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.

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

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.

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

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.

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.

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.

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

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.

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

Benjamin Graham There Are No Iron-Clad Laws

During my course at Flame University “Art of Investing with Neeraj Marathe”, Mr.Durgesh Shah Sir has suggested me to read a book which is “Big Mistakes”. So that I am hereby starting to write my learning from the book.

We make many mistakes in life and learn from those mistakes. We keep focus on does not repeat the same mistakes again and again.

My Guru always quotes that “If we focus on avoiding mistakes then we won half of the battle.” We always cannot keep on making mistakes and learning from it but also we can learn from others mistakes which we can avoid during our journey.

Learning from others mistakes and experience is the easiest way to learn and grow.

I am hereby starting my learning from mistakes made by well know investors. Upcoming series will be going to include learning from the book “Big Mistakes”. I am grateful to Michael Batnick – author of the book.

The first article of the series, I start with Mr. Benjamin Graham who is a father of a value investing. He has given a new direction to the investing field.

Mr. Graham is a guru of Mr. Buffett and we cannot imagine investing field without Mr. Graham. Few biggest gift from Ben Graham to the investing field are Margin of safety, the difference between price & value, calculation of value to the business, etc.

Many a time, we think that stocks fall ~40-50% from the high price, we should start trying to catch “falling knives” (Such terminology is widely used by so-called professionals). But we should focus on the value of the particular business rather focus on the high price and current price. During recent fall to the stock market, many of the people started picking stocks just because they fall much from the high price.

Indian companies examples

One of the media & Entertainment Company which is falling by ~51% from its high price but the company is making losses, negative CFO, management is taking a higher salary and also giving a loan to the subsidiary companies.

One of the companies which are into the DTH services and that company fall by ~79% from its high price. The company is making very little profit, very little FCF, huge debt, negative ROE% and where value can be still very less.

Such a fall in price does not make it attractive to buy which has very little or no value.

The market always works in a pendulum and people generally forget the nature of the pendulum. The pendulum always moves towards both extreme directions.

Whenever pendulum moves towards the bullish extreme, many of us forget that such situations will not stay forever. Many of us forget about the risk which involves during the bull phase. And start taking higher risk for generating higher returns; which invites a further huge amount of risk. At bullish sentiment, people generally buy assets at the highest valuations multiple and that invites the risk to the particular asset class. This scenario has a very high chance of getting damage to our wealth compared to generating a higher return.

Reverse to such scenario, whenever the pendulum moves towards extreme bearish phase, then generally people start recognizing the risk and start avoiding to invest in the particular asset class; which take out the risk from that particular asset class. Such a scenario is the appropriate time for capturing the opportunities because in such scenario we have very less chance to lose.

When people warmly accept any securities then the price will go far from the value and when people avoid or hate any securities then the security will fall in its value.

Mr. Graham has a strategy to purchase undervalued securities and shorted overvalued securities which have made him successful. Mr. Graham has started with $450000 and which he turns to be $2500000 in just three years.

During the last month of the year 1929, Dow Jones has started going down and Mr. Graham has started to cover his short positions and shifted to preferred stocks by considering prices are low. But the calculation of Mr. Graham went wrong and he lost 20% while Dow Jones down by 17%. After this Mr. Graham has considered that market has made the bottom and he used to leverage money to boost profit but again his calculation went wrong and he lost 50%. During the year 1929 to the year 1932, Mr. Graham has lost 70% of his money.

My learning

We should not take leverage to boost up our profits from the market, we cannot measure the madness of the market. I have implemented this learning from the mid time of my investment career and I have parked my money where I am convinced to park. I have never taken a leverage position rather I have to keep liquidity with my portfolio (I was holding ~73% liquidity in my portfolio during January – 2018 and currently having ~65% liquidity position). I have always focused on capital protection over the missing out of opportunity.

 An example of one the biggest wealth creator company of the Indian stock market—

Read for more detail: Big Mistakes: The Best Investors and Their Worst Investments by Michael Batnick

BIBLIOPHILE THE MOST IMPORTANT THING BY HOWARD MARKS

One of the books which have influenced me and my investment journey is “The Most Important Thing by Howard Marks”. This book teaches us the most important thing which we need to develop for becoming a wise investor.

“The Most Important Thing” has many concepts which can help us to our investment journey. I have posted articles on the book. Now, I have compiled different articles into the one file for the ease of reading.

For, All in One Article click – BIBLIOPHILE THE MOST IMPORTANT THING BY HOWARD MARKS

BIBLIOPHILE: THE MOST IMPORTANT THING BY HOWARD MARKS “AWARENESS OF THE PENDULUM”

In the previous article, we have seen that everything moves in a cycle. And if we cannot able to understand the cycle, then we must pay for it. In this article, I am going to discuss on moments of the pendulum and how we can take benefits of its moments.

We have seen pendulum and its moments. Generally, pendulums do not always remain to the extremes, majority time pendulum stays near to its main point. And whenever pendulum moves towards its extreme then again it will come back towards either extreme. The force of the swing of the pendulum itself responsible for its reversal.

Generally, our behavior towards the situation is responsible for the swing of the pendulum towards extremes and also responsible for coming back towards its mean point. Investors see the situation with either greed or fear and reach to the conclusion. When people are greedy, they become more optimistic toward the situation and they want to pay any premium for getting that situation favorable. Vice-versa, when people feel fear, then they are not ready to buy the stock at the cheapest value.

Excess greed creates risk taking behavior and excess fear creates a risk aversion among the people.

As there are two major risks in investing – 1) Risk of losing our capital and, 2) Risk of losing opportunities. But when pendulum moves towards the extreme end, then one of the above risks will dominate our investment decisions.

When pendulum at extreme bullish situation then

And when the pendulum nears to the extreme bearish situation then

When things happen in a good manner, then people become more greedy and confident about the situations which bring optimism towards the particular situations. People forget the involvement of risk and ready to pay anything for getting the assets. Vice-versa when things not happening in a good manner, then people are more fearful towards the situations and realize the inherent risk. Such situations bring bargains for the assets.

We can able to see that when prices of sugar were low, people not ready to make an investment in the sector, etc. at such situations provide us a bargain opportunities and when things start getting well, we can able to make a good return. Vice-versa when everyone knows about the story, then that story is there in the price. We cannot able to make an abnormal return or chances are high to lose of our capital.

Wise people recognize the bargain first, then others will follow them and run behind the assets for buying it at any premium price.

We have seen three phases of the bull market. As similar to it, the bear market also has three phases.

When everyone fears with the negative news, events and they start thinking that such worst situations remain forever. Major bottom occurs over such situations. When everyone forgets that tide can again come in and such situations provide us a bargain opportunity. Vice-versa when everyone thinks that good time never going to end and they can generate higher returns easily, people forget that tide can go out then major top gets formed.

Those people who understand swing of the pendulum then they have protected their capital as well as made the huge return during the year 2009 and year 2014.

When everyone fears from the situations and think such worst remain forever. When such situations arise then the person who analyses and conclude that things can go better he can generate a better return with lower risk. Vice-versa when everyone thinks that things remain better forever than that is a period of painful losses.

The pendulum never continues to swing towards an extreme, it will be reversed from extreme. Extreme swing of the pendulum is itself responsible for the swing towards the opposite direction of the pendulum.

Read for more detail: The Most Important Thing Illuminated by Howard Marks

 

BIBLIOPHILE: THE MOST IMPORTANT THING BY HOWARD MARKS “RECOGNIZING RISK”

We have seen the process for the identification of risk in the previous article of the same series. In the current issue, I am going to discuss regarding recognizing of the risk.

For the successful investing, we must have to focus on the generating return with having a proper control on risk. And for the controlling risk, we require to identifying and recognizing the risk.

The risk is always being at a much higher where we are too much optimistic towards the particular scenario and also paying a much higher price for the buying particular asset. But we should focus on When odds turn out against us than how we can able to protect ourselves or get out of such scenario with least damage. So, for the protecting ourselves, we need to avoid paying too high prices and also keep ourselves away from the extreme level of optimistic sentiment.

Click for Video — Auction scene

We always forget the real worth of the assets in the bull phase and start chasing that asset class. Such behavior is dangerous for the health of our wealth. This increases the risk while we are purchasing assets more than its worth.

The market always works in a pendulum and people generally forget the nature of the pendulum. The pendulum always moves towards the both extreme directions.

Whenever pendulum moves towards the bullish extreme, many of us forget that such situations will not stay forever. Many of us forget about the risk which involves during the bull phase. And start taking higher risk for generating higher returns; which invites further huge amount of risk. At bullish sentiment, people generally buy assets at the highest valuations multiple and that invites the risk to the particular asset class. This scenario has a very high chance of getting damage to our wealth compared to generating a higher return.

Reverse to such scenario, whenever the pendulum moves towards extreme bearish phase, then generally people start recognizing the risk and start avoiding to invest in the particular asset class; which take out the risk from that particular asset class. Such scenario is the appropriate time for capturing the opportunities because in such scenario we have very less chance to lose.

Many a time due to bullish sentiment, we think that the risk is very low, we start taking more risky situations, also start taking leverage and from that time risk starts taking its shape. Our behavior towards particular asset class invites risk.

Risk will be only low if we as an investor behave in a careful and wise manner. We cannot eliminate the risk, but we can able to control its effect. We have to analyze risk in every scenario. Risk always has its presence, though we are having a bullish sentiment. And according to me, the risk is much higher while having a bullish sentiment.

At the extreme bullish sentiment, we forget to worry, fear of loss and instead of it, we think about to miss the opportunity. We think that all others will earn the money and we remain without earning money. We start taking much leverage and believe that we are living in a low-risk world.

Click for Video — Bull phase in auction

We have seen in the above video that the person who doesn’t want to purchase a horse for the Rs.5 lakh; same person bought the horse for the Rs.5 lakh due to the influence of the increasing value of the bid for the horse. The person doesn’t want to lose the horse and cannot see others to take that horse.

Read for more detail: The Most Important Thing Illuminated by Howard Marks