General Thoughts

Markets are at a High

“The stock market is a giant distraction to the business of investing” – John Bogle

Stock market is a place with an ongoing tussle being the proverbial ‘bulls’ and the ‘bears’. Or as a philosopher might put it, between greed and fear. May be a neurologist might call it a fight between the two chemicals which our brain secretes – testosterone and cortisol.

Whichever way one thinks about it, markets reflect the underlying psyche of its constituents. And these are people with their own fantasies and fears.

Sometime either of these bull & bear periods could be prolonged enough to engulf even the toughest of the minds.

When it so does, the results are pretty silly. An adult with all this accumulated wisdom and with access to all unbiased facts ends up acting foolish. He does what his mind is ‘hardwired’ to do right since the days in savanna – following the crowd. “After all”, he thinks, “how can all of these intelligent fellows be wrong?”

And they are – if all are justifying their actions based on that of others. How is much is worth all your wisdom if you wish not to use it?

To me, it is crystal clear that we are living in one such irrational period of time. Broader market multiples are way far from where they generally are. In fact, they are literally going through the roof!

Image Source: Multi-Act newsletter (March 2017)

Current valuations are atleast 50% higher than their long term averages based on price to earnings ratio. And the results of such divergences have seldom been a ‘happy ending’.

So for current valuations to revert back to their long term average, there has to be at least one third of price correction or earnings should rise by 50% in the near term. Safe to say, chances of former is higher than the latter.

What should one do?

Armed with this knowledge, how should one respond? Is there a way to protect ourselves from someone else’s folly or even better, can we take advantage of Mr. Market’s folly?

This is how I happen to think about the subject:

  1. Predicting a fall is a futile exercise:

    Facts show that valuations are stretched and at some point, it has to revert back to its mean. But they don’t tell when. And they never do. There are hundreds of important variables interacting to determine our future. And to predict the it, one first have to predict those hundreds of variables, accurately.

    Any one wishes to give it a try?

  2. Ignoring valuations is dumb:

    People say that Indians are very price conscious. One generally does research, read reviews and ask friends before buying a 10K smartphone. They hardly do the same thing when investing 10L.

    Valuation is like gravity. Ignoring it is like intentionally hurting yourself. Higher the sums, more would be the damage.

  3. Be comfortable living with volatility:

    Just as gracefully one accepts ‘multi-baggers’, one need to take in those horrifying 50% falls. As Charlie Munger says, if you cannot stomach 50% declines in your investment you will get the mediocre returns you deserve.

    Well, I would add to it two things here (a) do not invest sums you would be needed within the next 5 years (b) if you indeed cannot stomach that kind of volatility, choose someone to work with who has a demonstrated track record of doing do.

I continue to do things I generally do. That is trying to turn around stones in search for bargains. Needless to say, this search has become painstakingly more difficult since, during such times, what we get is more dirt beneath those stones rather than what one would expect.

Which is fine. I don’t expect Kohli to turn centuries in every match then why should I expect too much from myself every now and then? I plan to continue with the routine and occasionally doing away with the overvalued securities and waiting on the crease for the ball that I can play well. Its test cricket which people are mistakenly considering as T20s. Difference between how one plays in each of these is huge!

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