A sleek Japanese bullet train glides noiselessly into the station. Then a strange ritual begins. The conductor in the last carriage jumps out and starts talking loudly to himself while pointing to different parts of the train.
The Japanese call this Shisa Kanko, a Japanese phrase meaning ‘point with finger and call’. As you can tell, there is a method to this apparent madness. This is an error-prevention drill that originated in the early days of steam rail. By conducting this exercise, he engages his sense of hearing, his eyesight, as well as muscles of the arm and mouth, all of which indirectly stimulate the brain to keep him alert. This, to a large extent, eliminates accidents cause by lapse of concentration and negligence.
Studies have shown that this technique reduces human error by as much as 85%. According to this report, New York subway train conductors have been using point and call since 1996. A New York Metropolitan Transit Authority spokeswoman said that within 2 years of implementation, incidents of incorrectly berthed trains fell by 57%. It is also used in Indonesia.
ARUN KUMAR brings this analogy to investing. Why? He believes that ALL of us have blind spots which can lead to derailment of our portfolio. By definition, we cannot see these blind spots. But a lot of it is to do with where we place our focus and what we give attention to. For instance, in an information overload world, the media may cannibalize the attention which needs to be given to fundamentals. This leads to flawed decision making.
To rectify this, he has structured a framework which is elaborated below and in the following 7 slides. He sums it up in the final slide.
Better decision making starts with frameworks
Let's start by developing a framework to evaluate the risk in markets. This should enable us to get a sense of when we need to go slow on equities and when we should plunge all in.
We all know we are in a bull market, that will inevitably end someday in the future.
Historically, we get to see 1 or 2 bear markets every decade. This means another 3-6 bear markets over the next 3 decades. In other words, we don’t get too many opportunities, or practical experience, to learn how to handle bull market peaks and the bear markets that follow. Of course, we shall have this opportunity soon (how soon is anyone’s guess). So, the key is to not let go of this great learning opportunity!
I cannot emphasize enough that the idea of the framework is not about precision – it’s just a disciplined way to get an approximate sense of which part of the market cycle are we in.
To evaluate equity market, I use 7 factors:
- Valuations
- Earnings Growth
- Cycle – Credit Growth, Capacity Utilisation
- Sentiment
- Interest Rates
- Other Dynamic Asset Allocation Models
- Momentum
To ensure that we do not miss out on any of these factors, we shall use the “point and call” Japanese concept for each and every one of the above factors.
The basic starting point will be to have a rough expectation of the long returns i.e 5-7 year returns.
Returns from equity = Change in earnings + Change in PE valuations + Dividend Yield
So predicting equity returns boils down to answering 2 questions: 1) What can be the earnings growth? 2) Will the valuations move up (increasing returns) or move down (reducing returns) or stay flat (not contributing to returns)?