Tag Archives: time

The Stock Market Is Getting More Expensive

One of the most underrated but among the most valuable skills required to succeed in stock market investing is resilience i.e., the ability to properly adapt to stress and adversity – either in the market, or in the businesses one is owning. How easily can you bounce back from a market crash? What would be your reaction to a sharp decline in your stocks’ prices? How many ‘surprises’ can you withstand in quick succession? How safe are your overall finances in light of extreme stress on the equity component of your portfolio? These are extremely important questions you must ask yourself every time you are looking at your portfolio, or looking to spend cash to buy more stocks. Surprisingly, despite its importance, resilience is least talked about by stock market investors and experts alike, and rarely considered an important mental model in investment decision making. Most of the time, we build our lives, our jobs or businesses around today, assuming that tomorrow will be a lot like now. Resilience, which is the ability to shift and respond to change, comes way down the list of the things we often consider. And yet, a crazy world is certain to get crazier. Jobs aren’t steady anymore. The financial market has gotten more volatile. The Earth is warming, ever faster. And the rate and commercial impact of natural disasters around the world is on growing exponentially. Hence the need for resilience, for the ability to survive and thrive in the face of change. Stock Market is Getting More Expensive Certainly I am not talking about stock valuations here. Because, if that were to be the case, the BSE-Sensex’s valuation – if you go by P/E – is now cheaper at 18x trailing 12-months earnings as compared to 23x just six months ago. Noted financial writer George J.W. Goodman – who used the pen name of Adam Smith – wrote this in his wonderful book, The Money Game – If you don’t know who you are, this is an expensive place to find out. By “this”, Smith meant the stock market. The people who bought commodity, infrastructure, or real estate stocks in 2006 and 2007 because they thought they had a high tolerance for risk – and then lost 95% over the next one year (some such stocks are down 95% even after eight years) – know just how expensive the stock market can be. While speculating on such stocks, they seemingly failed to answer the questions around their levels of resilience. And thus many ended up betting their houses and other people’s money on stocks that were destined to go down the drain. Something similar has happened to the guys who were utterly charmed by “moats” and forgot the subtle difference between paying up and overpaying over the last two years. A lot of such moated darlings are down between 30% and 50% over the past six months. Those who would have borrowed money to invest in such stocks are sitting on even bigger losses and much bigger dents to their egos. You see, knowing more about who you are as an investor can make you a fortune – or save you one. Knowing how resilient you and your portfolio are to severe market downturns also solves that purpose. Can You Handle Mr. Market Well? If you have been glued to financial media or online portfolio trackers, fixated on the sight of falling stock prices over the past few days and weeks, then this should tell you something about yourself that has enormous long-term importance – you probably have too much in stocks even as you don’t have the resilience to see your portfolio value declining (and that’s why you are checking stock prices so frequently). If you feel distressed by a decline of a few hundred points on the BSE-Sensex, then you are kidding yourself if you think you can withstand a drop of a few thousand points when it comes. Benjamin Graham, the father of value investing, divided investors into two types in his book The Intelligent Investor – defensive and enterprising. The defensive investor, Graham wrote, wants to avoid “serious mistakes or losses” and seeks “freedom from effort, annoyance and the need for making frequent decisions.” On the other hand, the enterprising investor, as per Graham, is willing “to devote time and care to the selection of securities that are both sound and more attractive than the average.” So, if you are an enterprising investor, then you should observe the stock market carefully in the hope that a substantial fall will present bargains. But if you are a defensive investor, you should observe yourself carefully. If you are not nearing retirement and have many years to invest and thus ability to see through a few big downturns; If you are not investing on borrowed money; If you are investing your own money, not other people’s money; If you do not owe a lot of money by way of loans, and have sufficient disposable income that prevents you from selling your stocks to meet your needs; and If you have seen through past market crises without much psychological upheavals… …you have adequate resilience to manage any major stress that the stock market may present you now. However, if you do not meet any or most of the above criteria, then beware. Reconsider your decision to be in stocks directly. Else, maybe, trim back on your stocks to create the much needed financial cushion so that any big decline does not become an even more expensive way for you to find out who you are. Remember what Keynes said – Markets can remain irrational longer than you can remain solvent.

What Powerball, Stocks, And Contrarianism Have In Common

“You’ve got to kick fear to the side, because the payoff is huge.” – Mariska Hargitay We all know that the lottery is random, and that the odds are one in 292 million. Maybe you’ll get lucky and win it all, or maybe you’ll split the payout because multiple people luckily choose the same winning numbers. But keep in mind that the higher the lottery jackpot goes, the more likely you are to split the pot with others. Lottery participation is not linear. Every new dollar increase in the jackpot game after game does not bring with it a set new number of people who play. Rather, the larger the jackpot, the more exponential the number of people who play becomes. That means the more attention the lottery gets, the odds of splitting the payout with others actually increases. Meaning if you really want to play the lottery, the best way to do so given the same odds of choosing the right numbers is actually to bet on a jackpot that is high, but not high enough to attract a large number of new players. And this relates to the stock market how? The more an investment is talked up (largely because that investment has already moved and made a boat load of money), the more likely you are to split the payout among others listening to the same reasons to buy that particular investment. The more people know about a big payout, the more likely you are to split the pot and not make as much as you hoped. There is a high correlation to the amount of attention the Powerball and stock market gains receive from the media and the jump in the number of new entrants who come in afterwards This is where contrarianism comes into play. Few people pay attention to losing investments. Those who do will often be too scared to buy in after a large drawdown, even though the very definition of “buy low, sell high” is based on those depressed prices that happen peak to trough. Some will argue that if a stock, asset class, or strategy is down, it must be down for a good reason. As we know from several quantitative studies of markets, however, that “good reason” may be either 1) legitimate, 2) random, or 3) based on a cycle that simply doesn’t favor that investment. We show the latter point as being a major one in our award winning papers related to predicting stock market volatility. Being a contrarian isn’t about going against the crowd. It’s about betting on a jackpot which few other players are betting on, so the odds of you splitting the payout are much lower. Let’s apply this to today’s market. Ask yourself very simply – where have most people overweighted their portfolios? What is the overarching narrative? Where are most people betting? Likely on the “cleanest dirty shirt” on the global landscape, which is the US stock market. Why? Because Fed policy and the Age of QE, combined with ever faster information flow from the internet has resulted in a similar Powerball mentality among a large portion of the investor landscape. Make no mistake about it – though we may hear stories about investors “selling” US stocks (NYSEARCA: SPY ) in this volatility, you can’t unwind 5+ years of divergence from the rest of the world in 5+ trading days. Where does the contrarian look to now? Reflation through a bounce in commodities (NYSEARCA: DBC ) and emerging markets (NYSEARCA: EEM ), both of which no one seems to want to buy a ticket on. Of course that doesn’t mean you buy that ticket right here, right now. But that also doesn’t mean you should ignore what on the surface looks like a low payout right now. 6 11 19 48 54 06 QP

The Bear Market Playbook

As many markets enter bear market territory around the globe, investors are inevitably getting skittish. Bear markets are a regular part of the financial markets, but that doesn’t make them easy to handle. Here are some keys to handling a bear market: 1. Don’t lose your perspective. In the last 45 years, a globally allocated 60/40 stock/bond portfolio has never had a negative rolling 5-year return. Of course, it’s not easy to maintain a 5-year time horizon, but if you have less than a 5-year time horizon, you probably shouldn’t be owning stocks and bonds in the first place. Resisting recency bias is the greatest struggle for most investors. And unfortunately, most people never overcome it…. I’ve witnessed this for decades with clients. The financial markets are a revolving door of investor after investor dying one funeral at a time, thanks to excessive short-termism. You don’t have to be irrationally long term, but focusing on the short term is just as irrational. Of course, if you don’t have a proper allocation in the first place, then you need to ensure that your risk profile is aligned with your asset allocation . 2. Turn off the news. Most of the financial media isn’t there to help you. They’re there to get your attention so they can earn a profit selling ad placements. Unfortunately, there is no emotion more powerful than fear. This is why financial TV ratings surge during bear markets. You tune in, get scared out of your wits, churn up a bunch of taxes and fees in your account, sell into panics, rinse wash repeat. I turned off financial TV almost a decade ago. It was one of the best financial decisions I ever made. 3. Stop looking at your account. Fidelity once found that investors who don’t log in to their accounts perform better than investors who log in regularly. The best thing most investors could do is lose their password to their account about once every five years. Logging in and incessantly focusing on your portfolio is just about the best way to ensure that you become a victim of recency bias. If you have a reasonable plan in place, you just need to let time do the heavy lifting for you. 4. Focus on something else. Get your mind off the short-term swings in the market. There is nothing you can do to control the markets. Excessive activity is the illusion of control during the course of creating inefficient portfolio frictions. Get your mind off your portfolio by focusing on hobbies or work. Sitting around worrying about your portfolio isn’t going to help you or your portfolio.