07 – THE PENDULUM OF INVESTOR PSYCHOLOGY – MASTERING THE MARKET CYCLE

Psychology/emotions affect corporate profits and investment cycles as well. We have seen the pendulum swings in both the extreme and investment world also moves in the same way.

Between euphoria and depression, between celebrating positive developments and obsessing over negatives, and thus between being overpriced and underpriced.

And few other observations of the pendulum – between greed and fear, between optimism and pessimism, between risk tolerance and risk aversion, between credence and scepticism, between faith in value in the future and insistence of concrete value in the present, and between the urgency to buy and panic to sell.

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Above is average return but what about good and bad cycle?

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When people feel good about the investment, Optimistic about it then they are in the greed and buy more which resulted in the increase of assets prices. On the other hand, when they do not feel good about the investment, pessimistic about it then sell their assets which reduces the prices of assets. Sometimes market plays between a range where greed and fear both having a stronghold.

When investors do not feel fear then prices of assets keep on raising up. Similarly happens during the tech boom 1999-2000, subprime in 2003-2007 and current scenario.

Somehow the greed evaporated and fear took over. “Buy before you miss out” was replaced by “Sell before it goes to zero.” When greed is high then people find for next Infosys, top-performing private sector banks but when fear is higher than seeing each as a next Yes bank, DHFL.

Other factors such as euphoria and depression are an extension of greed and fear. Continuing greed translated into the euphoria and fear into the depression.

When prices of assets raise then people believe in any stories prevailing in the market but reversely when prices falling then cheap assets does not get the attention of investors.

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Superior investors are wise enough and they buy assets when it available at the discount from intrinsic value and there will be a potential to increase in intrinsic value.

For making such investment decisions, they need to keep a balance between greed and fear. Very few investors remain cool and unemotional to stay at the midpoint of fear & greed. Else, the majority of people remains greedy when everyone is optimistic and fearful when everyone is pessimistic. The pendulum moves from one extreme to the other and remains quiet for midpoint. For becoming a superior investor, we need to be unemotional to such swings. Emotional people will require a great deal of self-awareness and self-restraint for becoming a successful investor.

People generally remains biased with their emotions to reach any conclusion.

INTEREST RATE CUTS: DOES IT PROVIDE LONG-TERM BENEFITS?

Many times, it has been noticed that news over both extreme – positive and negative but market keep on rising.

So that, Interpretation of the data has importance. During the depression time, positive news getting ignored and negative news only getting rewarded. Reversely, during the euphoric situation, negative news getting ignored and positive news only getting rewarded. Saving ourselves from such traps results in the superior investment returns and long-term survival of our wealth.

Disclosure – Companies mentioned in the article are just for an example & educational purpose. It is not a buy/sell/ hold recommendation. 

Read for more detail: Mastering The Market Cycle: Getting the odds on your side by Mr.Howard Marks

06 – THE CYCLE IN PROFITS – Mastering The Market Cycle

As we have seen that the economy moves in a cyclical way and if the economy moves in a cycle then the industry will get affected by the cycle and due to that corporates also getting affected. The profitability of corporate earnings has been affected by the economic cycle. But such effects vary from company to company as per the inherent capability of the company.

Corporate profits rise and fall more compared to the GDP growth and we need to focus on factors that cause such cyclical trends.

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And when GDP shows weakness

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So corporate profits also getting affected by the economic cycle. We can argue that food, beverages, pharmaceuticals do not have any impact on the economic cycle. Yes, not high but during a recessionary environment, people tend to save more than what they earlier used to. People prefer to eat at home rather than to go out to a restaurant. People prefer to cut costs while experiencing a tough time.

Durable products majorly affected by the economic downturn because such goods can last longer and people can defer spending on such goods.

We should not have to directly consider that increases in the sales will similarly result in the increase in profits. This is because of the operating leverage. Cost mainly remains fixed and few costs increase with the sales.

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In general, it’s higher for companies for whom a larger percentage of costs are fixed and lower for the ones whose costs are more variable. Operating leverage helps the companies when the economy is in good shape and sales rising. But when the economy and sales are in bad shape, profits fall more than sales.

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Other than these, there are few other factors which can also affect the profitability of the companies such as management’s decisions regarding inventories, production levels, and capital investment; technological advancements (on the part of a company, its industry competitors); changes in regulation and taxation; and even developments exogenous to the industry or war, weather, etc.

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The technological disruption led cycle such as streaming has killed the DVDs culture so that those businesses which does not welcome technological changes, they all get out of the business. Nokia & Kodak are also the biggest examples of got the worst hit on business.

Disclosure – Companies mentioned in the article are just for an example & educational purpose. It is not a buy/sell/ hold recommendation. 

Read for more detail: Mastering The Market Cycle: Getting the odds on your side by Mr.Howard Marks

05 – GOVERNMENT INVOLVEMENT WITH THE ECONOMIC CYCLE – Mastering The Market Cycle

Generally, the economy works as either a free economy or a communist economy. But the most accepted free economy also needs government interference sometimes. There are interventions made by controlling authorities for shaping the economy and help the economy to grow well.

Central Bank

Central Bank such as RBI concerns managing the economic cycle which is mainly through inflation and employment. Inflation has a two type –

  • Demand-pull where the demand for products increases more than of supply.
  • Cost-push where prices of labor and raw materials increases.

Central Bank involves in reducing money supply in the economy through increased interest rates, selling of securities which resulted in lower demand due to lower availability of money and inflation comes down.

Such an act also hampers the growth of an economy.

When it comes to generating more employment in the economy then the central bank increases the money supply to the economy through reducing interest rates, purchases of securities (quantitative easing), etc.

Central Bank has to maintain a balance between employment generation and limiting inflation.

 INTEREST RATE CUTS: DOES IT PROVIDE LONG-TERM BENEFITS?

Government

The government has a wide area of responsibilities and the economy is one of those. The government has the main tool for managing the economic cycle is fiscal which includes taxing and spending. So, for stimulating the economy, government cuts tax, increases government spending, provides stimulus packages. Government reversely increase taxes, reduce spending and another stimulus when they feel that the economy is overheating.

Also, the government has to look after the deficit which results in the increases in debt levels.

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The above stimulus will invite higher taxes when either economy overheating or debt level of economy crossing limits.

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If higher taxes and lower spending by the government with the fiscal surplus resulted in the lower down of debt level and the fund goes out of the economy. Reversely, lower taxes and higher spending by the government bring more fiscal deficits and that will have resulted in the increasing borrowing levels.

Similarly, currently, Government has cut corporate tax rates in India and this will have resulted in the above process mentioned in rate cut but in a longer period, this lower tax can be increasing a debt level. India is a developing economy that requires higher government spending as well so that that will surely going to increases a deficit and will increase a debt level. But for stimulating growth in the economy it is a welcome step. Otherwise, the economy starts failing. The government has to take appropriate steps whenever requires.

Disclosure – Companies mentioned in the article are just for an example & educational purpose. It is not a buy/sell/ hold recommendation. 

Read for more detail: Mastering The Market Cycle: Getting the odds on your side by Mr.Howard Marks

04 – THE ECONOMIC CYCLE – Mastering The Market Cycle

The economy also moves into the long term and short-term cycle as an industry, stock market and everything else moves which are explained further.

Long-Term cycle

We know that the growing economy graph going upwards in the long term but it has short-term ups and downs.

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Long term straight line is made up of small cyclical ups and downs of the economic cycle of recession and recovery, slowdown and prosperity. These are part of any economy.

Everyone gets agree with the above point but we also need to understand that long-term trends also having a cyclical move as same as the short term. Here we also need to put a focus.

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We can see that the GDP of India has moved from US$ 0.04 trillion to US$ 2.72 trillion which shows long-term up moves but if we see shorter-term momentum of growth rate than it shows highly fluctuating with ups & downs.

 When Population growing it will lead to more consumption and that encourages more production. For producing more, companies need more working hours and that will be converted into more GDP.

So, population growth remains key to the growth of an economy. If growth converts to degrowth then economy starting to shrink.

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When the growth of population changes, it affects the GDP growth for a longer period of time. When a child gets born then it takes around 20-22 years for a child to become an employee. Also, migration from other countries replaces the birth rate of the country. Migration from other countries also enhances consumption and productivity which resulted in growth in GDP.

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Another factor that affects GDP growth is productivity. As productive can be raised despite any growth in the population, then GDP also grows or getting slow with the slower or declining in productivity. We have seen the growth of productivity when human labour replaced by machines, new automobiles, electricity, and computer has introduced. But these all have taken decades of time to affect the GDP. So, for the year to year productivity remains steady. This is not a change that will come overnight and disrupt everything rather it will slowly create changes over a long period.

The aspiration to live a better life encourages people to work hard and produce more. Educational people contribute more to the economy but if people do not like to be educated then it will affect negatively the economy. Such negative effects need to be overcome by the migrated.

Technologies that introduce new businesses and replaced the older. Also, it affects employment.

Automation might have an effect on reducing employment, and thus income and consumption will also decline which again affects the GDP growth.

Globalization provides a chance to export to the other economies which enhances the GDP growth. But the impact negative to the economy which only relies on the import from the other economies.

Short-term cycle

We have seen that many factors take time to affect a long-term trend of GDP. Then why short-term fluctuations occur and why we need to focus on it?

There are factors that cause short-term fluctuations in GDP growth. We always need to focus on those factors to get an edge to our investment. The actual investment game is to getting superior returns than average. We should not focus on the correct forecast but should focus on the superior forecast.

Many of the economists extrapolate current trends and publish reports on it. Such information is available with every so that it does not add much value. Also, we do not get superior returns by doing the same what the majority is doing. It is easy to make any forecast on the excel sheet but it is very difficult to keep it near to reality.

Spending patterns of the individual affect the production of the companies and that has an impact on the GDP growth.

Similarly, companies feel that demand remains robust then they keep on producing more and more but what happens when demand does not come. These unsold goods added to the inventories and companies has to cut production until inventory does not come back at a normal level.

Recession in an automobile has impacted the inventories of OEMs

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Few events also affect the performance of GDP such as war, changes in tax rate & trade barriers by government, cartels in the price of commodity, drought, flood, hurricane, and earthquake.

Superior forecast where we identify the deviation from the long-term trend and recent status of it. Identifying such deviation provides us with an edge. But identifying such is not an easy task and not all unconventional deviation also gets correct. We remember people for their correct unconventional prediction but they also have many failed predictions.

These all short-term factors affect GDP growth in a shorter time frame but that also helps us to get an edge into our investment. So that we require to have a keen understanding of all and focus on it for taking benefits.

Disclosure – Companies mentioned in the article are just for an example & educational purpose. It is not a buy/sell/ hold recommendation. 

Read for more detail: Mastering The Market Cycle: Getting the odds on your side by Mr.Howard Marks

03 – THE REGULARITY OF CYCLES – Mastering The Market Cycle

The world is full of randomness and people behave differently at different times so that it is difficult to predict the exact future. If we study the science and mathematics cycles then those have predictable sets of rules and moves in a regular way. But economics, companies, and participants are relying on the psychological influences so that they do not behave in a regular way. When emotions have an involvement then things become more difficult to predict.

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So that Greed and Fear of the investors remain regular in every cycle. This affects the prices of the assets.

As per the Cambridge dictionary, the definition of cycle “a group of events that happen in a particular order, one following the other, and are often repeated.”

We can see that many factors affect the occurrence of the events and that makes it difficult to predict the exact for the future. Current global scenario, we have an ample number of factors that can affect the cycle such as crude, the decision of the USA, domestic economic conditions, etc.

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Disclosure – Companies mentioned in the article are just for an example & educational purpose. It is not a buy/sell/ hold recommendation. 

Read for more detail: Mastering The Market Cycle: Getting the odds on your side by Mr.Howard Marks

Mastering The Market Cycle – 02- THE NATURE OF CYCLES

Cycle changes for the different time period, details, extent but it will be ups and downs forever which changes the investment environment & behavior.

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There are cycle moves in an identical phase such as a low to the middle point, middle point to a higher point, higher point to middle point with correction, middle point to lower point and then again to the middle to a new high. It is not necessary that the cycle starts from the low and ends at high or at again low, but it can start with any point and end up at any point.

Actually, the cycle never starts nor ends. We need to know why this upswing starts, where we are into the cycle, are we near the end of up/downturn, etc. Such answers need to be sought for the better judgment of the cycle.

Details of every cycle can change such as speed, time, reason, duration, etc. but cycle repeats.

Mr. Marks has quoted a story that blind persons touch the different parts of the elephant and make a story based on that touched part. Mr. Marks has explained that we are also similar to them, we also do not try to put things together and make a judgment. We must remember past events and keep in mind the cyclical nature of things. We also keep on thinking that the bull/bear run will continue forever but we need to focus on the previous cycles and understand the cycle that no phase-in cycle remains forever.

Cyclical development into one area also affects the other area of the cycle. That is if growth in an economy starts going down then the central bank will also work on reducing interest rates which involves a different cycle.

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We must have to understand that cycles are interconnected and one affects others, others affect another. We can study individual cycles for the analysis purpose but for the conclusion, we need to combine all together. Without putting everything together, we cannot reach a conclusion that where we stand at the cycle.

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We have seen that it takes time when we pump air into the balloon but it takes very little when air goes out from the balloon. Similarly, asset booms take time to occur but the majority of the time bust happens very rapidly.

Every boom and bust having a similar lesson that excessive optimism is a dangerous thing; that risk aversion is an essential ingredient for the market to be safe; that overly generous capital markets ultimately lead to unwise financing, and thus to danger for participants.

Generally, we do not learn lessons from past mistakes and doing the same things with the expectation of different results. This is never going to happen. Every time when asset prices start moving towards the bubble territory then people start running to take the asset with the missing feeling. And similarly, when asset prices are near to bust then all running away from the asset. This is a common and repeatedly occurred event. And every time, people keep believing that it’s different this time. But it’s never different but yes the majority of people are different in the different cycles which make them a force to think that it’s different this time. Those who have survived during the different cycles must know that every cycle having the same characteristics and it will always be going to occur.

Disclosure – Companies mentioned in the article are just for an example & educational purpose. It is not a buy/sell/ hold recommendation. 

Read for more detail: Mastering The Market Cycle: Getting the odds on your side by Mr.Howard Marks

Mastering The Market Cycle – 01 – WHY STUDY CYCLES?

After the completion of the Bibliophile series on the book “The Intelligent Investors” by Mr. Benjamin Graham; I am hereby starting a series on the book “Mastering Market Cycle” by Mr. Howard Marks. I have already completed bibliophile series on his first book – The Most Important Things. He is one of the investors to whom I admire and learn about the cycle and always get to protect my wealth while nobody thinks about it.

As the cycle getting change, our odds also start getting change. It is mainly depending on our position to the cycle at where we stand to the cycle. If we are standing in a favorable position then we can increase our bets and reap the benefits of the cycle. Similarly, in unfavorable situations, we can protect ourselves from unfavorable changes in the cycle. If we are standing at unfavorable situations then we can adjust our position.

If we have the same information as others have and we analyze as similar to them then we cannot outperform the mass. Consistently outperform the mass is already a difficult task to perform.

Mr. Buffett has mentioned regarding the desirable piece of information – it has to be important, and it has to be knowable. Macro definitely affects the market so knowing it helps. But for consistently outperforming through knowing macro is difficult.

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When we are constructing the portfolio then we generally look at the difference between price and value. Also, we bought the company which has the highest value I. E. Company available at a discount to its value.

So, does it not look at the quality of the company?

Yes, it is right that for successful investing, we need to identify the company which understates the value proposition. Higher the upside, we can take a position accordingly. But if we adjust our position as per the upcoming market storm then it can be more profitable and can add further value to our investment journey. This estimation of the upcoming market situation helps us with the decision making to remain aggressive or to be defensive in our portfolio. We only make an aggressive /defensive decision when we know the investment environment and where we stand in a cycle. When we get investment opportunity at cheaper, discounts to value then we should be aggressive and when getting expensive, then we should be defensive.

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Similar we can do for the midcap and small-cap universe. And prepare ourselves from an upcoming cyclone.

We all talk about the risk but what actually risk mean? It can be loss of capital, academic says the risk is volatility in the price of assets. So, Mr. Marks has explained the types of risks in a good manner.

Opportunity loss, this is a missing out a potential gain, our investment has underperformed compared to what we missed and things do not happen the way we want it.

Risk means the occurrence of more things than we have predicted. If we know what is going to happen then there will be no uncertainty or not any risk. And if things are certain then we also get certain returns such as bank deposits. We cannot surely know the outcome of the events but we can assume the probability of the occurrence of the events. We assume the probability of the events that does not mean that we know the occurrence of the events. Anyone event can occur out of the many events. When we do not know the occurrence of the events, then we do not have an edge and we have to stay depended on luck. When we have the knowledge of the occurrence of the events then we have an edge and winning probability will increase with lower down losing probability.

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Superior investors are attentive to cycles and they capture the cycle for reaping profits.

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When a cycle is in our favor, we can earn good profits by taking benefits of it and visa Versa, when the cycle does not favorable to us then we can protect ourselves for loss of capital.

When cycle at extreme of Greed then we have to protect ourselves from capital loss. There will be a higher chance of incurring losses rather than earning profits.

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If we look at the P/E of Midcap and Small Cap index during the year 2017-18 then on the closing basis it was 37.22x and 86.19x respectively and high P/E of both during the same period was ~47x and ~114x respectively. At such valuation, we are not ready to buy a few growing large caps but having a huge hope of getting a return at such high valuation and transformation of small-cap as a future large cap. So that such a scenario is for protecting capital rather than chasing high returns. I had parked ~73% of my portfolio in the liquid fund during the same period which has helped me to survive in such cyclone. We need to focus on the cycle, pendulum where it is moving and where we stand in the cycle.

When in a similar cycle economy, corporate profits and prospects remain the same but pessimism among the participants provides an excellent opportunity to make an investment, increase our position to be more aggressive. And when the economy, corporate profits, and prospects remain the same but having a huge optimism among the participants then we should adjust our position as a defensive investor.

When our position in the cycle changes, our odds also get change and if we do not change our investment accordingly then we miss the opportunity to enhance return or protect capital.

Disclosure – Companies mentioned in the article are just for an example & educational purpose. It is not a buy/sell/ hold recommendation. 

Read for more detail: Mastering The Market Cycle: Getting the odds on your side by Mr.Howard Marks