to the Russia Ukraine Situation.
As the saying goes, being prepared is half the battle won and in investing, being prepared for the bad days is critical for success.
The title of the book was what interested me to check it out. While the title can be said to be slightly misleading (though true), the contents were pretty good. I highlighted some interesting chapters on Twitter
Bought this book attracted by the Title. Bulls Make Money, Bears Make Money, Pigs Get Slaughtered
A decent read for anyone who is fresh in the markets. For those who have been here for long, kind of a recap of things we have learnt first hand. https://t.co/JcfDHyxMgx
The book, while written in 1999, isn’t as dated as one assumes a 20 year book on markets will be. Most of the lessons that can be learnt 20 years back are applicable even today. I particularly liked the Psychology chapters the most. While a newbie may not be able to grasp all the information and analysis, this book is good for someone who is exposed to markets and trying to smoothen the edges.
Outside of Twitter, when I meet traders / investors, one word that never is much of a talking point is drawdown. One reason is most investors and traders don’t even calculate a NAV styled return matrix to understand where they stand relative to where they were say a month ago or a year ago.
Maintaining performance records gives a deeper understanding of both the strategy strengths and the weaknesses. While we all remember our winners, the losers barely stand any scrutiny. Finally, the question though – is our return from the total investment that has been committed greater or lower than the Index remains unanswered.
Draw-down is a measure of how much one’s equity has fallen from the peak. Assume you had bought a stock at 100 and it went upto 150 and today trades back at 101, while for all practical purposes you are still profitable, if someone asked what the draw-down on the trade is, you will say it’s 32%. For someone without context, this would seem like you are deep under water even though you are actually floating just above.
Draw-down provides perspective when it comes to trading systems that employ leverage. A higher draw-down in historical testing would mean that one needs a higher amount of margin and lower leverage to be able to overcome and sustain trading the strategy through and through.
While drawdowns are painful and may result in an existential crisis for traders, the question is whether investors should be really bothered with it?
Markets go down every year. That is guaranteed. It’s more in some, less in others but on an average a 10% drawdown is guaranteed while even 20% is possible though in recent years we haven’t really seen one other than the Covid fall.
Look at the drawdown from all time high for the Sensex.
A 30% fall was normal pre-2008. 50% or more happened just twice. Things have changed a lot since 2008.
If you can have and really have and really live by a good long-term investment outlook, that will be close to an investment superpower as you will be ever able to achieve – Cliff Asness
Louis Simpson was one of the favorite fund managers for Warren Buffett. So good was he that if not for his age, he was seen as the person Warren would have been comfortable handing over Berkshire Hathaway post his own retirement.
In 1987, before the crash, he moved GEICO’s portfolio to approximately 50 percent in cash because he thought the valuation of the market was “outrageous. He was right and the market moved down 41% in the space of less than two months.
Simpson says that the huge cash position “helped us for a while and then it hurt us,” because “we probably didn’t get back into the market as fast as we could have.”
The key to success in avoiding a drawdown and benefiting from it lies being right twice – once when getting out and then when getting back in.
Everyone of us would love to be out when a drawdown hits and back in when the trend returns again. While advisors claim this is possible, I have for once not found a single PMS (where you can actually go to 100% cash as and when you feel like) ever talking about having either done that or this being part of their strategy.
The reason is simple – there are way more tradeoffs that one bargains for when trying to move to cash and back. First and foremost, the fact is that not every dip will result in a large crash making the move worthwhile.
The best strategy is one where you get out right before a big fall and get in before it starts to rise again. Other than in hindsight, you can never be right in such a manner. In almost any strategy, you shall get out once the trend has started to become bearish and re-enter when the trend has started to become bullish.
To better understand, we will need to look at what kind of strategy can get us out before big crashes and get back in post the event while also being mindful about not getting in and out one time too many.
Let’s take the 200 day EMA and assume one shall get out every time Nifty goes below this and gets back in when it goes back up. This strategy for instance would have kept you out of the Covid Crash of March 2020.
Even in 2008, while the strategy did not get out cleanly and stay out, it would have still saved a ton of money. In 2009, it went long just before the markets shot up 20% in a single day on the back of the election of the second UPA government. What more could you really ask for?
Nothing comes for free and even here there are some downsides.
The best way to compare a strategy is to compare it with a strategy that does nothing – in other words a Buy and Hold.
If you implemented the strategy – getting out when you were told so and got back in versus your friend who is a buy and hold investor who invested the same amount in Nifty in 1992, today your friend’s equity will be higher than what you would have had. In other words, your friend would be richer than what you are today even though both of you had invested in the same underlying index.
On the other hand, during the worst times, you were sitting pretty in Cash while your friend would have been aghast at seeing how much money was lost in such a short time. Most investors give up at the worst possible times. Having a strategy even as dumb as a 200 EMA cross minimizes that risk.
The second and bigger trade off is with the ability to stick to the strategy. Remember, your friend has to act only once and he is done. For you, it’s different. Since 1992, you would have entered and exited Nifty an additional 110 times. That is more or less 5 to 6 times a year. What is worse is that 75% of those trades lost money.
Finally, let’s assume that the investment is your life savings in its entirety. The larger it gets, the tougher it always is to get out when the markets are falling and even tougher to buy it back at a loss at a higher price. Not to mention the taxes to pay and the charges you end up paying. Life ain’t easy.
While the number of trades reduces a bit, the outcome isn’t too different. You still would have underperformed your friend. Of course, if you calculated this not when the markets are high but when the markets are at its low, you would have seen yourself as a winner.
The other day, I was listening to an interview of Bill Miller, the famed Value Investor and his thoughts on Volatility seemed interesting.
Achieving lower volatility than the average or achieving low volatility is not the objective of investing. It might be a psychological objective for people because their psyche’s don’t like to see them losing money because the coefficient of loss is two to one. But the objective is to make money and outperform the markets.
There is no escape from Drawdown regardless of the strategy. Charlie Munger in 1973 was running a partnership which saw a drawdown of 53% vs Dow’s drawdown of 33% for the Dow. While the intrinsic value of his holdings were definitely higher, the problem is always about not what it’s worth but what the market values it at.
Risk Tolerance & Asset Allocation
The other day I was listening to a very well known and accomplished person in the world of finance. He talked about how when markets fell in March of 2020, his system told him that it’s time to move 20% from Debt to Equity. He ended up moving 2%.
The pain of buying equities when the whole world seems to be selling is way too great to overcome even if we somehow have overcome that pain by selling after the markets have gone down from their highest point.
This is also one reason that binary systems which move from 100% Cash / Debt funds to 100% Equity (Dual Momentum for example) have so few takers despite tons of data on the benefits of following one such strategy. In fact, beating the underlying such as Nifty becomes possible in a Dual Momentum strategy if you were to move to say Gold vs Cash but who in their right mind can be 100% invested in Gold at any point of time?
Assume you own a portfolio worth a Crore of Rupees and as of today that is all you have. Markets start to fall but your system is still telling you to stay being long equities. You are uncomfortable but you are intelligent enough to know that the system is always right and you are better off sticking to it.
Market falls even more and finally your system says – Sell everything, move to Cash. Depending upon your own predisposition, the probability is that you will do exactly as the system said, more so if the day post the signal gets generated is a negative day.
Post your sell decision, the market starts to seemingly flatten out but we are now hit by a wave of bad news, news that was most probably the reason why markets fell in the first place. You start to think that you did the right thing by getting out for who knows how deep the markets can go down.
But a few days later, the market starts to climb. You ignore this as part and parcel of the gyrations that one will see in such times. A few more weeks later the market is higher, higher than where you sold. You would feel bad but still believe your call to exit was the right one. Two days later, the news is as bad as it was at the bottom but markets have moved up 15% from the lows and 10% from where you sold and your system signals a Buy.
Would you turn around, sell all the Debt Funds / use the Cash and buy back 100% of the equity you sold?
The probability of one doing it is low and this is how the majority will actually react. It doesn’t matter how much experience one has, the probability is always low, more so if one already has had seen a couple of whips.
Why this dichotomy between the decision to sell and buy?
The answer lies in the fact that when we lose money, even notionally, we suffer pain. Pain is so great that we are happy to unload the position even at a substantial loss. But buying again is tough because our recency bias tends to reflect upon the recent bad news with expectation of failing once again. Why get back so soon, should not the news settle down is a much asked question during these times.
One reason investors choose the Do it yourself approach especially when it comes to stocks is the control one has over the construction of one’s portfolio. An added benefit is of course that there is no fee you would pay.
Do-it-yourself also means a low or flat fee at best. On the other hand, the fee we pay is not in terms of money but in terms of being able to mold our psychology and be prepared to continue with our journey in both good days and bad.
Finally a slide from Ravi Dharamshi of Value Quest Advisors. Key point is the last point – 4 big crashes out of 30 years that should be avoided.
4 in 30 years is close to one in 7.5 years. Trying to get in and get out wondering if this fall is going to be the 5th will in the long run turn out to be more expensive than staying put and sailing through the rough waters.
It’s always fascinating to read about great investors and who is better than Warren Buffett and Charlie Munger. But unlike other investors, it’s tough for neither have written a book themselves or are there any authorized biographies.
Warren Buffett’s rise is more of an open book. Charlie Munger on the other hand is much more subdued.
Instead this book looks at Munger with focus more on his family and his the path he took before he joined Warren Buffett at Berkshire Hathaway.
While compounding may be the 8th wonder of the world as Albert Einstein once put it, compounding from a small base doesn’t really place one in the Forbes list of the richest folks in the country.
Warren Buffett’s path is well known as to how he came to accumulate enough capital. Charlie Munger on the other hand isn’t that well known. For me at least it was a surprise to learn that Charlie made his first Million in real estate deals.
Compared to Warren, Charlie comes off as a risk taker. His real estate deals as well as a couple of stock acquisitions were leveraged to some extent. Of course, his bigger risks were career related, taken at a time when he had a large and growing family.
While much of the talk is about the folksy way with which the two went to town acquiring good business at reasonable prices, this book and the one I read before – Capital Allocation: The Financials of a New England Textile Mill 1955 – 1985 showcases that it wasn’t such straight forward, especially in the early days. They were able to acquire good companies but were going through their own difficulties.
The biggest advantage Munger and Buffett had during their early years was the fact that they matured during a period when the market went nowhere for a decade and more, providing them not just the opportunities but also showcasing the advantage of patience.
Today with blank check companies raising billions, the edge has receded a lot for anyone who wants to follow a similar path. While we may never be able to replicate the path the pioneers take, reading provides a framework of what can be applied to areas that are different and yet similar to Value Investing.
If you are a fan of Munger and wish to read more about his life and family, this is a book for you, else one can give this a pass.
“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.
Michael Batnick who is Director, Research at Ritholtz Wealth Management tweeted out the following chart of Amazon
Implicit in the message (my presumption since nothing was blogged / tweeted) was that its not enough to buy a great stock, you need to have the stomach to take big draw downs like Amazon say (90%+ after the IT bubble crashed in 2000).
But what is missed is the fact that Amazon was one of the very few survivors of the carnage of the 2000’s. While I don’t have the actual stats, my guess is that greater than 80% of the stocks that were listed at that point of time don’t even exist (in any form) today. Pet.com / Webvan.com / eToys.com being some of the biggest losers.
The same is the case with Indian IT stocks as well with very few surviving the carnage. In Bangalore which was and has been a Infotech hub, we had stocks like Shree MM Softek, International Computech, Cybermate Systems among others (50 IIRC) that no longer even exist. Bigger ones you may remember would be Pentafour Software / DSQ Software / Aftek Infosys among many others.
Returns don’t come from suffering unbearable draw-downs. Returns come when you are able to balance out the risk with probable rewards and if your stock is down 80% or more, you have a 20% or lower chance of ever getting your money back. Things like Amazon / Apple happen, but only in hindsight do we recognize the great opportunity that it was.
And last but not the least, while its seem one easy way to avoid total destruction would be to be well diversified, it has to be across asset classes / sectors / industries. Buying 10 NBFC companies (Today’s hot sector) or 10 Pharma would either make you very rich or very poor and is not definitely for someone who wants to achieve returns greater than what a simple Index fund would provide.
A small table listing out % of stocks that are at different draw-down levels. Remember, these are those who survived and continue to be listed – many don’t.
A adage in the market says that Stocks take an escalator up, and an elevator down and in this environment with Nifty falling like nine pins day in and day out, one actually wonders if it has taken the elevator or has actually fallen through the elevator shaft.
While till recently the mood of the market wasn’t bearish, the last time we saw a new high was way back on 3rd March and a month from now, we would have passed a year without being any closer to the same (unless of course the market decides to make up for all the mistakes in double time and make a new high before that).
But, historically what has been the duration of time spent between two highs and more importantly in light of the fact that we are now down 18.75% from the high point, what is the average draw-down one encounters.
When markets are hitting new highs, there is generally some amount of continuation and to avoid small number bias, I have reduced the number of highs to those that occur at least 1 month after a previous high. In other words, if markets hit a new high 3 times in the month, I ignore the 2nd and 3rd high and take for my calculation only the first.
But to calculate the draw-down and number of days spent, I use the 3rd high so as to ensure that only the draw down seen after the last high to the next high gets measured.
So, we have had one more day of Blood letting with markets showing no signs of bottoming out even though domestic institutional investors continue to Buy into the weakness, a weakness that has been caused majorly by global factors accompanied by ceaseless selling by foreign institutional investors.
Blood letting was a medical practise carried out as late as end of the 18th Century due to the belief that only by removing all blood could some of the ailments be resolved. The reason is survived so long was due to the faulty way its success and failure was calculated. If the patient survived, the blood letting worked whereas if the patient died, the catch was that the patient could not be saved even though blood was let. A kind of Heads I win, Tails you lose.
In the markets, blood letting is a ritual that is practiced every year. Investors who are strong survive to see another year while weak Investors just die never to come back again and will be replaced by a new breed of investors hoping to make a mark.
Markets are now down 18.43% from its peak but for many a investor, it seems as if the floor has given way. This could be due to the fact that the markets which topped out in early 2015 has been on a consistent decline ever since. Of course, this was not visible in the Mid and Small cap segments which till a few days ago were in a world of their own, but the flight of capital from Small Caps where the exit door is very small has made it similar to people trying to rush out of a single door when a room full of partying people suddenly realized there was a raging fire outside.
But the draw-down in itself has not been abnormal. Nifty has seen a average decline of 21.87% (even if you remove 2008 from the calculation) from the year high and in that aspect, the current draw down for 2016 is just 6.60%.
Every fall is a opportunity provided one is ready to catch the same when its available. In panics, investors (both retail and institutional) are so immersed in trying to get out that they are willing to sell Gold for a few trinkets of Copper only if they can get ready access to cash. We are no way closer to that though a final long term bottom would see something similar. Hope you are ready when that happens.
