Monthly outlook

DON’T LET THE ALTITUDE BOTHER YOU

 As the Nifty crossed the 6000 mark last January, after a two year hiatus,  it triggered celebrations and concerns alike. The celebrations were quite  in line. After fall that is what you do when your portfolio appreciates and gives you a sense of well-being.

 But the investors were also concerned. The issue at hand was simple. You  have waited for these levels of the Nifty for two years and now that those levels have been reached, should you sell and count the wads?

Booking of profits to carry to buy your own house or to take a long promised family holiday is never a bad idea. After all, booking of profits has always been a profitable idea. But selling simply because of the fear that markets could fall from here is something that needs to be revisited after you have washed your face with some cold water.

Where does the fear stem from?

Fear stems from history. Past highs seen act as a natural resistance. Because people remember the levels at which the indices or stocks had reversed last time, the levels act as a barrier and require higher volumes and more vigour to cross.

Merely looking at the Nifty’s 6000 levels can give you vertigo. But the moment you dawn your fundamental glasses, things begin to change and fear begins to ebb. We will come to the fundamentals in a while, but first a trip down the memory lane is a must to judge where we have been and where we are.

The first time the Nifty touched 6000 level was on 1st November, 2007 when it touched 6011 in intra trade but fell back to close at sub-6k levels. It wasn’t until six weeks later on 11th of December that it finally managed to close above the 6000 mark at 6097. The Nifty made an all-time intraday high of 6357 on 8th January 2008.

After plumbing the depths at 2252 on 27th October, in the post Lehman  crash, the Nifty recovered one ore time to the 6000 levels in in September 2010 and closed above the 6000 mark for a collective period of 45 days, before slipping off the perch in the first week of January, 2011.

Changed fundamentals

But when you look at the fundamentals, they are not the same. Our GDP has grown between 6.2 and 9.3 in the past 5 years. But markets are still lower by about 5 from the all-time highs. The actual earnings per share of the Nifty for the year 2007-08 was  Rs 229, which gave you a price earnings ratio of 27.75 times. Today the Nifty is at 6034. With most of the results for the December quarter in, the expectation is that Nifty could clock an EPS of Rs 411 this year ( March 2013). This gives you an attractive PE of 14.68. That’s almost half the PE of 28 in 2008. Feeling better? Good. Read on.

The Government is in execution mode

Ever since Mr Chidambaram moved into the North Block, the Government has  been in a tearing hurry. The GAAR ghost has been exorcised. Investor confidence, read FIIs, has come back. The disinvestment programme which had hit the pause button is once again in play. Diesel prices have been hiked and have been put on the auto mode.

Some worries would always be there

The worries are that you don’t know, when the Government could draw a line of Diesel hikes. If the Government runs it food security programme will not the fiscal deficit rise. How would Chidambaram marry the desires of the FIIs and the poll bound Congressmen is a genuine question.

But we must remember that the current valuations also reflect that. Had these concerns not been there, we would have long crossed the 7k mark, forget the earlier high.

Some worries would always be there. If you wait for the perfect setting you will never be able to invest.

But let’s take a practical outlook. The current problems in coal allocation , gas pricing, land acquisitions are nothing but an opportunity if looked form a different angle. Fresh opportunities would arise from the very same problems.

It takes two to tango

For a change both the FM and the RBI Governor are on the same page. Both are now rooting for growth. The benefit from the double bonanza of a Repo Rate Cut and a CRR cut would be reaped in the days to come. The new bank licenses, when they are announced could see frenzied buying in some stocks and selling in others. But the gains of the market operations of the RBI would be keenly watched and positively reacted. The improved liquidity and lower rates will start showing in the corporate bottom lines.

Don’t fret about US contraction

The markets may be worried that Q4 GDP shrank 0.1% . They were expecting a growth of 1.1% from the 3.1% seen in Q3.  Hurricane Sandy and a deep cut in Government defence spending are the two
  reasons attributed to the contraction.

But beneath the surface, the economy is in better shape than what the headline number would suggest. Consumer spending rose  at an annual rate of 2.2% , led by the largest increase in purchases of durable goods in two years. Consumers don’t buy durables unless they feel a bit confident that their incomes will keep coming in. Businesses increased capital expenditure at an 8.4% rate. Spending on equipment and software increased at a 12.5% pace, the best in more than a year.

A big change from the scene in 2008 and 2013 is the US Housing. Housing, which was in the dog house  in 2008 is now making a comeback. Home building added 0.4 percentage points to growth in the quarter. Economists are of the view at full throttle, housing alone can contribute 2% to GDP.

February: When expectancy runs high

This is the month in which the FM presents his Union Budget. But how the markets actually behave during the month is more about what the expectations and the events that lead up to the budget than the budget  itself.

The Rail budget precedes the actual budget. There is no need for a separate railway budget. It could well be a part of the Union budget itself. In the future, like the way that the time of the of Budget was   changed , this too will change.

Readers would recall that till the  year 2000, the Union Budget was presented in the Parliament at 5 PM on the last  day of February. This practice was inherited from the Colonial Era, when the British Parliament  would pass the budget in the morning followed by India in the evening of  the day.

It was Mr.Yashwant Sinha, the then Finance Minister of India in the NDA Government of  Atal Bihari Vajpayee, who changed the ritual by announcing the 2001 Union Budget at 11 am.

The change in timings did wonders for Mr Sinha as the markets surged 4.36% that day. The crown of the highest budget day surge of 5.13%   in the benchmark also rests on the head of Mr Yashwant Sinha. The year was   1999.

Last year, the month of February gave a return of 3.25%. The average returns for the 23 years is 4.27%. If you normalise that be removing the best and the worst year, it comes to 3.27%. But one must remember the risk in dealing with averages.  If you consider only the last ten years, then we have a negative reading of 0.58%.

Some sectors shine brighter than others

The outlook for the various sectors is always dynamic. Some sectors like the Television Media are rocking. Here you can change horses mid-stream without missing a beat. The Oil Marketing PSUs are beginning to sense blood. Telecom appears to be turning. The rumbling in the belly suggests the sector is getting the first positive signals on pricing. And if you want to be sector agnostic then nothing better than our old fashioned Index Funds.

Bottom line

Don’t allow the high altitude of the index to get to your head. Make some cool calculations.

7 Investing Sin’s

Since these common errors are self-imposed handicaps, identifying them would result in
a superior investment process.

Years ago, even before the financial crisis was spotted on the horizon, James Montier of
Dresdner Kleinwort Wasserstein came out with a white paper titled “Seven Sins of Fund
Management”. This holds true even today and we reproduce them here as the common
mistakes your investors (or asset managers) make. If you find your investors committing
one of these “sins”, it’s time to reform their ways.

Sin 1: Forecast

Forecasting is an integral part of our lives, investment or not. Even the weather cannot
escape it. But a heavy dependence on it is sheer folly because evidence indicates that
your investors are bad at forecasting. The core root of this inability seems to lie in the fact
that we all seem to be over-optimistic and over-confident. The answer probably lies in a
trait known as anchoring which means that in the face of uncertainty, we will cling to any
irrelevant number as support.

Sin 2: The illusion of knowledge

The desire for more information stems from the efficient market theory: if markets are
efficient, then the only way they can be beaten is by knowing something that no one else
does. Your investors believe that they need to know more than everyone else in order to
outperform. But we seem to make the same decision regardless of the amount of
information we have at our disposal. Beyond pretty low amounts of information, anything
we gather generally seems to increase our confidence rather than improve our accuracy.
So more information isn’t better information, it is what you do with it, rather than how
much you collect that matters.

Sin 3: Company interactions

Why do company meetings hold such an important place in the investment process of
many fund managers? The white paper gives at least five psychological hurdles that must
be overcome if meeting companies is to add value to an investment process.

1. More information isn't better information, so why join the futile quest for an informational edge that probably doesn't exist?
2. The views of corporate managers are likely to be highly biased.
3. We all tend to suffer from confirmatory bias – the habit of looking for information that agrees with us. So rather than ask lots of hard questions that test our base case, we tend to ask leading questions that generate the answers we want to hear.
4. We have an innate tendency to obey figures of authority. Since company managers have generally reached the pinnacle of their profession, it is easy to envisage situations where analysts and fund managers find themselves effectively awed.
5. We are lousy at telling truth from deception. We like to think otherwise but we generally perform in line with pure chance. So even when you meet companies, you won’t be able to tell whether they are telling the truth or not.

Sin 4: Think you can out-smart everyone else

Keynes likened professional investment to a newspaper beauty contest in which the
aim was to pick the face that the average respondent would deem to be the prettiest. We
played a version of this game with our clients to try to illustrate how hard it was to be
just one step ahead of everyone else. The results illustrate just what a tall order such a
strategy actually is. Only three out of 1,000 managed to pick the correct answer!
The most common behavioural traits of over-optimism and over-confidence are what
lead money managers to believe that they can out-smart everyone else. Everyone thinks
they can get in at the bottom and out at the top. However, this seems to be remarkably
hubristic.

Sin 5: Short time horizons and overtrading

Because so many investors end up confusing noise with news, and trying to out-
smart each other, they end up with ridiculously short time horizons and overtrade as a
consequence. This has nothing to do with investment; it is speculation, pure and simple.
Over very short periods, the return is just a function of price changes. It has nothing to do
with intrinsic value or discounted cash flow.

Sin 6: Believing everything you read

We appear to be hard-wired to accept stories at face value. Stock brokers spin stories
which act like sirens drawing investors onto the rocks. More often than not these stories
hold out the hope of growth, and investors find the allure of growth almost irresistible.
The only snag is that all too often that growth fails to materialise. In fact, evidence
suggests that in order to understand something we have to believe it first. Then, if we are
lucky, we might engage in an evaluative process. Even the most ridiculous of excuses/
stories is enough to get results. We need to be skeptical of the stories we are presented
with. Your investors would be better served by looking at the facts, rather than getting
sucked into a great (but often hollow) tale.

Sin 7: Group-based decisions

Many of the decisions taken by your investors are the result of group interaction.
The generally held belief is that groups are better at making decisions than individuals.
The dream model of a group is that it meets, exchanges ideas and reaches sensible
conclusions. The idea seems to be that group members will offset each other’s biases.
Unfortunately, social psychologists have spent most of the last 30 years showing that
groups’ decisions are amongst the worst decisions ever made. Far from offsetting each
other’s biases, groups usually end up amplifying them! Groups tend to reduce the
variance of opinions, and lead members to have more confidence in their decisions
after group discussions (without improving accuracy). They also tend to be very bad
at uncovering hidden information. Members of groups frequently enjoy enhanced
competency and credibility in the eyes of their peers if they provide information that is
consistent with the group view.