The (in)ability to Act

There is a famous saying by Mike Tyson

Everybody has a plan until they get hit. Then, like a rat, they stop in fear and freeze.

As Investors, it’s easy to quote 

Buy when there’s blood in the streets, even if the blood is your own.

Baron Rothschild

but as another famous quote goes

In theory there is no difference between theory and practice, while in practice there is

When we talk about markets, we generally refer to the large cap Index – Nifty 50 or Sensex as the indicator of how good or bad the markets are. While the Corona Virus has brought down markets around the world by a notch or two, the fact remains that this fall is nowhere if compared to earlier falls that have been seen by the Index.

Take a look at this historical draw-down from the peak chart. At just around 10%, this fall is nowhere in comparison with even the falls of 2012 or 2014 let alone historical falls. In a way, if history is any guide, this is the start and not the end of a correction.

But, Nifty 50 for a while has not been the correct way to measure market sentiments. While Nifty 50 was hitting new All time Highs, more than 70% of the stocks that are traded on the exchange were trading below their 200 day averages

To get a better sense of the market, I created an equal weighted index of all stocks. Do not that its equal weighted in price terms and not on the basis of market capitalization. The overall market seems to be down by around 14% with the bottom made in October 2019 being in a similar range of the draw-down that we saw in mid 2013.

Don’t catch a falling knife is another quote that is used during market downturns. Then again, if the final destination of the falling knife is your foot, that risk may be well worth taking.

I am a strong believer in buying momentum when it comes to stocks but playing contrarian when it comes to asset allocation. This means that you should be wary of adding money into equities when markets are rising and wary of withdrawing money from equities when markets are falling. 

Having been in the markets since long, one observation I have been able to make is that while pre 2008, rarely did people refer to the crash of 2000 as something that could reoccur, despite the passage of 12 years from the time of 2008 crash, every fall is looked at as maybe the start of the next great melt down similar to what we saw in 2008.

Indian markets history is very small which makes it imperative to look at Dow Jones which has the longest running un-interrupted Index since 1896. Most of us have at max a 30 year period of Investing. 

If you had started your investment journey in the US in 1902, at the end of 30 years, you would have been negative at the end as markets buckled down destroying years of hardwon growth. The low of 1932 was the same level as was seen in Dow Jones was in 1896. 

An investor who invested in the depths of the great depression and let the investment grow for the next 30 years on the other hand gained a return that was not seen by investors until the investor of the 1970’s

One of the toughest things when it comes to finance and investment is to be able to stand against crowd thinking. Right now the crowd is basically wondering if this is just the beginning of a bear market. 

Purely going by the 200 day Moving Average as the line in sand between a bull market and a bear, we are in a bear market with all major indices now trading below. Then again, if you were to observe historical data, the 200 day average has been violated once too many.

A much more stabler and better alternative seems to be the 200 Weekly Average (approximately average of 4 Years). Here is a chart that plots the difference (in percentage terms) between the 200 Week Average of Nifty 50 and Nifty 50 itself.

Whenever blue has turned to red has generally tended to be a good time to invest but not every fall resulted in index dropping into the red zone. In fact, during 2004 when markets tumbled post the election defeat of NDA, even the unseen lows did not test the 200 DMA.

What this means is that if you wish to invest more into equities, waiting for the bottom may prove to be a wait in vain if markets take off without providing one such an opportunity. On the other hand, it’s always advisable to have some dry powder if such a situation emerges.

So, how do we deal with such a situation?

This is where Tactical Asset Allocation comes into play. Unlike traditional asset allocation where the view is to stick to a single allocation and relook at the same once a year or once in 2 years (or as a AMC head recently tweeted, once in 4 Years), the advantage tactical offers is the ability to move higher or lower depending on the situation at hand.

In Bull Markets, we are comfortable with a higher allocation to equity (even musing if we should have risked even more) while in Bear markets, we wonder why we are so high on Equity. The ability to act against the trend is neither simple nor easy and yet acting in line with the crowd while it offers ability to share the happiness in good times also means sharing of sorrow in bad times.

While being too early is as wrong as being too late, we all need to act at some or the other point and if you cannot, your returns will match your expectations or even market returns. Our inability to act during opportunities is because of the fear that we may be too early. Based on whatever data we have, I believe that is not the case. Yet, markets could fall more and hence going all in at the current juncture is not a good idea either.

Stagger your investment to predetermined levels based on either your own portfolio draw-down or the market and act on it. The other day I tweeted out saying that the worst case, I am expecting a 20% dip from here for the large cap and 30 to 40% for the Mid and Small Cap. But that may or may not happen.

Based on the above thesis of mine, my strategy is to stagger so that I can invest / move a part of my capital from Debt to Equity at every X% fall in my portfolio. If markets fall to my worst case scenario, I expect to reach the maximum allocation to equity I am comfortable with, else, I shall still continue to hold Debt higher than the lowest allowable level.

There will always be regrets, the question though is which regret is better to live with and which is not. No one is going to tell when the bottom is hit but having a plan (preferably written down) can go a long way in helping you act when the opportunity arises.