Pareto Principle

Pareto Principle

There are a few principles that stand the test of time.

Pareto principle is one such. The old, famous, 80-20 rule.

The picture below explains it eloquently:

       

To the best of my knowledge, Pareto principle works perfectly in all walks of life (at least in 80% of the situations).

All the more so, in the world of personal finance, especially in the wonderland of shares & equity mutual funds.

Some of the things that I've observed:

• 80% of the profits that you derive come from 20% of your investment decisions
• 
  

  80% of the profits that you derive come from 20% of your shares & mutual funds
• 
  

  80% of the total losses that you incur in each year comes from 20% of your shares & mutual funds
• 
  

  80% of profits (and losses) are generated in 20% of your holding period of the concerned investment (unfortunately, as David Ogilvy would have perhaps said, you don't know which 20% - Hence it makes sense to refrain from trying to time the markets!)
• 
  

  80% of what you hear / read / listen to from public sources are either unreliable or have already been factored in by the markets already
• 
  

  80% of the "secret tips", "sureshot advice" that you get from friendly brokers, neighbours, relatives, colleagues, well-wishers are junk material
• 
  

  80% of such junk material referred to above are very tempting to act upon. 
• 
  

  80% of our actions based on such advice referred to above result in losses
• 
  

  80% of ALL short-term predictions that you act upon are totally wrong, misleading, unreliable, useless or all of this and more!
• 
  

  80% of ALL short-term players, traders, self-learnt share "dabblers" lose money. Often lose the principal.

So, what does one do?

For those of us who are not making 80% of our total income from trading in shares, it does not make sense to "trade" at all!

Instead, the 80% of us who are not making 80% of our TOTAL INCOME from trading in shares must become investors in the true sense of the term.

And follow some basic norms such as:

• Don't forget - It is your money that you are investing. Never lose the capital. Don't take a risk that you can't accept. Mentally or financially.
• Do not buy before doing your own research - Really.
• Do not invest in shares if you are unwilling or incapable of holding the shares for at least 3-5 years. Really.
• Do not expect returns which are more than double what you get from a fixed deposit in a public sector bank.
• Do not hesitate to book your profits when you get your expected returns. Especially when you get such profits in unexpectedly quick time!
• Do not invest any money that you may require within the next 1-2 years
• Do not invest borrowed money in shares
• Just like you can't catch all the fish in a fishing trip, you will miss buying the right shares OFTEN and you'll sell too early - OFTEN. It is OK, as long as you don't end up buying the wrong shares and end up holding such junk for too long.
• Do not invest ALL your investible surplus in a single company / sector / promoter group.
• Do understand your risk profile and plan your asset allocation carefully before investing in shares.
• If, in the unlikely event of your share zooming into the stratosphere after you bought it, just before selling it to book your profits, ask yourself: "Will I buy this share at the current price if I had the money?" - If the answer is an unequivocal "Yes", Don't sell right now.
• The share market is not for historians. You deal with the future; you deal with uncertainties; you deal with probabilities; you deal with the unknowns. Be prepared by understanding the concept of "Maximum acceptable loss" and get out if your share price falls below this level.
• The shares you have bought are not your parents nor is it your beloved spouse. Be willing to "Let go" and sell it - either to book profits or to minimise losses.
• The share market does not owe you money. The share market does not know that you have bought a particular share. The share market will take the share prices up and down. The share prices will be volatile. Make volatility your friend. If not, it will become your worst enemy.
• Investing in shares is not a game of cricket or chess or soccer. It is like manufacturing steel or creating software or making biscuits. You should not treat it as a game of chance or a game of skill. You should treat it on par with something like buying a house, for instance. Before purchasing a house, all of us go through a whole range of evaluation parameters.

All said, remember the Pareto Principle.

Learn to relax by focusing on the key 20% - Always.

Regards,

N

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Ben Graham on Speculation

Ben Graham on Speculation

 

What is in the best interests of brokers--that is, maximizing commissions--is not in the best interests of investors.

Wall street historically has prospered from speculation, according to Ben Graham, but he believed that speculators themselves on the whole lose money. "Hence," he stated, "it has been logically impossible for brokerage houses to operate on a thoroughly professional basis."

If only we could actually listen to Graham, the father of Value Investing, and actually force ourselves to follow the above advice, we would all be:

• Richer
• Able to sleep peacefully at night

I must admit, however, that despite trying for at least a decade and beyond, I have not been able to overcome the temptation completely!

Regards,

N

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An Interesting Fact after the sharp move of September 13th

An Interesting Fact after the sharp move of September 13th

On Sept 13, we saw the markets zooming ahead. And I got a mail highlighting the limited number of scrips that outperformed the index on this very day.

What are the implications?

Are we seeing the typical blow-out phase of any bull market?

The real answer - I don't know. The bitter truth - No other persons knows, either.

Hence, what should we be doing at this stage?

My own recommendation from Nifty levels of around 5500 would be as under:

• For every 5-7% increase in Nifty, keep lightening up your stock portfolio by around 12-15%, in all the stocks which have run up significantly in the past 3 months, thus increasing your cash levels
• If you have the capacity to be patient, and if you don't mind seeing all your friends, colleagues, etc. making more profits than you in the very short term, sit tight on cash
• If you are the type of individual who must compulsorily remain invested in shares and don't believe in holding cash, at least try to buy in a staggered manner
• Also, in these highly risky global environs, if you insist on buying shares at current levels of Nifty,
• Try not to buy shares which have run up very significantly in the past 3-4 months (After all, I'm recommending that you keep selling such stocks!)
• Instead, try to buy those fundamentally sound stocks which have not run up already - like Reliance Industries, NTPC, Real Estate stocks, Specific Agri-product stocks, Specific cement stocks, etc. Ideally, stick to large-cap stocks at this moment - AND BE PREPARED TO HOLD FOR A LONG PERIOD!
• Make sure that unless you are a past master, don't play with futures & options at this stage
• As always, keep your stock exposure in line with your risk profile and asset allocation norms.

Most importantly, don't ever rely on experts, self-proclaimed experts, including me. Rely on your own individual research - At the end of the day, it is your money - You certainly don't wish to convert it into someone else's money!

An Interesting Fact after the sharp move of September 13th

Posted by: "GV" 

Mon Sep 13, 2010 10:42 pm (PDT)

Yesterday when nifty broke out sharply by about 2.13 % ;

- there were only 26 stocks among nifty category which outperformed the
index and 76 that under performed.

- and among a-z category, there were just 216 stocks that out performed and
as many as 1101 stocks which under performed.

*gv*

Regards,

N

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Investors Beware - Chinese Real Estate Bubble is coming next!

Investors Beware - Chinese Real Estate Bubble is coming next!

Or, effectively, so says this article:

• Chinese Real Estate Bubble is due to burst any time now!

I'm reminded of the story of the boy who cried wolf. And of the Great Depression of 1929-33.

And of the Tulip Mania that preceded it several decades earlier.

And the dot com bust that came along a decade back. And the sub-prime crisis.

After every bubble, a few interesting things happen:

• Every economist, every "expert" and every central bank governor claims that he / she had predicted the bubble a couple of years earlier. And, in all probability 99% of them are lying
• People start seeing bubbles everywhere around them
• Experts predict the next 237 bubbles out of the next 2 bubbles with absolute certainty and total accuracy, especially within the next couple of years.
• And, the general public does not know which ones among the 237 referred to above are the 2 real bubbles!

The only thing that I can say with certainty is that all these predictions make interesting reading!!

Regards,

N

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Sensible Advise for Volatile times

Sensible Advise for Volatile times

My last post (Beware of Conmen) was about someone inviting you to take what could perhaps be perceived as "unduly high risk". A reader had forwarded this mail from HDFC Securities and asked me for my comments.

First, I'd suggest that you read the inputs from HDFC Securities:

Investors get perturbed when the markets are not moving up in a sustained manner. And rightly so, because most investors have a mindset of buy and hold. And when the markets frequently change their direction, investors find it difficult to cope with such volatility.

Changed environment calls for a change in the strategy we deploy to tackle the markets. Just as you adopt different strategies to face fast bowlers and spinners and play the ball on its merits similarly the strategies need to change to play different market condition.

The volatility could be a blessing in disguise, if you can acclimatize yourself with it.

1.Take your ones and twos

In a volatile market you should learn to take small gains and losses. Instead of yearning for a large gain, hitting a six in cricket parlance, you should settle for smaller gains and take them as they come.

A stock may not give you a 20% return in one go but may give you 25% returns in trenches.  Sounds impossible? Lets see.

We chose Tata Steel and studied how it behaved during the Months of April and May. The stock gave 5 upswings of 5% or more and 5 down swings of 5% or more during the period.  So whether you are a bull or a bear, you got ample opportunities.

The Tata Steel swings were larger than 5%. The 5% was only a filter mark. The upswings were to the tune of 18, 5, 10, 8 and 7% respectively. Even if you could catch any one of them and rode only 5%, it would have been a good return to post. 

On the downside, the swings were 9, 21, 20,10 and 6%. The magnitude of these downswings was larger than those of the upswings.

The best part of a volatile market is that you get to buy the same stock again and again at the same level or lower. The chances are that if you get this act once right, subsequent opportunities will be easier to spot and ride.

2.Create some cash

If you are sitting on a pile of cash, you will see the falling market as an opportunity to buy. But if you are fully invested you will be fearful. In that fear, you are likely to sell some of the stocks at a loss.

On a day like this, when the markets tumble sharply, the one with cash will confidently buy where as some one who is fully invested may end up selling his stocks at a loss.

I have always thought that sitting on a 20-30% cash is a good idea. The very fact that you have to maintain this kind of cash will make your investment decisions well thought out. You will research and then buy and that too when the valuations are compulsive.

And on a day when the markets open down sharply, this cash can be put to good use. The stocks that you buy with this cash will have to sell in a disciplined manner. The cash so generated will be used only when the markets tumble further or a really good investment opportunity is spotted.

If you are fully invested, sell a part of your stocks when the markets move north. Selling and creating  cash at leisure and when the markets move up is better than selling in panic. However, if you realize that the recent investment you made is not a sound decision, selling that stock at a loss is not bad idea for cash generation.

3.Buy Puts

Buying a Put in the stocks concerned protects your portfolio. Protection comes at a cost. In the beginning of the month, the costs are pretty high. So in order to reduce your protection cost, you may perhaps want to trade off writing a lower Put. Your portfolio is protected till the strike price for which you write or sell a Put. When you do such a thing, it is called constructing a Bear Spread.

4.Write higher Calls

When stocks are tumbling and you are not buying Puts, it may worthwhile to write a higher call for the stocks that you have. If the markets tumble you will get to keep the premium you earn. To that extent you are compensated. Should the markets reverse and move higher, what you do next will be a function what is your trading profit or loss in the call written. If the call is going in your favor, cover it. But if you are making a trading loss, don't book it. Hold your position till settlement. On that day, if the call premium is still higher than your buying cost, let it lapse and sell your existing stock (for which the Call was written) in the last 10 minutes of trade in the cash market.

5.Keep your stop losses tight

When you are playing for smaller profits, it is advisable to keep your losses even smaller. So keep tight stop losses. Decide on your stop loss before entering the trade and make it a trailing one as the market moves your way. Even in Puts and Call options stop losses can be kept.

6.Be Nimble footed

Expecting that the markets will tank, you by puts in the Nifty. And after going your way for some time, the market changes direction. While you have the choice of selling your Put option, you may consider buying a Nifty Future to make the best use of the Put that is already bought. If the markets recover to the level where you bought the Put, your buying of the Nifty future would have been justified.

There are further games you can play with this Put you had bought. If you think the Nifty is likely to lose momentum, book profits in the Nifty, still holding on to your put. This gives you another opportunity to enter the Nifty Futures again at lower levels. You can repeat this several times in a week.

The adept amongst you would have understood that with the protection of Put to support you get the full advantage of the range of futures movement. If the Nifty moves in a range of 50 points, you get the full advantage of trading in the Nifty. Where as trading in the option alone would give you only half the range.

Similarly, when the Nifty reaches the upper range of the range, buying a Call and then shorting the Nifty Futures and covering at lower levels will be helpful. Rinse and repeat as many times as you want, till the option you have bought remains relevant.

7.Buy in small quantities

If you hate trading and are not the like who will settle for smaller profits, the least you can do is, defer your buying over three stages. You may buy a third quantity of your researched share at the first go. The next third can be bought 5% or 10% lower depending on the volatility of the stock and the balance quantity still after another same percentage gap.

You may repent buying only a third of your desired quantity if the stock surges after your buying. In such a case, you would probably end up with notional loss, for the quantity you never bought. But if the market does go down, you will appreciate your foresight.

All said an done, if you plan your trading and investing assuming that the volatility will continue, you are likely to land on your feet. As you go through this experience, keeping your cool, you will begin to appreciate the opportunities volatility offers and may in fact begin to love it.

And in a few months you will also get to trade in Volatility Index (VIX) itself. So treat the current volatility as a practice session to master VIX trading.

Sincerely,

HDFC Securities Limited

My comments:

• First, the HDFC folks are not "directly soliciting business" - That by itself makes me positively inclined about the contents of their mail
• Secondly, they do not give any "specific" tips nor any "vague" tips. Instead, they talk about a specific strategy to handle volatile markets. This makes me even more impressed, prompting me to seriously consider and evaluate their strategy.
• Now, to the contents of the strategy:
• First, by and large very sensible strategy.
• Second, this is not for novices except the bit about staggered purchases and holding 20-25% cash levels - which, by itself, is an excellent recommendation for all. The typical novice MUST not be bothered about the "notional" or "real" opportunity loss due to funds lying idle. Typically, the interest lost is of the order of 3-11% per annum. This will possibly be "more than adequately compensated" by the very real "buying low" that would be feasible by patiently waiting for opportunities.
• Third, dealing with futures and options, buying calls and puts, and, worse still, writing calls and puts - This is not for the faint hearted. As one of my favourite anchors on a business channel repeatedly says, "Remember that while you can make 40-100% returns in options in a couple of days, you can, and certainly will, occasionally (hopefully only occasionally and not frequently) lose your entire capital. That's a very real, live probability."
• This is where the importance of stop losses becomes vital. The downside to stop losses in volatile times is that it is very common to be "whip-saw"ed both on the way up and on the way down due to these "strict stop losses".

All said and done, these inputs from HDFC Securities are very valuable with the following caveats:

• Understand the inputs before even attempting to implement them
• Applicable only for "seasoned players"
• Start practicing with  "Throw-away" money, and gradually increase your exposure to the F & O segment.
• Be prepared for "serious losses" in the initial several months before you "see green"
• Make sure that "Greeed" & "Fear" are your servants and not your masters.

Take care!

Regards,

N

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Some interesting stuff on Behavioural Economics

Some interesting stuff on Behavioural Economics

- Before my holiday

Interesting stuff, indeed:

• Check out this interview from dnaindia.com with Senthil Mullainathan

Regards,

N

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Which month is the best time to redeem Equity Mutual Funds?

Which month is the best time to redeem Equity Mutual Funds?

A few words of caution: This post might be of interest and utility only if you are:

1. Investing both in Shares and Equity Mutual Funds
2. Reasonably financially literate (so that you'll follow the substance of what I'm talking about - nothing complex, but slightly boring stuff nevertheless)

The above question, according to experts, is probably irrelevant.

They'll probably say that your redemption decision should be driven by factors such as:

• When you need the money,
• When markets are generally overvalued,
• When the PE is too high, etc.

However, let me rephrase the question.

If you need to generate some cash for a specific bulk expense from your shares or equity mutual funds, should you be indifferent about whether you sell shares or redeem mutual funds?

Or is there any logic in redeeming mutual funds Before selling shares? If so, will the answer be different in any specific month of the year?

I don't have any definitive answers Yet.

However, I've started developing a hypothesis about the same. Let me share with you the broad idea.

Well, I happened to review the portfolio (which I manage) of a family member for the month of October 2009, and I found something curious:

	% Change over the previous month	Change
	Equity MF (A collection of Equity funds from different fund houses)	-2.16
	Sensex	-7.38
	Nifty	-7.38

In all preceding months, through thick and thin, through bull markets and bear markets, the above figures used to be somewhat comparable to each other. I've never noticed a significant difference in the past. Of course, I'll need to re-check the data over the years to see if such differences have occered in the past either for this individual or for any of the other portfolios that I manage.

The difference in October 2009 appears to be huge. While the Sensex and Nifty have fallen by over 7%, the Equity mutual funds net worth has declined by just above 2%. Amazing indeed. An outperformance of over 500 basis points. Within a single month.

Have the fund managers suddenly become "super-efficient"? Or have they got plain lucky?

I've been in the market for way too long to believe in either of the above possibilities.

I delved deeper into the matter and did some quick research. I found something very basic and interesting.

This family member had received dividends (interim and final) on many shares held by him during the month of October. Obviously, many companies forming part of the Sensex & Nifty would also have paid out dividends during October (and hence gone ex-Dividend).

This implies that all those companies which had gone ex-Dividend in October 2009 would have started quoting at a price duly reduced by the dividend amount by the end of October, thereby reducing the Sensex and Nifty levels correspondingly.

On analysing the Mutual fund portfolio of this family member, most of the Equity Mutual Funds in his person's portfolio had Not Declared any Dividend during October 2009. However, most of these Equity mutual funds would have Received dividends from companies held by them in their portfolio. To that extent, the NAV of these Equity Mutual Funds would, as on October 31, 2009, be quoting at levels which would include the impact of dividends received by them.

This could be one of the possible reasons for he huge difference of 500 basis points in the performance of Equity Mutual Funds vis-a-vis Sensex / Nifty during October 2009.

If my above hypothesis is indeed true, while you can be indifferent about whether you sell shares or redeem equity mutual funds in other months, in those months when you receive lots of dividends from companies whose shares you own, you must prefer to redeem equity mutual funds rather than sell shares. Like in October 2009, for instance.

As a corollary, if you must either invest in shares or equity mutual funds in months such as October 2009, obviously, you must prefer to invest in shares directly rather than investing in equity mutual funds.

Think about it. Perhaps there's a grain of truth.

Also, do give me your feedback on the same after making a similar study of your own portfolio.

Regards,

N

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Contrarian Pick for Samvat 2066

Contrarian Pick for Samvat 2066

Many friends have asked me for "A good stock to pick for the next one year". While I'm not normally comfortable giving recommendations, Diwali is an occasion when I like people to be happy.

Hence, here goes my suggestion for the next one year:

• Favourite Sector - Telecom
• Top Pick in the sector - Reliance Communication
• Rationale:
• Lots of negative news, resulting in surprisingly low share prices:
• Most other sectors have run up quite a bit in the post-March 2009 rally
• Scrips from the telecom sector has actually fallen in the same period
• Telecom stocks have taken a beating even more in the last couple of months
• Especially Reliance Communication has been involved in a lot of bad stories - Just do a Google search and you'll hear enough of them
• Long-term story of the sector is intact
• Indians love to talk
• Current levels of penetration is very low vis-a-vis developed countries
• The business is an annuity business - Once a customer is acquired, he stays with you unless there are strong negative reasons
• Value added services like mobile banking, DTH TV, etc. are likely to gather steam tremendously in the months to come
• Top quality management in the sector's leading players, including Reliance Communication - fully competent to face challenges
• Underownership is likely to change in the coming months
• Likely corporate action with lots of M & A
• Likely re-rating of the sector with 3G introduction, popularisation of value added services, etc.

Given all the above factors, most shares in the telecom sector are likely to outperform the major indices in the next one year. My vote goes to Reliance Communication, which is heavily oversold at current levels.

Watch out for the same in the next several months.

Disclaimer: My family members (including me) hold a few shares of both Bharti and Reliance Communication.

Do enjoy a great Diwali, and a safe one!

Happy investing. May your wealth grow at a safe and sustainable pace.

Regards,

N

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Scary Scenario

Scary Scenario

I hate fear mongering.

However, Value Investing Gurus have, over the past several decades, emphasised the importance of:

Return of Capital

over

Return on Capital

I can, and I have been quoting in several contexts about the pace and vigour of the current stock market rally as being discomforting.

It would be easy to quote a whole host of data, articles, etc. to point out that the current valuations are not sustainable.

The rally can, and very well may go on to greater heights - like it did between September 2007 and January 2008 - But

• The continuing financial woes in US, UK and many European nations
• Stories that one is hearing about Latvia (do a Google search!) and the potential repercussions (remember Lehman and its aftermath?)
• Emerging credit card crisis in US and Europe
• Highly optimistic predictions coming from all our business papers, magazines and channels
• Monsoon failure in many parts of India, accompanied by floods in other parts of India
• Increasing internal security issues with naxalites and maoists in India and, last but not the least,
• My hunch

tells me that the time has come to become increasingly cautious - which, in my language, translates into increasing the cash levels in one's portfolio.

Better to lose an opportunity than to lose cash!

Take care!!!

Regards,

N

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Why individuals have an edge over Fund managers - Prisoners' Dilemma

Why individuals have an edge over Fund managers - Prisoners' Dilemma

For your benefit, let me explain the old but eternally relevant concept of "Prisoners' Dilemma":

Imagine that you and another armed man have been arrested and charged with jointly carrying out a robbery. The two of you are being held and questioned separately, with no means of communicating. You know that, if you both confess, each of you will get ten years in jail, whereas if you both deny the crime you will be charged only with the lesser offense of gun possession, which carries a sentence of just three years in jail. The best scenario for you is if you confess and your partner doesn't: you'll be rewarded for your betrayal by being released, and he'll get a sentence of fifteen years. The worst scenario, accordingly, is if you keep quiet and he confesses.

What should you do? The optimal joint result would require the two of you to keep quiet, so that you both got a light sentence, amounting to a combined six years of jail time. Any other strategy means more collective jail time. But you know that you're risking the maximum penalty if you keep quiet, because your partner could seize a chance for freedom and betray you. And you know that your partner is bound to be making the same calculation. Hence, the rational strategy, for both of you, is to confess, and serve ten years in jail. In the language of game theory, confessing is a "dominant strategy," even though it leads to a disastrous outcome.

If we extend the analogy to Fund managers of mutual funds, we'll comprehend their compulsions:

• Logically speaking, investors like consistent, long-term outperformance vis-a-vis peers and the benchmark indices
• However, magazines, newspapers, business channels tend to publish comparive performance data on a weekly, monthly, quarterly basis. This creates a lot of "noise"
• Fund managers need to be evaluated for determining their increments, bonuses, promotions at least once every six months - this would again involve comparing their relative performance over short durations of time such as a quarter or six months.
• Hence, fund managers are forced to think of an investment horizon of less than six months, even while advocating a long-term view for investors
• This results in a peculiar situation where:
• If the market is overheated according to the fund manager, he may be fully aware that any minor negative trigger can cause a significant downfall. However, he'll be equally conscious that if he is in cash and the other fund houses stay invested and there is no negative trigger for a couple of months or thereabouts, markets are likely to continue to rise with irrational exuberance for quite some time. If your fund manager wants his increments, bonuses (and even his job), he is forced to go against his own better judgement and remain invested in the market - with the hope and prayer that he'll be successful in bailing out at the very peak
• If there is a savage bear market, the fund manager may be aware of huge upside potential over a longer time horizon. Many scrips will be available at mouth-watering levels. However, if he invests and the market continues to tank  and other fund managers remain in cash, he'll underperform his peers in the forthcoming quarter. And in bearish times, he can ill-afford - He may be out of a job before he can say "Long-term".

If you're an individual investor, you must be conscious of these compulsions of typical fund managers before investing in mutual funds.

Mutual funds will be relevant for you if and only if:

1. If you lack the skills or
2. Can't afford the time or
3. Don't have an inclination

to study and invest directly in the markets.

Regards,

N

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Theory of the Greater Fool

Theory of the Greater Fool

All of us in the markets are familiar with the theory of the "Greater Fool" - In a raging bull run, the idea is to keep buying stocks with the fond hope and a fervent prayer that there will be a bigger fool who will be eager to buy the same stocks from you at a higher price in the next few days, weeks or months!

The inimitable Nobel Laureate John Maynard Keynes, in his masterpiece "The General Theory of Employment, Interest, and Money," elucidates this point elegantly.

He pointedly referred to the inconvenient fact that "there is no such thing as liquidity of investment for the community as a whole."

Whatever the asset class may be—stocks, bonds, real estate, or commodities - the market will seize up if everybody tries to sell at the same time.

Financiers were accordingly obliged to keep a close eye on the "mass psychology of the market," which could change at any moment.

Keynes wrote, "It is, so to speak, a game of Snap, of Old Maid, of Musical Chairs—a pastime in which he is victor who says Snap neither too soon nor too late, who passes the Old Maid to his neighbour before the game is over, who secures a chair for himself when the music stops."

If you're not nimble-footed enough to grab a chair when the music stops, better ensure that you buy shares recommended by Buffett - "Those that you'll be ready to hold gladly even if the entire market is going to shut down for the next ten years".

Take care, and safe investing!

Regards,

N

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Top 10 Signs that the Market Could Be "Topping"

Top 10 Signs that the Market Could Be "Topping"

Got a wonderful piece about the US markets in a mail from one of the e-groups that I'm a member of. I've reproduced the same at the bottom of this post. Don't know about the original author. Due credits to the good soul.

What's the relevance for us in India? Some pointers:

• Index PE Ratio is over 23 - Implying that
1. Either the market should be topping out soon or
2. There must be significant earning upgrades among index heavyweights or
3. There must be a mother of all bubbles or
4. There must be a huge scam pushing up share prices
• Many, if not most of the big guns have missed out the rally from March 2009 - Implying that
1. Every dip will be bought into, quite eagerly - Nobody wants to miss the bus again
2. If crucial technical levels are breached on the downside, there will be utter chaos, with everyone wanting to sell out all at once
3. All possible good news appears to have been built into prices - However, any significant negative surprises have apparently not been taken into account. Hence, a sudden downward pressure on share prices can be quite nasty. See what happened to telecom stocks!

What should We be doing at this juncture?

• Each of us should re-visit our Asset Allocation and stick to the same in a disciplined manner
• We should analyse our own risk profile and decide the extent to which
1. We'll participate in the ever-accelerating F1 race going straight uphill towards Suicide Point and
2. We'll attempt to catch falling knives as and when the knives start falling.
• To the extent we can, we must keep the gun powder ready - Start accumulating lots of cash from your Long-Term Equity Portfolio, with the conviction that
• You'll never be able to catch the absolute Top
• You'll be in a position to grab a whole lot of quality stocks at much more attractive valuations a few days / weeks / months down the road.

Standard word of caution: While I continue to remain invested in several shares as part of my long-term portfolio, I'm constantly increasing my cash levels with every few percentage point increases in the Nifty levels. Obviously, I'm trying to gather enough gun powder. 

Happy investing!

Regards,

N

Top 10 Signs the Market Could Be "Topping"

/By Justin Ford, Executive Editor/

Let´s get right to it. Drum roll, please...

*# 10) Irrational Exuberance gives way to Incomprehensible Elation.* In
the midst of the worst recession since the great depression, on the
heels of a 50% stock rally in six months and just before a new major
wave of housing foreclosures and a likely commercial real estate bust...
Wall Street is selling stocks like there´s no tomorrow. A screen of
5,817 actively screened stocks yields just 154 with a "sell" rating.
That´s one out of 38. At the height of the tech boom, it was one out of 29.
*
# 9) The "Invisible Bailout" reaches record levels.* This is the bailout
no one´s talking about-executives bailing out of their company´s shares!
Trim Tabs reports the highest level of insider selling since they began
keeping records in 2004, with insiders dumping $105 billion of stock
during the rally. That´s 31 times greater than the pace of insider
buying. This is almost the exact opposite of Wall Street´s sell-rating
ratio. Well, the sharks have to sell to someone, and brokers appear to
be lining up the minnows to take the CEO´s shares off their hands.

*# 8) Ugly is beautiful and bad is good.* Excessive credit caused the
crisis we´re in but you wouldn´t know it by looking at the stock market.
A recent survey of public companies showed those /with the worst credit
ratings/ have led the rally-soaring 89% while the S&P 500 rose 53%.

*# 7) The Rally is long in the tooth. *We´ve had greater rallies than
the current one but not longer ones-at least not after major crashes.
The longest rally during the 1929-32 bear market was 155 days. We are on
day 204 of the current rally.

*# 6) A New Wave of Housing Foreclosures will begin in the 4th quarter.*
Loan modification plans have been largely ineffective because banks have
been stingy and loan servicers don´t have the authority to modify many
of their loans. Consequently, many foreclosures that have been postponed
until now, will be postponed no longer. They´re going to happen. And
there are quite a few of them. Mortgage companies hold 1.2 million loans
on which they haven´t received a payment in 90 days, another 1.5 million
that are "seriously delinquent," and 217,000 that haven´t received a
payment in over a year. In all, 3 million new foreclosures could come on
the market in the next year, further depressing real estate prices. A
big chunk of those could happen in the next few months. "We are going to
see a spike from now to the end of the year in foreclosures as we take
people out of the running," a Bank of Ame rica spokeswoman told /The
Wall Street Journal /last week.

*# 5) Dirt-cheap mortgage money may come to an end soon. *If you can get
a mortgage today, the money is as cheap as it´s ever been-about 5% for a
30-year fixed-rate loan. But that may not last long. The Fed has bought
80% of the Freddie Mac and Fannie Mae mortgages since the crisis began.
Private investors still aren´t interested. What´s more, the Fed´s $1.25
trillion program for buying these mortgages is two-thirds done and
scheduled to finish at the end of the year. If the government doesn´t
incur more debt to buy this debt, rates will rise and put a further
kibosh on the decimated housing market. And all these housing woes don´t
even count the considerable trouble brewing in the commercial real
estate sector...
<http://clicks.sovereignsociety.com//t/AQ/ew4/gGg/tNk/AQ/AkgWOw/TUtv>

*# 4) The Crisis in Commercial Real Estate is just beginning.
*Delinquencies on commercial real estate loans recently rose above 3%.
That´s more than six times the level of a year ago, but it´s likely only
the beginning. Double-digit unemployment and a chastened consumer's are
causing office and retail vacancy rates to rise and rents to plummet.
Making matters worse, most lenders finance commercial properties with
balloon loans. These are typically due in full after just five, seven or
ten years, and loose-money loans originated in ´05 and ´06 are now
coming due. Yet since values are falling many commercial property owners
will not be able to refinance. The problem is widespread too since
commercial real estate loans are usually the bread and butter of local
banks. Only ten major banks made up the bulk of the housing lending
market. Yet, according to /The Wall Street Journal/, more than 3, 000
banks and savings institutions have more than 300% of their risk-based
capital in commercial real-estate loans. And almost $100 billion of
their loans coming due in the next three years may have difficulty
getting new financing.

*# 3) The Consumer isn´t coming to the rescue, as hoped. *Consumption is
the biggest component of the U.S. economy-but getting smaller.
Unemployment is at 10% by official figures (over 20% according to Shadow
Stats); there are six job hunters for every job opening and 52% of job
hunters say they´re exhausting benefits before they find that next job.
Credit card delinquencies are up 60% and 7.6% of all U.S. households
were late on their mortgage last month!

*# 2) October is a scary month.* OK, there´s nothing very scientific
about this one, but October is the month for Halloween and major market
crashes. Past Octobers have seen intra-month plunges of 41% in 1929; 39%
in 1987; and 29% last year. As we enter month seven of a record rally,
this odd piece of history may replay yet again.

/And the # 1 reason the market could be topping.../

*1) The # 1 Predictor of Collapsing Share Prices just issued its first
sell signal in 226 days.* The predictor is The Credit Crunch Short
Indicator. It consists of four criteria that appear very rarely together
in any one stock. The first identifies a company that is going through a
credit crunch. The second and third confirm the situation is getting
worse. The fourth indicates the credit problems are beginning to show up
in the share price.

The one problem with the indicator is that it is /extremely/ selective.
It doesn´t tell you when to short an index or a mutual fund or ETF. And
it doesn´t try to catch all falling stocks. It only targets the ones
that are the "weakest links" financially.

But when it triggers, it has proven to be very accurate. And when it
doesn´t find easy pickings, it´s as silent as a church mouse. In fact,
during the recent bull market rally the Credit Crunch Short Indicator
didn´t issue a single sell signal in over seven months. After averaging
over two a month covering nearly a three-year period, it went dead
silent. Until last week.

Then, like a reliable old boiler kicking on again the first cold day of
winter, it revved up and spit out a brand new sell signal. And then
another. Both those stocks are down double digits in less than a week
and the recommended put options on them could realistically deliver
profits of 60% to 100%-plus by the end of the month. Even more telling,
there are now over a half-dozen stocks on the Credit Crunch Short
Indicator´s "Watch List."

Two months ago, during the height of the rally there were none. But now
seven are "knocking on the door" with three criteria for shorting
confirmed and only a few points away from a possible 4th criterion and
another "sell signal."

The point is that when the most selective indicator we´ve ever seen
begins to issue sell signals, it is another good reason to keep an eye
on the exits and take action to protect your capital and possibly even
make significant profits in the next market correction.

In itself, a 50%+ rally in just over six months should be enough to give
even the most bullish investors pause. But combined with other
unpleasant news on the horizon and the sudden "talkativeness" of one of
the market´s most selective indicators... it all leads me to believe it´s
time to take some defensive action.

What´s that mean?

* Buy gold if you haven´t already. It could be an ETF like GLD or
bullion if you prefer to own it physically. If a market correction
turns into a panic even for a little while, you could see gold and
silver rise smartly. And if it´s a dull steady decline, gold tends
to hold when paper assets fold.

* Consider picking up shares of the VXX, an exchange traded note
(ETN) tracking the VIX volatility index. Volatility has decreased
sharply during the market rally. In any sharp correction, it is
likely to spike. In the first quarter of this year the VXX spiked
to as high as 120. A move to just half that would represent almost
a 25% gain from current levels.

* Set stop losses on your long positions. It could be 20% or 25%.
They could be market stops or mental stops (which makes you
responsible for placing the sell order when the shares drop 25%
from their high). Either way, pay attention to your stocks,
especially in broad market declines and stick to your strategy for
protecting gains and preserving capital.

* Look for opportunities to make money on the short side, profiting
from falling share prices by targeting the most financially
vulnerable companies, /waiting for technical price confirmation/
before placing your trade, and again-having a stop loss in place.

They say an ounce of prevention is worth a pound of cure. It´s time to
take a few ounces.

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Fatal Attraction to Intra-day Trading

Fatal Attraction to Intra-day Trading

There are a few other sites of interest that I visit from time to time. Here's an interesting article that I came across about the fatal attraction of Intra-day Trading.

• http://sagecapital.wordpress.com/2009/09/19/why-do-people-get-attracted-to-intraday-trading/

All the points mentioned in the above article are quite relevant. My own additional two cents to the topic:

1. Intra-day Trading is more popular during bull markets than during bear markets - Human beings love to think that markets are looking up. And they love to take additional risks especially when they feel that they are smart - as they do when they see their paper wealth soaring along with the indices!
2. The potential returns from intra-day trading is huge - Even 1-2% per day translates into obscene returns on an annualised basis. And who is not tempted by good old Greed? Especially when the markets are zooming.
3. People just don't invest adequate time, energy and effort in learning the "tricks of the trade" - Instead, they just trade - Obviously, this just results in losses for them and a bigger booty for the brokers. Only problem is that they realise it way too late - After the horse has bolted and after their "Risk Capital" is gone for good.
4. This loss, in turn, ensures that they decide that the share market is nothing but a Gambling Den in disguise and stop investing in shares "Altogether"
5. Their resolve to stay away from the market remains perfectly strong as long as the market is going down and a powerful bear market pulls down the prices of "Gold" to levels of "Bronze".
6. In the process, they miss out the opportunity to buy a TISCO at Rs. 150, a Unitech at 25, an ICICI Bank at 300, a Hindalco at 50, an Infosys at 1200
7. In due course, the market starts recovering - slowly at first, and rapidly later.
8. Our friends watch "Everyone else making money" in the Share Market.
9. Suddenly, they realise that every neighbour is talking about the "Smart money" that can be made in shares
10. Result: Once again, they start from point No. 1 above!!!

Sad, indeed!

Regards,

N

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The Excuses We Make

The Excuses We Make

(For NOT Saving For Retirement)

 

Though old, this one from a recent issue of Money Today website is indeed enlightening ... ... ... ...

 

In our 20s

·       I have just started working.

·       There is nothing left after the monthly expenses.

·       I have to save for a house.

In our 30s

·       There is no spare cash after I pay the kids' school fees.

·       I have to plan for my child's higher education.

·       I am still repaying my home loan.

In our 40s

·       More money needed for child's higher education.

·       Expenses are going up.

In our 50s

·       It's too late to start now.

·       I'm close to retiring; my pension will suffice.

·       My children will take care of me.

 

What's your excuse, my dear????

Regards,

N

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Tiger Pie

Tiger Pie

If the Sensex PE is @ 21, as it happens to be right now, chances are bright that the situation described below is quite apt!

Read on & take care:

Got from the link: http://www.moneycontrol.com/news/market-outlook/powerful-bear-rally-underway-discontent-likely-enam-sec_416088-4.html

 

Q: So what sums up your strategy now? Would you say you're little circumspect about valuations but keep buying good prices?

A: Yes. At heart we are bullish folk in our firm, so every time the markets go down we like them to get cheap and like to buy them and sit tight but Nandan who is our Head of Research put a very lovely piece out where he said you have to play the tiger bird strategy. There is this bird apparently called the Tiger Pie sits and removes the picking from the teeth of the tiger while it is feasting. It is a very dangerous strategy to play and that's the phase the market seems to be in – that we are sitting on the mouth of Tiger over the next three-months – something has to happen in the world and we are trying to eke out 2-5% gains every week. It may not be the best thing to do, so for those who can afford it, you may want to lower your risk profile of your portfolio whether by more cash or having stocks which you can liquefy and then quickly go back into the markets or you have to extend your time horizon and say I do want to play this power and insurance thing and I don't care if I hit air pocket in the middle and if it does fall I will actually start increasing my weightages and holdings over there.

Q: Statistically how often does the bird live?

A: I don't know.

Q: He gets chomped by the tiger most likely?

A: Most likely.

I've started increasing cash levels in my portfolio - Would like to keep a good load of cash to invest when the markets eventually turn around.

Regards,

N

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Commitment and loss aversion

Commitment & Loss Aversion

I recently received the excerpts from the book "Sway" given at the bottom of this page through email. I remember having seen it some time back on the web. Can't recall the source.

However, the stuff is quite interesting in the realm of behavioural finance.

After reading it, we must understand the following:

• Money earned from Salary, Received as a gift, Won in a lottery, Obtained by providing services, Got from capital gains by selling shares - All of it is of the same value in monetary terms. For instance, just because it is money from "hard-earned" salary, it should not be preserved more carefully. Likewise, just because it is earned from an "easy" source like a gift or in a lottery must not be frittered away.
• When your portfolio value (or the share price of one of your holdings) increases - for any reason whatsoever, you must ensure that you make all efforts to "preserve" the profits and should not treat a reduction in value as being acceptable merely because it is still higher than your original purchase price
• In a similar vein, when your portfolio value (or the share price of one of your holdings) decreases - for any reason whatsoever, you must ensure that you do not allow your emotions to either
• "wait till it regains its original value to get out" and keep increasing your de-facto losses (because you know that some of those scrips will never get back to their original prices) - You must just get the hell out by cutting your losses and move on to better securities
• "Get the hell out of the scrip as soon as it comes back to your purchase price or thereabouts" (Despite knowing that it is indeed a blue chip and you've already borne the pain of the temporary downturn and you're perhaps likely to reap the rewards of your patience because the business cycle has turned positive)
• And you must know the difference between the above two categories - After all, you need to know the difference between your "core portfolio" - the "hold for the long term scrips" and the "trading scrips - use the momentum, flavour of the season and get in and get out quickly categories"

Regards,

N

Commitment & Loss Aversion

In a great book "Sway", the authors, Ori Brafman and Rom Brafman, write on commitment and loss aversion.

 

"We've all experienced the pervasive pull of commitment in some form or another; whether we've invested our time and money in a particular project or poured our energy into a doomed relationship, it's difficult to let go even when things clearly aren't working. As difficult as it can be to ad­mit defeat, however, staying the course simply because of a past commitment hurts us in the long run.

 

Independently, each of these two forces-commitment and aversion to loss-has a powerful effect on us. But when the two forces combine, it becomes that much harder to break free and do something different.

 

It's precisely because of the compounding effect of these two forces that students in Max Bazerman's negotiations class at Harvard Business School would do well to hold on to their wallets when he introduces his "twenty-dollar auc­tion." They say it's easy to take candy from a baby; Professor Bazerman has found that it's just as easy to take money from Harvard MBAs.

 

On the first day of class, Professor Bazerman announces a game that seems innocuous enough. Waving a twenty-dollar bill in the air, he offers it up for auction.

 

Everybody is free to bid; there are only two rules. The first is that bids are to be made in $1 increments. The second rule is a little trickier. The winner of the auction, of course, wins the bill. But the runner-up must still honor his or her bid, while receiving nothing in return. In other words, this is a situation where second best finishes last.

 

Indeed, at the beginning of the auction, as people sniff out an opportunity to get a $20 bill for a bargain, the hands quickly shoot up, and the auction is officially under way. A flurry of bids follows. As Bazerman described it, "The pat­tern is always the same. The bidding starts out fast and furi­ous until it reaches the $12 to $16 range."

 

At this point, it becomes clear to each of the participants that he or she isn't the only one with the brilliant idea of winning the twenty bucks for cheap. There is a collective hard swallow. As if sensing the floodwaters rising, the stu­dents get jittery. "Everyone except the two highest bidders drops out of the auction," Bazerman explained.

 

Without realizing it, the two students with the highest bids get locked in. "One bidder has bid $16 and the other has bid $17," Bazerman said. "The $16 bidder must either bid $18 or suffer a $16 loss." Up to this point the students were looking to make a quick dollar; now neither one wants to be the sucker who paid good money for nothing. This is when the students adopt the equivalent of football's war-of­-attrition model. They become committed to the strategy of playing not to lose.

 

Like a runaway train, the auction continues, with the bid­ding going up past $18, $19, and $20. As the price climbs higher, the other students don't know whether to watch or cover their eyes. "Of course," reflected Bazerman, "the rest of the group roars with laughter when the bidding goes over $20."

 

From a rational perspective, the obvious decision would be for the bidders to accept their losses and stop the auction be­fore it spins even further out of control. But that's easier said than done. Students are pulled by both the momentum of the auction and the looming loss if they back down-a loss that is growing greater by the bid. The two forces, in turn, feed off each other: commitment to a chosen path inspires additional bids, driving the price up, making the potential loss loom even larger.

 

And so students continue bidding: $21, $22, $23, $50, $100, up to a record $204. Over the years that Bazerman has conducted the experiment, he has never lost a penny (he donates all proceeds to charity). Regardless of who the bidders have been-college students or business executives attend­ing a seminar-they are always swayed.

 

The deeper the hole they dig themselves into, the more they continue to dig."

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