Thursday Trivia ~ Where are the stock markets headed?

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August 24, 2017

It’s a Saturday evening, as a thumb rule Meera’s kitchen is on a holiday. Mahesh has already planned the evening with his school friend. As they are heading towards the restaurant, Mahesh is excited by the possibility of making investment in the stock markets. He told Meera, a story about his colleague who recently went on a vacation by redeeming his mutual fund investments.

How’s it even possible?, aren’t they supposed to be subject to market risk or something?’ enquired Meera. Mahesh with a smile on his face said, he has asked Rohit, school friend and now wealth manager to meet them at dinner. ‘You’ve become smart off lately’, chided Meera.

As dinner progressed, Mahesh asked ‘Rohit, markets seem to be booming, you must be making a lot of money.’ Rohit was not surprised as he has been listening to such conversations since quite some time now. ‘Mahesh, that’s always the case. People will always want to bet on a horse that won last 2 races. Same is the case with stock markets’ calmly Rohit replied. Meera with a twinkle in her eye remarked, ‘even Mahesh wants that horse which has won last 2 races.’ Three of them erupted in laughter.

Rohit on understanding Mahesh wanted to start investing in the stock markets, highlighted a few points which he needs to consider before starting the journey. ‘While starting your investment journey, don’t just get carried away by rewards. First try and understand where the market is and it’s risks at every level’, Rohit said.

Businesses are cyclical

‘After the crash of 2008, nobody ever imagined that markets would be back to all time high levels again. The atmosphere was so negative that we were considering ourselves lucky to have never invested our money. In fact, we used to hear horror stories of people who lost a lot of money’ remarked Mahesh.

“Exactly, that’s because businesses go through their cycles. Sometimes, a particular industry is in demand and when the peak is reached, it starts to fade away. At that time, a new industry is born. Think about it, 10 years ago, did we ever think that we would meet again by connecting through a social networking website. It would have been so hard otherwise.

As businesses have their ups and downs, so does our investments in those businesses made through markets go through a very similar roller coaster ride,’ replied Rohit.

An extremely positive environment

‘I am shocked to see so much positivity around. Even our neighbours are now talking about mutual funds all the time. Just see how geo-politically much better placed than most other countries.’ Meera replied with a hint of joining the conversation too.

‘Yes, the environment is extremely positive. Media has been speaking about India’s future prospects with some awe. Does that mean, even our markets will also perform the same way in future? Or think about it, has anyone been able to predict the future?’ This question from Rohit, put Mahesh in a deep thinking mode.

Early success

‘Isn’t trends of past an indicator of future success? I mean, just look at my colleague at office for an instance, in last three years he has made a decent return on his investments. We call him the wizard of investing, he won’t need to even work for a salary after a couple of years it seems.’ Mahesh tried to make his point.

‘Wow, that’s wonderful. So what were you doing three – five years ago? There are a lot of people who have made a decent return on their investment in the past. Same was the case from 2003-2007. But then 2008, did happen.

It’s called hindsight bias. Just because something has performed in the past, we think it will perform each time. Remember the horse story. There is no denial of markets doing good in last few years but would it perform the same way? A question we need to ask ourselves before starting the journey.’ Rohit seemed stern this time.

Over supply of money 

‘Rohit, so much money is going into markets each month. Do this businesses really need that kind of money right now? Would it not result in too much money chasing too few companies? Would that not result in eventual over confidence of businesses to perform?’ Meera, a finance student finally revolted.

‘Yes Meera. You are absolutely right. Suppose, there is only one horse who is consistently winning, everyone would want to bet their money on the same. You a finance student would understand, for horse winning the race, that much money is not required. It just needs to be healthy and participate in the race with a damn good jockey.

Suppose, jockey gets too overconfident about their odds of winning. Then there is a fair chance of horse not being able to win. Same applies to stock markets, if these businesses get money more than they require, will they be able to utilise it appropriately? Even if your answer is yes, does it mean that businesses will start earning a lot just because it’s getting more money through markets?’ Rohit smartly put both of them into one more dilemma.

This time it’s different

‘Rohit, you are right. But this time it’s different. 2008 happened because some greedy bankers in America couldn’t get enough. This is our time. We don’t need any external money to run our markets.’ Mahesh came back as a storm.

Rohit realised the storm, ‘Mahesh you are right but does that mean fundamentals of businesses have changed?’

Funda ka mental

‘Rohit bhai, sab funda ka mental hota hai (Hindi). [fundamentals of a company are just a mental disorder] Mahesh replied with a smirk.

‘Mahesh, you and Meera have studied finance. While you commenting on the basis of a company is not important is not acceptable. I am not saying to avoid stock market investments, but just understand whether you want to invest completely now or wait for a while. As this cycle ends, another will begin. Isn’t it so?’ Rohit now replied with great caution.

Fear of missing out

‘But Rohit, we don’t want to miss out on this journey. What if this cycle has no end. It will make us look fools to sit out while everyone enjoyed.’ Meera said with concern.

Rohit with a smile said, ‘Wasn’t this the same feeling of 2006 also. I am not saying that we are in those times at all. Nobody can predict when market is at peak or it’s at bottom. But on a general basis trend can be understood.

‘Be fearful when others are greedy and greedy when others are fearful.’ – Warren Buffet

Just look around, with so much optimism, people are getting greedy to invest in stock markets. Everyone is entering to make that quick money and dream of a lifestyle which their regular jobs will not give them. But are their good hikes in salary packages? Can companies afford them? Then what will they do of so much money coming their way?’

A bell rang in Mahesh and Meera’s mind.

Youngsters- systematic investment planning

‘Yes, you are completely right. But where is so much money coming from anyways?’ asked Meera.

‘Young salary professionals are easy targets these days. There is so much peer pressure for them these days. That if one person invests and makes some money, everyone wants to join the bandwagon. With tall claims of money doubling in 5 years or so, youngsters have already started planning which car they will buy and where they will spend their international vacation.’ Rohit commented with sarcasm.

‘So what to we do now?’ asked Mahesh.

‘A single simple rule holds true: make good decisions and you’ll succeed; make bad ones and you’ll fail. So, move forward, but with caution. Given these conditions, with even more caution than in the recent past.

The keys to avoiding the classic mistakes (in such market conditions are)

Awareness of History 

If History has to be ready in detail, one would be able to find businesses are cyclical (as discussed above) due to which even markets have gone through it’s own bullish and bearish cycles. When somebody says, they made Rs. 10 lakhs by only investing Rs. 1 lakhs in last 10 years, it doesn’t mean that every year there was a 10% growth. Some years may have seen negative return as well.

Skepticism regarding the Free Lunch

Just because markets have given good investment return in the last few years, it doesn’t mean that there s a free lunch being distributed. There is a cost always attached to it. When few people were chasing that lunch, it was cheap. But since, number of people chasing that lunch has increased, definitely it won’t be cheap anymore.

A great level of caution and prudence need to be exercised by Mahesh now since lunch has started to become expensive and too many people along with him are chasing it.

Asset Allocation and Goal Planning

It all boils down as to why hard earned money is being invested in the stock market? Is it just because bank rates are going down or property rates have been stagnating? Or simply because there is a peer pressure to invest in the stock markets.

It’s more prudent to have the right asset allocation and not merely put all the eggs in one basket just because that basket seems to be very attractive. Also, when purpose of that money being invested is defined, change in price will start to affect on a much lesser scale. Suppose, Meera wants to buy a house after 10 years and her budget comes to around Rs. 80 lakhs. Then by starting with just Rs. 45 thousand per month, she will be able to reach her goal with annual return of merely 8% where she doesn’t need to take a lot of risk in the stock markets.

Such goal planning helps to stop any irrational behaviour which might emerge as markets goes through their own cycles.

Adherence to these things invariably will cause you both to miss the most exciting part of bull markets. But they’ll also make you a long-term survivor.’ said Rohit with a broad smile on his face.

– Jinay Savla


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