Amay Hattangadi, Managing Director, and Swanand Kelkar, Executive Director, Morgan Stanley Investment Management, tell investors how to stay grounded.
In a recent interview on CNBC, legendary investor Warren Buffett remarked “I never know what markets are going to do..... I know what markets are going to do over a long period of time, they are going to go up. But in terms of what’s going to happen in a day or a week or a year even, I never felt that I knew it and I never felt that was important”.
While these words may seem simple, most investors would find it extremely difficult to not get swayed by short term market movements.
Since the beginning of this year, Indian markets have seen volatile moves, gyrating to the tune of both global markets (led by the Shanghai Composite) and local events (such as the Union Budget).
While this essay does not purport to be a critique on the recently announced Union Budget, it would suffice to say that the Budget proved once again that ‘big bang’ reforms will not be the operating template for India. Reforms in India will be a slow and tedious process, requiring the buy-in of the opposition and the bureaucracy.
Moreover, what was evident once again this year, is that while India may be in a relatively better position based on external macro indicators compared to 2013, the correlations with global markets always rise disproportionately during periods of heightened uncertainty in other parts of the world. As we navigate the volatility in markets, we constantly refer to some guideposts or rules so as not to deviate from our core job of generating superior returns as investors.
1. Do not stop evaluating stocks.
As bottom up investors, we remind ourselves to not get caught up with trying to predict the next move of the index at large, but to continue to research stocks on our radar. Moreover it is not necessary that stocks that have fallen the most are most attractive. The ones that may be down more than the others may be so for good reason.
Market participants have a tendency to obsess over ‘price’ rather than ‘value’. Just because a stock is down, say 25%, does not make it cheap. There is a possibility that the starting price was way off the mark or that the dynamics of the company have changed by virtue of the fact that a turnaround in earnings may have been postponed or the assets are more impaired than originally assumed.
2. Do not obsess with timing the market bottom.
In his recent newsletter, Howard Marks, while referring to the current state of the markets, says “while this might be ‘a time’ to buy, I’m far from suggesting its ‘the time’ to buy”. Market participants in our opinion spend disproportionate mental energies in trying to find the precise bottom. If in the rare case one does get it right, it might make for a good story to tell at a party, but it is more likely going to be a case of lost opportunity where the individual totally misses buying in the market. Often the difference between making say five times your initial investment or seven times is not nearly as important as totally missing the opportunity.
3. Do not be impatient in playing contrarian.
Quite akin to recent studies that reveal that our attention span has shrunk to eight seconds (not much better than a goldfish), so too in the markets there is a growing sense of impatience to enter what appears to be a contrarian trade.
At the first sign of a seeming trend reversal, market participants are quick to pile onto a trade assuming they are among the minority contrarian investors. In reality, when everyone thinks he or she is contrarian, chances are that the contrarians are actually becoming a part of the emerging consensus. We have seen this play out several times in the last few months with oil prices.
A related pitfall is the rubber band effect i.e. the assumption of mean reversion. One needs to distinguish the mere mean reverting stocks from great investment opportunities at bargain prices. More often than not a major and volatile stock market correction could signal the end of an era (such as the super-cycle in commodities), and it would be a costly mistake to assume that all stocks in that sector will regain their lost lustre.
4. Do not ignore emerging themes.
The importance of focussing on emerging themes is even more relevant when the corrections run deeper, such as in 2008, where the repair and recovery process could take even longer.
Usually after a major market correction, a new investment theme may potentially be emerging in some ignored corner. One needs to remain attentive to these changes.
5. Do not lose sight of what is important.
In summary, to quote Thomas W Phelps , author of the book ‘100 to 1 In The Stock Market’ - “thinking too much about what the market is going to do can be expensive, even when one is right”.
So, we relentlessly focus on our research, switch off our screens and stick to our knitting.
