The Indian economy - tough choices!

Dr. D.V Subbarao's (Dr. DVS)speech on the Emerging Market concerns: The Indian Perspective (Oct 5 - G 30 banking seminar - Istanbul) succinctly describes the problems faced by India
1/ high inflation (despite muted economic growth - causing stagflation - a phenomenon where an economy slows down, yet faces high inflation, hurting everyone!) - on account of high food prices
2/ possibility of a surge in capital inflows (especially if rates are increased!)
3/ monetary transmission mechanism - the translation of monetary easing to credit disbursal to the real economy
4/ a poor fiscal condition - with huge fiscal and current account deficits - although current account deficits are going to come down from 2.6% of the GDP in 08/09 to much lower levels in 09/10 (on account of the lower oil import bill).
Dr. DVS must surely be in a fix considering that despite low WPI - 0.84% for the week ended 19/09/2009, food price inflation is in the double digits. And despite the monetary easing (with key rates kept at levels unseen in the last 5 years), bank credit growth stands at a measly 13.2% y-o-y (as of 11th Sep 2009) versus 26.3%!
The RBI, in its next monetary policy meeting must make some tough choices. On one hand, a low credit growth is a problem and the RBI must ensure that the rates are kept low enough for good credit off-take, and on the other, it must ensure that the ghost of inflation doesn't haunt us.

Various brokerages suggest that the RBI isn't going to raise rates just yet and will wait till Q3 FY10 or Q1CY10 to raise rates.

PS: Will discuss how our banks are doing in the coming posts

Analyst upgrades continue as the markets spiral upwards!

As you can easily observe – The last post in this blog has been written over a year ago

Yeah, I admit, I've been lazy, really lazy...had plans to blog on a sustained basis, but couldn't motivate myself to do so.

However, now, I hope to revive my dream of blogging on a sustainable basis. So, here I am restarting the blog with a few updates (most of which is common knowledge)

→ The Indian markets dipped to levels that were last seen in May 2006! - the NIFTY went down to 25xx in Oct '08 and 27xx in Mar '09.

→ the NIFTY is now at 5020, returning almost 100%, from its October trough level! Many stocks have doubled/trebled/quadrupled.

→ Several developed economies have shown signs of a surpising recovery. Analysts/agencies across the world are revising earnings forecasts upwards!

What's happening now – well, most analysts are now calling the Oct '08-Mar'09 period, a trough and everyone seems to be very happy and smug with the bull-ride that the markets have given this year.

Secondly, no one wants this to end – this is resulting in every good news being amplified and used as a justification to chase the markets!

And finally, people are investing like there's no tomorrow. It seems that those who missed out on the rally (yours' truly included) are now coming back with a vengeance wearing 'Better late than never' and 'I believe in the greater fool theory' t-shirts.

Well, despite the trough valuations in Oct '08 and Mar '09, I am still un-invested in the markets. Things (lame excuses) that prevented me from investing – 1/ My poor time management which prevented me from  analysing companies from an investment perspective 2/ A business idea (which kept me busy in Q4 FY 09) 3/ the panic that set in during October!

So, why am I restarting this blog. 1/ I know that I am not going to invest in the markets unless I make an informed investment decision. This blog will help me keep a log of the work and enable a feedback on the same (if you people oblige :) ) 2/ by getting the ball rolling and writing a few posts, I hope the habit will spur me on and make me a better investor.

Meanwhile, here's some stuff that's really kept me interested in the period I was missing

1> the NSE market map -

http://www.nseindia.com/marketinfo/marketmap/NseMaps.jsp – this continues to fascinate me as I faithfully check the map to catch glimpses of the day's trading

2> the RBI RSS feeds – finally an alternative to hitting refresh on rbi.org.in - http://rbi.org.in/rss.aspx

PS: A personal update – cleared CFA L1 in June :)

The 'Buy buy...Bye' syndrome

There are times when we decide a price that we're willing to pay to own a fundamentally good stock, say when it's trading at 20-30% discount to its intrinsic value.
And in a falling market, we find that the stock comes tantalizingly close the intrinsic value just to bounce back to the old unattractive levels.
Let me give you an example of this... In recent times, a company that I felt was trading at a discount to its fair value was SBI

SBI touched a high of 2540 on 14th Jan 2008, and since then it has breached a strong support line and resumed its uptrend... as shown below

@ CMP of Rs. 1,565...Here are a few estimates of the P/BV of SBI

                                    P/BV                       P/E

                          FY09E    FY10E     FY09E   FY10E

Citi                      2.17        2.06           14.53     10.63

Kotak                  2.05         1.84           16.65     13.08

Consensus           2.11         1.95           15.59     11.86

SBI touched it's year low of 1025 on 1st July 2008...and was trading at the following consensus multiples

                          FY09E    FY10E     FY09E   FY10E

1007                    1.36        1.25           10.02     7.62

1100                     1.48       1.37           10.95     8.33

1200                    1.62        1.49           11.95     9.08

Very attractive multiples for the India's top bank by M-Cap, Assets/loans/deposits...
ONGC's case is similar as it tested new lows and resume its upward march....
These cases make me think...whether we should invest in a very active manner and pounce on opportunities, or should we buy into good companies in a systematic manner...
I will try to answer this in the next post

The Art of selling stocks

The current state of the markets reveals a thing or two about the behaviour of investors.I saw an article on rediff  discussing about what mutual funds have been buying/selling. 

The top 5 'sells' by mutual funds are the following 

 > Jaiprakash associates 

> Cairn India

> Zee entertainment

> IDFC and

> Satyam computers.

3 of the above companies, Jaiprakash, Cairn, IDFC have delivered stupendous returns to investors who'd entered 2-3 years back. Jaiprakash associates at today's closing price of Rs. 73 has still managed to give a 2 year return of 73% while IDFC has returned 85% during the same period (taking today's closing prices for all companies), Cairn delivered 86%.

Many companies which have collapsed in this fall are companies which have given a good return over a period of 2-3 years... despite the steep correction. The sell off in market out-performers is reflective of how we as investors behave. 

During a market fall when we see our portfolios, we tend to sell off the assets which are in the green (making profits), and hope that the rest of our portfolio recovers. This is because a loss causes much more pain than the satisfaction that an equivalent gain would bring us.We can compare our practice of selling profitable investments during bearish phases, with the shorting of an investment that has outperformed the market till now.

Whether this is correct or not, is something that the fundamentals and other factors will tell us. However, if the fundamentals of these companies are sound then there is no reason why such stocks shouldn't bounce higher than the markets on a rebound. 

For those of you, who've seen your well researched profitable picks pare their profits due to purely 'technical reasons,' I have one thing to say... Hold your horses or sell off if you feel that these technical sell-offs will take your stock to the lowest of lows but remember that you will find it tough to buy them back at the lowest of lows, as it's almost impossible to pick the bottom.

Psychology and investing

While reading Fooled by Randomness and More than you know... I encountered a term called the Babe Ruth effect. This term was used to explain the simple concept of expected return of an investment, which is the sum of the products of the returns and their probabilities of occurrences. To make it simpler here's an example: An investment having two payoffs: a 100% upside with a probability of 20% and a 10% downside with a probability of 80%. This investment will have an expected return which is as follows: 100% *20% + (-10%) * 80% = 20% - 8% = 12%.

The Frequency v/s Magnitude trade-off

The noteworthy feature of the above example is that seeing the probability of return i.e. 80% chance of getting a negative return and 20% chance of getting a positive return, it would be very tempting to write a call or go short on the security. However, it is very important for us to understand the effect of the magnitude of the return for the probabilities while taking decisions. This is also known as the frequency v/s magnitude trade-off.

This is the Babe Ruth effect, as Michael Maubossin and Bartholdson call it in their paper. They named this observation after a legendary baseball player Babe Ruth, who exhibited similar characteristics with respect to his hitting.

Investment lessons

The paper on the Babe Ruth effect gives some advice on approaching investments which include thinking in terms of decision trees, focusing on things we know, making the most of the limited opportunities and understanding that we don't need to put everything in stake every time.

Apart from the lessons mentioned, we must also delve deeper into the investment decision tree which may lead us to conclude various things.

Problems with this approach

I'm afraid that most investing decisions we take are not simplistic enough to enable us work in the decision tree manner and gauge the magnitude/probabilities so explicitly.

More rumination in this area may bring us to issues like: Whether we should sell puts/calls when we spot gaps which may result in a high probability low return event and be content with a paltry return or buy a put/call which will lead to us forgoing the premiums in maximum occasions while leading to massive payoffs in the unlikely event scenario. Taleb seems to favour the second scenario.


Other thoughts on the same tune...

Hold on to your beliefs in tough times

The continuous movement of the markets and the news that flows influences us in a such a way that we tend to sway our loyalties/discard our personal beliefs in favour of some research by a bank which hasn't been able to guard itself from this crisis. This is something that we must be wary of. We shouldn't let these blips or short term concerns override the decisions that we've based on our sound judgment.
I say this because, this crisis and all the other crises in the past have shown how foolish these institutions are in guarding the interests of their own shareholders... Some have had their asset bases shaved off to quarter of the what they had in the peak of the bull run!
And in a desperate bid to save themselves from utter damnation (read: the bear stearns episode) many are seeking capital from Middle east investors... the same sovereign wealth funds which the westerns considered anathema are now rescuing them.


PS: Back after a long hiatus for CFA preparation. Please pour in with your views to help me improve my thought process.

Comment based addendum: The frequency magnitude trade-off... The sheer magnitude of the return in the event of a positive earnings surprise should prompt an investor to go long despite a very high chance of negative return or opportunity loss (0% return). Please check the below figure.