Noise

NOISE



Nowadays whether the markets fall or rise, the experts tend to be equally surprised.

I have no hesitation in admitting that I have been as surprised by the stock market upswing as any other bloke.

And I am not even an expert.

Problem is, whenever there is a major movement in the markets, vividity takes me right back to the dark days of 2008 and a rise or fall seems equally fraught with danger. Dusk and Dawn are similar to look at after all.

The feeling of ‘Deja moo’ takes over. What if the rise is a dead cat bounce? What if the fall is the first step towards the 55% fall in 2008?


Meanwhile the experts all over the world are laying down their arms. As per a report on Bloomberg, strategists at the biggest banks are capitulating on their bearish forecasts after the best start to a year for global stocks since 1994.

Two weeks after saying that investors should “remain cautious,” Larry Hatheway, the chief economist at UBS AG, raised his recommendations on global shares and high-yield bonds in a Jan. 23 note to customers entitled, “Wrong, but not too late.”


As per a book called ‘The Zulu Principle’, both bull and bear markets have several different stages. In a bear market for example, stage 1 is usually a sharp fall during which economic conditions remain positive.

In stage 2 economic conditions deteriorate but the market becomes over-sold.

There is then a sucker rally, powerful enough to persuade most investors into believing that the market has bottomed.

During stage 3, the economic news becomes awful. Investors panic and sell at any price. The market declines very sharply as the downward spiral becomes self-feeding. Stage 3 is only over and ready as a springboard for the next bull market when investors abandon all hope for the future. The first positive sign will be that shares no longer fall on bad news.

That’s fine and dandy. But how does one figure out if this is a sucker rally or the end of Stage 3?


And what’s caused the recent rise anyway?

It’s almost as if people were just waiting for 2011 to be over before they wipe off the cobwebs on their cash piles and jump into the markets like this is all they were forever waiting for.

Meanwhile:

Did the European crisis get solved? Well, not really, no.

Did Greece, Spain, Portugal and the others manage to pay off their debtors? No..

Did the Israeli PM just tell Iran ‘let bygones be bygones’; Iran is Israel’s long lost brother? Er.. No.. There are enough indications that there could be a unilateral strike by Israel sometime in March.

Did US and UK’s debt levels come down? Of course not!! ‘Austerity drive’ everywhere is just polite noise from politicians. Everyone has one eye on the elections (the statement could be true from Greece to US to India).

Did China’s GDP just go up by 10%? No.. Recent reports suggest that China’s GDP could fall by HALF if Europe goes into a turmoil.

Did India’s Government just decide to be investor friendly and were the ‘policy inactions’ fixed by the Government? NO! (I don’t even want to elaborate on this.. you trying to embarrass me??)


OK, so what the heck is going on?

Niels C. Jensen of the Absolute Return LLP is someone whose writings I follow carefully.

In a recent note he writes: “The ECB’s balance sheet has expanded almost 50% in the last six months to €2.7 trillion and it doesn’t stop there. The balance sheets of the 17 eurozone central banks have grown even faster and now add up to €1.7 trillion, creating a consolidated balance sheet in the European central bank system of €4.4 trillion, almost twice the size of the Fed’s balance sheet.

“There is no question that the liquidity made available by the ECB has eased the liquidity squeeze in the European banking system and thus provided some much needed energy to the equity markets.”

He further makes an interesting differentiation between Economists’ Hypothetical Time (EHT) versus Real Market Time (RMT): basically suggesting that market practitioners (those who manage money and thus have an effect on markets) are forced to operate in RMT if they have any desire to make money for their clients.

Thus, as per him market practitioners no longer care about Greece or about Portugal. Instead they are now entirely focused on whether Italy and Spain can ride out the storm. And as per him, on the evidence of the recent performance of European markets, the verdict is that they can.


There you go.. The last of the dominoes just fell. The above, in my view, very eloquently explains the reason for the increase: The heady mix of liquidity and money managers’ frustration at being made to look like fools by holding on to cash while the markets went up.


As for me, purely by instincts since everyone is now positive, I tend to be the reverse. It helps that I am not answerable to too much ‘external pressure’ as of now.

I recently did a review of the portfolio under my management; tactically exiting some stocks that I felt had reached their optimal value. These included some mistakes, eventuating into losses. This freed me up with some cash in case some good opportunities come knocking.

Yet, I am holding on to the ‘long-term positions’. These are stocks that in my opinion will accrue positive returns to me over the longer period of time, notwithstanding the short-term blips. A list of such stocks is the topic for another note. More important for now is to explain my rationale.

Forget the Noise. Think longer term.

Firstly, like I said, after the 2008 knockdown in the markets, I am able to sleep more peacefully by being more conservative. Hence keeping cash on the side helps in case 2012 becomes 2008.

On the other hand, longer term, there is nothing better than equity in my view. This is one of the only asset class where the underlying value can be assessed closely. One can decide whether to pay 3x or 5x or 10x the earnings/ cash for a stock. But the underlying the valuation is visible: earnings (or cash on books or whatever). How does one decide the optimum value for Gold, for example?

For a company that is likely to have a growing trend on earnings or one which has some other hidden value, one has to stick on, no matter how the market behaves.


Prof. Shlomo Benartzi, an authority on behavioral finance, in an interview differentiated between Loss aversion and the myopic component of investing. We all suffer from one or another every once in a while.

Loss aversion refers to the fact that people think illogically about losses, so the pain of suffering a loss is about twice that of the enjoyment and pleasure of having an equivalent gain.

The myopic component occurs because people tend to count their money very often they tend to be myopic, i.e. they focus on short-term gains and losses, rather than taking a long-term perspective.

As per him, the “typical” investor has a horizon of about one year (BTW, one amazing stat quoted in Niels Jensen’s note was that the average holding time of a stock in US is now 22 seconds! Blink an eye and the stock got sold. Go to the loo and the entire portfolio got bought and resold!).

Prof. Benartzi goes on to say that if people count their money less often they would put more money into equities and the equity premium would probably be lower. Accordingly, he tried to focus on how to stop people from focusing on short-term losses.

To do this he conducted a few experiments. In one of them people were presented with an annual return on a stock fund and a bond fund and asked to decide how much to put in each fund. In this case they put about 40% in stocks.

In another version he showed people what the returns would look like over a 30-year horizon. Now they put 90% in stocks.

That’s because they stopped thinking about short-term losses.


Returns Since %

1992 (20 years) 778%
2002 (10 years) 420%
2006 (5 years) 95%

And these are just the sensex returns. Any individual stock picking strategy should yield much more.

Need I say anything mooore?