February 25, 2009

Bear market to end soon !!!

Did I catch you on that ? are you expecting someone would be able to predict that for everyone ?

For the last one year, there has been an army of people trying to predict the end of the bear market. Most of the so called pundits were expecting the global recession to end by Q1’09. Now the predicitions have shifted to Q3’09 or towards the end of the year. The same pundits were predicting oil to touch 200 dollars a barrel. As the saying goes – If I had a penny everytime a bozo made a prediction, I would be rich !

I would suggest you to read N N taleb’s books – Fooled by randomness and The black swan which talks of this bias. All of us have this strong desire to predict and see patterns. It is a strong, innate human tendency which causes most of us to seek predicitions of the future and see patterns where none exist. The problem with markets is that there are often no such patterns and the future can rarely be predicted accurately for a long period of time. Yes, some so called gurus can get one predicition correct, but that does not mean that this person has some special ability to see the future.

If you predict often, you will be correct a few times too. There is considerable research into the accuracy and success rate of such predictions and most of the studies point to less than a 50% success rate. That is worse than a coin toss !!

How to invest without predicting the market ?
So how does one invest, if one cannot predict where the market will be in the future ? I think there is a big mis-understanding that one has to know where the market is going, to be a successful investor.

If you plan to invest in an option which will expire at a fixed time, then you will need to predict how the market will perform during the duration of the option. However if you are able to identify a good company with a sustainable competitive advantage, which is likely to do well over the next few years, then you are likely to get a good return on investment.

As the company does well, the underlying intrinsic value is bound to increase. When this happens, the gap between the price and the value will increase (assuming the price is stagnant ) and the stock will be get progressively more undervalued. In most of the cases (not necessarily all), this undervaluation will create an upward pressure on the stock price. In most of these cases, the gap closes suddenly and the returns are made quickly over a very short interval of time. It is however diffcult to predict when this will happen.

So what happens if the price takes longer to recover ? Well, if the intrsinc value is increasing, then you have an opportunity to increase your holding as the gap keeps getting larger and the returns should be better when the gap finally closes.

So why does’nt everyone do it ?
For one, it is painful to watch your stock stagnate over long periods of time. If you look at price to validate your decision, then a stagnant price only increases your self doubt and anxiety. Most investors are not wired to ignore the price and focus on the intrinsic value. That also explains why it is diffcult to practise value investing.

Where do we go from here ?
For starters, stop trying to figure when the bear market will turn. If your imvestments are based on the market turning soon, you could be in for a lot of dissapointment if that does not happen.

I personally watch CNBC, read the news and listen to all possible predicitions from all and sundry, but only for entertainment. Whenever some tries to give me an elaborate reason on when the market will turn or the recession will end, I have a single thought in mind – ‘How the hell do you know ?

What am I doing ?
I am reviewing my current holdings. The Q3 results have been announced for most of my holdings and I am in the process of analysing the same.

In addition I am focussing on learning about behavioral finance and biases. I would be updating my templates based on my learnings and would be re-analysing my holdings again. It is quite possible I may discover that I should exit some holding and some bias is holding me back. I will be posting such analysis when I come to such a conclusion.

16 comments:

karthik said...

Hi Rohit,
Good one... You nearly got me..I also find the CNBC amusing ... good entertainment at the end of an stressful day.

In one of your recent post you had mentioned that Maruti and Crisil are part of your core portfolio... Which holding did they replace ?...

Anonymous said...

Hi Rohit,

Excellent post again. People like me, who are in equity investing for less than a year, can also predict the turn around time / Index bottom numbers. I predicted 6 months back (to myself) that economies will turnaround by middle of 2009. I also predicted sensex bottom would be at around 9000. It was all based on the data from previous bear phases in India - totally ignoring the causes of economic problems this time and future events which will decide the turnaround of market, etc. If you are biased, you will find some logic to support your decision / prediction / etc, which may not be relevant to the event.

I have started to realize the importance of behavioral aspects in investing and started reading books on this subject. One decision I took recently is that I will not invest in any company, which is not trading at 50% below my estimate of intrinsic value, even my favorite company and even part of my current holding.

Anyway, I am eagerly waiting for new “un-biased” template.

Thanks
Prashant

Rohit Chauhan said...

H karthik
i did not replace any holding in my core portfolio. i have 2-3 slots open in core portfolio ..so i filled them up these companies. as of now i have atbest one more opening and need to find a good company for that

regards
rohit

Rohit Chauhan said...

hi prashant
generating the template will be the easy part. the more diffcult part for me is accepting the bias and then acting on it. it is painful to accept that you are wrong ..but it has to be done

regards
rohit

Anonymous said...

Rohit,

I am a new investor, would appreciate your response to my question.

How does the dividend payments work? Do they directly deposit to the Demat Account/ OR send a physical cheque in the shareholder's name? I have a demat account with ICICIDIRECT.

technomart webmaster said...

i m new investor..so plz give me a true information.......
:)

Rohit Chauhan said...

hi anonymous
dividend are sent to you account if you have a account linked with the demat.

technomart
that depends on the info you are looking for :)
i do my market forecast using a coin toss ..and i have higher accuracy than most of the pundits

regards
rohit

income.portfolio said...

RC: Very timely post. Perhaps the one aspect you missed in "So why does’nt everyone do it?" is that our tendency or urge to earn quick bucks fails us. We do not believe in building over a period of time. We spend 16-17 in school/college to lay down a platform for a decent career. But when it comes to investing, we do not follow the same approach. Perhaps, the speculative environment surrounding the stock market does that. Investing is a marathon, but majority of individual investors make it a 100m dash.....

Bharat said...

Hi Rohit,

Are you going to be covering the "follies and fiobles" of Buffett as admitted to by Buffett himself in his 2008 ltr?

Would be interested in reading your take.

regards.

Pebbler said...

Today I across something similar as how to media brings in unnecessary angles to a story. This was in relation to Warren Buffett's letter. I posted a small note on my blog on that. Such titles and forecasts will always attract people - though not necessarily for the best.

Pebbler

Rohit Chauhan said...

hi bharat
i plan to write soon on the letter. the first thing i did on the saturday was to read the letter as soon as it was posted

hi pebbler
true ..the typical headlines are all misleading. the easiet way to get hits is to put a totally misleading title. buffett bashing these days gets good hits ..the problem is that most of these moron have no idea what they are taking

regards
rohit

Anonymous said...

Again a nice write up Rohit ! As you told I think the most important part of investment is the behavioural & emotion control part. In fact we are human and we naturally tends to react to things happening around us, without any valid reasons. I think that is why market also exists. Just imagine a situation, where there are no human participants, only robots are there ! I think in such a situation there won't be any marekt !! So controlling emotions is the most difficult thing for humans and that is secret behind good investment ! Isn't that told in our Gita and Mahabharat also !

Warm Regards
Gacpradhan

Manish Chauhan said...

Nice views Rohit .

For common investor, who does not want to deal with direct equtiy , the best thing would be to just invest through SIP over long term , that shall take care of all the volatility over long term and should generate excellent returns .

Incase people wnat to read some SIP stuff... they can read my post on SIP MAGIC : http://www.jagoinvestor.com/2009/03/sip-magic-part-1.html

Avadhut said...

Hi Rohit,
You mentioned that you would be reviewing Q3 Results and based on that may exit some stocks.
Would like to know when do you think is the right time to exit? Only after making some decent profit or anything else? How Q3 results will verify that?

Avadhut

Rohit Chauhan said...

Hi gcpradhan
yes life would dull if all of us were completely rationally ..like robots

i agr geeita and our other scriptures have a lot wisdom which one can apply to life and markets in particular

avadhut
reviewing Q3 results is to check the fundamentals of the company and to see if the company is doing as i expected. In my case sell happens if i have been wrong in the analysis or the price is way above intrinsic value. whether i have made money or not should not drive the decision

regards
rohit

Investors times said...

I also dont believe in timing the market. I have always believe in buying for the long run. so do like me, buy everything that is undervalued and that has value. Once the recession ends you might regret that you have been among the chickens and miss a nice opportunity.