Don't Press the Panic Button: It's Time to Churn the Portfolio

Whatever happened on the Indian stock market on Monday 20th June was inevitable, however, the reasons chosen by market participants to hammer down the stocks was an aberration. But that's the way markets tend to behave if we try to understand it from the 'Behavioural Finance' perspective. The sharp knee jerk reaction to the news on Indo-Mauritius Tax Treaty can be explained through behavioural biases which market participants tend to follow. The reaction of Monday was a result of two commonly observed biases;

1. Availability Bias: Investors tend to heavily weigh their decisions more towards recent information which is widely available in the public domain. Availability is affected by various factors such as source of information, ease of remembrance, reaction time. Very often market participants overreact to new information leading to a dis-proportionate movement in market indices. The news on the review of Indo-Mauritian Tax treaty is as old as 3 months, and even if the changes are agreed to between the two countries the same will be implemented with a time lag of at least 6 months. The market reacted the way it did because of the reasons explained above.

2. Herd Mentality: It is the tendency of an individual to mimic the actions of a larger group, without bothering whether they are rational or irrational. The reasons for herd mentality are: i) a large number of people cannot be wrong, ii) social pressure of conformity. Investors influenced by the herd mentality constantly buy and sell their holdings based on the current investment trends. The initial reaction by a few FII's on Monday was to take advantage of the news on Indo-Mauritian Tax Treaty and press for stock sale, soon the herd mentality gripped the market and within seconds the stock indices started tumbling.

However, there is no need to press the panic button. I continue to hold a view that the markets are going to go down in the medium term, but that will not happen in a hurry. On the contrary, what has happened to the markets on Monday is extremely positive in the very short term. The markets in panic did touch their immediate support levels of around 5200, albeit briefly, on Monday. There is a very strong possibility of a strong rebound in the coming weeks which is likely to pull the market back to around 5450-5500 levels on the Nifty or even higher. But investors are advised to book profits on every rise in the momentum stocks, the likes of GTL group stocks which crashed by 40-60% in just one trading session. The list of such stocks is endless. The front line indices may go down to 4800-4900 levels on the Nifty, before the next bull run resumes. If that is going to happen, the probability of which is quite high, the Mid cap and Small cap indices may tank up to 15- 20%. But, as I said, this is not going to happen in a hurry. The events likely to trigger such a slide could be:

• Fall/ Major shake up in the Central Government: You cannot afford to overlook this scenario anymore with the kind of mess the Govt. finds itself at this juncture. If at all this Govt. has survived this long is through the generosity of the principal opposition party, which is in the middle of an even bigger mess.
• Real Estate Crash: A bubble seems to be forming in the real estate sector. When this bubble will burst is any body's guess. Real estate growth is sustained in an easy liquidity scenario, a real estate crises is waiting to happen once liquidity dries up. This could happen anytime when highly liquid FII's, Hedge funds take a flight out of India.

Markets on the edge: Protect your portfolio

Equity markets after maintaining a tight range for about 3 months are finally giving signals of a breakdown from the range on the downside.  The recent weekly close indicates weakness in the markets as the market is in no mood to discount good news: Crude oil prices have retreated sharply during the week and the advance tax figures of India Inc. have shown a 77% increase y-o-y. On the contrary, market has given more credence to the negative news on the Greek crisis emanating from the international arena. Retail interest in the market has waned significantly in the recent months and FII's have also started to press the panic button. RBI has given ample signals to fight inflation at the cost of growth. The Govt. is grappling with the onslaught of pressure from the opposition as well as civil society activists which has led to a paralysis in the decision making process.

The slow and steady grind of the major stock indices downwards is leading to comparative inactivity on the volumes front. The volatility during the week (measured by the VIX) has also climbed to over 20 towards the weekend. All these factors are pointers towards a short term weakness in the Indian markets. Past experience tells us that the so called momentum stocks are the worst sufferers in a prolonged downturn. Investors holding on to such news driven stocks would be well advised to lighten their portfolio. Certain defensive stocks from front line indices will be good bets to protect the investor's portfolio. 

 

The next downturn in equity markets is more likely to be caused by a catastrophic fall in the real estate prices. The pressure on the Govt. to enact the Lokpal bill and the issue of black money stacked abroad is the primary reason for the impending realty prices crash. This issue can no longer be brushed aside, and the Govt. will be forced to take some corrective steps to redeem its credibility. The Competition commission is aggressively pursuing cases of complaints against some top real estate firms regarding malpractices in their affairs with buyers/ investors. Once this happens, there is fear of a severe liquidity crises in the markets leading to a further downfall in stock prices due to lack of buying support. Before this scenario unfolds, it would be wiser to have a closer look at your portfolio and take suitable remedial measures to protect it from a major downside risk.

 

India poised to become a major 'Manufacturing Hub'

India is poised to overtake China as a global manufacturing hub. Fortune 5000 global companies have shown their preference for India for outsourcing manufacturing over the next 3-4 years. With a host of these global firms setting up manufacturing facilities in India, the manufacturing sector may overtake the services sector as the major contributor to India's GDP in the next 5 years. India with its manufacturing, engineering and technological capabilities offers a conducive environment to qualify as a global manufacturing hub, provided it can overcome the political impasse and getting along with the economic reforms agenda. I am very sure this will start happening in the next 5-6 months.

Currently, India's GDP is dominated by the growth of the services sector, prominent among it being BFSI and IT sectors. But a change in trend is beginning to emerge. Historically it has been proven that a services led economic growth invariably leads to a collapse, as it has happened in the case of Iceland and Portugal. Even the Lehman brothers episode gave a big jolt to the US as a services led economy. Countries with a strong manufacturing base like China and India are likely candidates for a more sustainable economic growth.

What could be the impact of India transforming into a 'Global manufacturing hub' from a 'Services dominated economy'. Our markets will sooner than later accept this reality and re-rate the stocks from various sectors. The future belongs to the real economy rather than the virtual economy. In the emerging scenario investors are advised to focus on accumulating blue chip stocks from the manufacturing sector, and at the same time reducing exposure to service sector stocks like BFSI and IT. The next bull run which is likely to start unfolding in the second half of FY 2011-12, in all probability will be led by the real economy stocks - Domestic and foreign companies having a substantial presence in manufacturing sector. Most stocks from this sector including blue-chips like BHEL, L&T are languishing at their 52 week lows. As the markets are down and likely to remain in a subdued mode for another 3-4 months, investors with an eye on the future can start accumulating the manufacturing sector stocks which include steel, cement sector stocks which will be the indirect beneficiaries of the growth in manufacturing sector.

Dull phase in Equity Markets: Testing times for Investors

A dull phase in life can be quite a challenge. Human beings by nature love and enjoy action: We admire the gushing waves of the sea, we also get pleasure in admiring the snow capped mountain peaks, but we seldom derive the same satisfaction by watching the barren land. Equity market investors also strive for action, because the swings in the market enable them to make money. Dull phases in equity market can be quite nerve wrecking for the investors. The markets are currently passing through a dull phase and investors must learn to cope with this phase. Market analysts call such phases as 'range bound movement' or 'consolidation phase'. What should one do in a dull phase:

• Take a break from the market: It is better to take a few days break from the markets rather than watch your portfolio move in a narrow range. This would help you to keep boredom at bay, because the more we think about the listless market, the more frustrated we get.
• Reshuffle your portfolio: The dull phase should be used to get rid of the dud stocks in the portfolio with blue chips. The blue chips have a better chance of outperforming the markets when markets resume their trend.
• Increase the cash levels: Dull or flat markets do not deliver a return on your capital, hence trimming the portfolio and increasing the cash levels/ debt exposure can see your capital earn reasonable returns. The surplus cash can be redeployed in equity markets once a trend reversal is evident.

Our equity markets are likely to follow range bound movement for a few months from now (say the next 4-5 months). The broad range being 5200-5700 on the Nifty. The range can be broken decisively on either side with the global news flow. The positive triggers would be: Normal monsoon, cooling of inflation, return to governance by the Govt. The negative triggers bothering the markets are: Withdrawal of stimulus leading to liquidity crises, political instability in the country, defaults in global markets etc. Let us bide these testing times without getting ruffled too much, because good times are likely to return to the equity market in about 6 months time. We need to be patient to reap the fruits of equity investment.

The ‘Exit option’: Use it judiciously to make money

The very essence of ‘Investment’ is to make money or create wealth. In this context, it is equally important to use the exit option (sell decision) judiciously as it is important to make an investment decision. Be it investment in stocks or mutual funds it does make sense to make a sell decision at the opportune time. The sell decision may result in a ‘profit’ or at times could result in a ‘capital loss’. The decision should always be influenced by the long term health of the portfolio. It is comparatively easier to book profits as one is taking money off the table. But, it is a painful decision to exit at a loss because nobody wants to destroy capital. But then, sometimes this painful decision needs to be taken if one is to protect the portfolio from higher risk in the future.

It is unfortunate that most advice is available to buy into a stock or a mutual fund, but seldom do we find advice to sell your holdings. Perhaps, it is not in the interest of the mutual fund company to give a sell call at the cost of running down its AUM (assets under management). Similarly, brokerages also focus more on buy calls and sell calls, if any, are put up for the short term traders only. Investors also tend to spend a lot of time on reading research reports, searching websites before taking a decision to invest. But seldom do we keep track of our investments to look for the appropriate time to exit or dis-invest. Does it mean that an investor should stay invested for a lifetime! Learning to use the exit option for ‘profit booking’ and at times for ‘loss booking’ is an art which every investor must learn.

Here are some key factors an investor must analyse in order to exit his/her holdings (individual stocks or mutual fund schemes):

• Relative performance: If the stock/ MF is under performing vis-a-vis its peers it is a time to take an exit call. The YOY (Year to year) and QOQ (quarter on quarter) performance based on declared results helps an investor to take this decision.

• Unrelated diversification: The announcement of an unrelated diversification, deviation from stated objectives in case of MF, puts pressures on the performance of the company. It should be analysed in terms of future profitability to arrive at the exit option. On the other hand backward/ forward integration of businesses helps in consolidation.

• Achievement of target: Most investors take an investment decision based on a specific target for the particular investment. If your favourite scrip has achieved its price target, it is advisable to book at least partial profits in the scrip.

• Negative news on the company/ MF scheme: Any negative news on the company/ MF should be viewed with suspicion. For example, detection of a fraudulent practice by the company, change in Fund manager of the MF scheme, should be analysed for the future impact, and an exit call taken after due analysis. In this case even ‘loss booking’ would be advisable’.

• Long term trends: Although, it is said that investors should not time the market, it is worthwhile to study the long term trends for the markets. Disturbing macro factors, uneasy economic situations invariably have a negative impact on risk assets (equity markets in particular). Such a situation should be used to press for the exit option. This gives an opportunity to sell now to buy cheap later.

Remember, equity investment is undertaken for ‘wealth creation’, one must take necessary steps to avoid ‘wealth destruction’. Exit option is a means towards achieving this objective.

Markets ride on the 'Feel Good' factor

In my post dated 20th February I had tried to focus on the mood of the investors and its impact on stock market movement. Since then we have seen a lot of improvement in the stock indices, primarily due to the positive mood of investors. The positive mood has been broadly created by two events which have been perceived as extremely positive by the market participants. The first event was an investor friendly budget, which articulated the resolve of the Govt. to control the deficit, and the other prominent event has been the spectacular win of the Indian cricket team to lift the world cup after a scrappy start. Investors would be able to analyse the steady improvement of the stock indices as India's campaign progressed in the world cup. The mood of the nation is euphoric at the current juncture, so how does it auger for the immediate future of our markets!

It is my firm belief that these events have given the stock markets an opportunity to extend their gains in the current rally that is unfolding on the bourses since the presentation of the budget for FY 2011-12. The positive news flow from the cricket field has even overshadowed an important negative event: Filing of charge sheet by CBI in the 2G scam. The market will ride on the cricket euphoria in the short term, and may even overshoot levels of 6000 on Nifty and 20000 on the Sensex soon. But the spate of bad news is likely to come back to haunt the markets thereafter. The corruption saga in India and the instability in the middle east is likely to keep the oil on the boil and inflation in India well above the comfort zone of RBI. And these factors do not hold good for the stock markets in the medium term.

Here is how investors should approach stock markets at the current juncture:

• India's growth story remains intact, long term investors should continue to hold on to their blue chips.
• Markets could react from the levels indicated above, and if investors are looking for profit booking this is the level for partial profit booking.
• Markets could temporarily go down towards 5400 levels on Nifty again, after the initial euphoria. Fresh investments should be considered at close to these levels.
• However, investment through SIP mode should be continued irrespective of the movement of the indices.

Buffetology: Mantras for Investors

The grand old investor 'Warren Buffet' was in India recently. He has once again reiterated his opinion on India as a compulsive investment destination for any investor. He has returned to India to scout for attractive investment opportunities for his companies. It would be worthwhile to revisit the investment philosophy of the legendary investor.

The term 'Buffetology' has been coined by authors Mary Buffet and David Clark in their book titled 'The New Buffetology'. The greatest contribution of Buffet to the cause of Indian investors has been his passion for bringing the gains from long term investing to the centre stage. Unfortunately, in India the focus of investment has been on making money through short term gains, which is detrimental for the psyche of investment. The idea of long-term investment is treated somewhat like a doctor’s advice to start exercising and eat healthy. Most people agree that it’s good in theory, but few actually get around to doing it. Buffet's life and his success demonstrates that all you need to do is to understand a few simple things and do them faithfully over the long-term, with the long-term measured literally in decades, not years.

Here are a few pillars of the so called 'Buffetology':

• Invest in companies companies with consistently high rates of return on equity, preferably rising.
• Rule No. 1: Never lose money.
  Rule No. 2: Never forget rule No. 1
• Invest in a business that even a fool can run, because some day a fool will.
• Time is the friend of the wonderful company, the enemy of the mediocre.
• Simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.
• You only have to do a very few things right in your life so long as you don't do too many things wrong.

Let us derive inspiration from these words of wisdom and create wealth for ourselves through the concept of 'Value investing' propounded by the legendary Warren Buffet.