On doing nothing

The US government shutdown has finally ended and it was interesting to see that the S&P 500 was actually up by about 3% in October which roughly overlaps the time this circus lasted.

I was watching these events closely from an investment perspective because I have a lot more money invested in the American markets right now than I have in India. That these events didn’t affect the stock market isn’t that big a deal, but I was surprised to see that the market actually went up by 3%.

Ignoring this event and doing nothing would have been the best bet as far as I am concerned, and this is what I did. However, this made me wonder what would have happened if I hadn’t done anything at all this year?

My portfolio is down 1.5% for the year, and the S&P is up about 20% for the year so I have obviously done quite badly. It is just a small consolation that I was up 60% last year when the S&P was up about 13%.

All of my losses stem from Put options, and a simple calculation showed that I would have been up about 20% had I not traded in any Options at all.

Next, I looked at the three sales I made during the year, and found that had I continued to hold on to those shares, they would have added two percentage points to my gains. So, in all, if I hadn’t done anything I would have been up about 22% for the year.

Now, hindsight is a wonderful thing, but what lessons can I learn from this that can be practically applied.

Since I do use some sort of valuation when I buy a share – I only sell them when they seem overpriced, and in these cases it did feel that the shares were overpriced. The market says I’m wrong, but only by a little and I can live with that.

The Put Options are more interesting to me because of the allure they hold. It is easy to make money when the market is up, and everyone is doing it anyway, but making money when the market is down is far more sexier and holds a lot more appeal than going long.

It is as if the money you make by going short is more valuable than the money you make by being long and I would say that the good feeling that comes along with it certainly makes it feel like it.

The great difficulty in this is that not only do you have to be right about price, you have to be right about timing, and it is entirely useless if you get just one out of the two.

Now, the other aspect of doing nothing is not buying. I have not been buying as much as I did when there is panic in the markets and I think by and large time will show that it is the right strategy. However not doing anything is much harder than it actually sounds.

I get tempted by a new share every other week but I just bite my lip and wait. I have not completely stopped buying to hedge against the scenario where I am wrong and the markets rise a lot more before they fall.

This past year has taught me to not seek the excitement of shorts and continue to restrain myself when shares present them to me in seemingly comfortable markets because I’m sure deals will present themselves later. There is a lot of value in doing nothing, the hard part is to recognize this and then being patient about it.

Buffett’s six criteria for business acquisition

I’ve been reading all of Warren Buffett’s letter to shareholders these days, and beginning with the 1982 letter, Buffett lays out five simple criteria for buying businesses or stocks.

This appears for the next few years, and I think presents a useful guide to retail investors to evaluate stocks as well.

Here are the six points from Buffett’s ’82 letter

 

We prefer:

        (1) large purchases (at least $5 million of after-tax 
            earnings),

        (2) demonstrated consistent earning power (future 
            projections are of little interest to us, nor are 
            “turn-around” situations),

        (3) businesses earning good returns on equity while 
            employing little or no debt,

        (4) management in place (we can’t supply it),

        (5) simple businesses (if there’s lots of technology, we 
            won’t understand it),

        (6) an offering price (we don’t want to waste our time or 
            that of the seller by talking, even preliminarily, 
            about a transaction when price is unknown).

The second point is of interest to investors as a way of identifying stocks that can be potential purchases. I have bought several potential turnaround stocks in the past, and if the company actually does turn around then it is a great bet but you usually have to wait for a few years to get the benefit.
I feel that if you own a turnaround company then what you’re really looking for is for the stock to grow three or four times at least else the risk is just not worth the return.

I say this because you see a number of opportunities with companies that are making good profits and double in price when bought low enough that you don’t want to have that low an expectation with a turnaround situation.

Getting back to companies with consistent earning power, you can look at the past record of the company for a number of years and see if the revenues, cash flows, and profits have increased or not, and that can be an easy indicator to shortlist the stocks you can further screen to invest in.

The second part of the statement about debt is also a good parameter. I usually look at that number quite closely and am elated to find a company that has zero long term debt, or has as much cash as it has debt. That’s another parameter you can look at after you have identified a company with steady earnings.

Point number 6 about an offering price is also very good. For a long term investor who views stock purchases as stake in business, you want to ensure that the price you’re paying for that stake is a fair price for what the company is earning.

For people who are not well versed with accounting concepts, this can become overwhelming but I think everyone can look at two numbers very easily and build on them. You can look at the market capitalization of a company and their current profits, and ask yourself will you pay that much money to buy the whole company to get about this much profit every year. This will eliminate many companies because they are priced high. But when you do find some that look priced reasonably, you can then look at the cash flows of the company to further analyze the company and determine is it a fair price or not.

SIPs are a small step in the ladder

I’ve been busier than usual for the past few days and I’ve only been able to look at headlines and glance at my portfolio from time to time.

I looked at my portfolio today and saw that iShares S&P India Nifty 50 Index Fund which is a Nifty based ETF that trades on the NASDAQ, and was down about 5% a month and a half ago is up 10% today. As much as I like to say that it is the nature of the markets to surprise you, and you should always expect this — I was really surprised to see this move.

Nifty itself hasn’t moved as much during this time period, and it is the appreciation of the Rupee along with the Nifty that has brought about this quick positive up-move.

The last time I bought iShares S&P India Nifty 50 was on August 27th of this year, and at that time the dominating thought in my mind was how much should this fall further to warrant more purchase? I couldn’t imagine at that time, and this is not too long ago that the ETF will be up so much in just a matter of days. I bought this with the intention of holding it for a long time so it didn’t matter if it was up or down in a few days.

This is what I had tweeted then.

 

If you follow me on Twitter, you can pretty much see that there is a very simple pattern I follow. Buy when the market falls and sell when it rises. The buying is usually a lot more than selling because I usually buy in installments but sell in one lot.

This strategy has worked well for me since a number of years, and I was wondering today why this simple plan is not part of mainstream advice, and why it comes across as market timing which most people absolutely abhor.

For any long term investor who views buying stocks as buying businesses (a la Buffett) – why is price not a factor while making a purchase?

I like the concept of SIPs (Systematic Investment Plans) to the extent that I feel that they save people from themselves by enforcing discipline on them and not selling in panic, but this can’t be the final stage of how you view and invest in equity.

If you invest in shares at all, and it is quite understandable if you don’t, then the ultimate goal should be to reach a place emotionally where you can have the courage to buy more when the market falls and sell off when you see euphoria in the market.

This is of course very hard as I know from personal experience and not many people are able to do it. That is perhaps the reason why not many people write about it and it is nowhere close to the mainstream idea on equity investment.

If you have SIPs then I’d suggest giving this a try. For anyone beginning, I think an easy way would be to save some money specially with this purpose, just let it lie in a savings account which can be easily accessed by you, and identify some stocks and mutual funds that you would like to invest in. Then when you hear panicked stories on the news, and read about doom and gloom in the papers, use that money to buy stocks.

You risk the money you invest, but the return can be learning a very profitable process that will continue to reward you throughout your life.

Some good news at last

I read the new RBI governor’s speech twice today because quite frankly I wasn’t able to grasp all the things he had announced at the first read.

This is quite amazing because it covers an incredible amount of ground, and takes a very liberal, progressive and long term view of the economy – something that we haven’t seen for a while. The speech can be found on this link and Business Standard has a good summary of the announcements that can be found here.

My first idea was to write about some things that would impact a regular person directly like the CPI linked bonds he spoke about, but that is simply taking too narrow a view. In this particular case, the steps that don’t directly impact you or the steps that are longer term in nature like building individual credit histories (not a new idea) are likely to impact you a lot more than any purchase of CPI linked bonds.

What Dr. Raghuram Rajan showed today was how RBI can take several small steps to liberalize the economy, instead of fixating over the Repo rate or conducting strange operations to drain liquidity which have terrible unintended consequences.

The Rupee and the market both gained today and normally I hate ascribing any market moves to an event, the speech quite clearly did the trick today, and I myself am feeling a little positive after a very long period.

I realize that there is a lot of difference between a speech and executing these steps, but if you don’t have a plan to execute then you there is no hope of execution. In this case there is a plan and let’s all hope that the RBI stays on course.

As I was reading through the speech, I came across the part where Dr. Rajan said these were his plans for the “short term time table” for the RBI, and I thought to myself, wow if this is really short term, I can’t wait to see what long term is like.

On Market Fluctuations

Yesterday was an extremely volatile day at the markets, and while I often remind myself that it is the nature of markets to surprise you, I can never fully take that advice myself, and am always surprised by some of these crazy movements.

I don’t think there was a single person who could have predicted the 400 point up-move that took place yesterday, and while surprising in its own right, it is no more surprising than what the market has consistently done since it existed.

I’m currently reading all of Warren Buffett’s letters to shareholders in a sequence, and I just happened to read the ’87 letter today, which had this great bit of advice about fluctuations in it.

Ben Graham, my friend and teacher, long ago described the 
mental attitude toward market fluctuations that I believe to be 
most conducive to investment success.  He said that you should 
imagine market quotations as coming from a remarkably 
accommodating fellow named Mr. Market who is your partner in a 
private business.  Without fail, Mr. Market appears daily and 
names a price at which he will either buy your interest or sell 
you his. 

     Even though the business that the two of you own may have 
economic characteristics that are stable, Mr. Market's quotations 
will be anything but.  For, sad to say, the poor fellow has 
incurable emotional problems.  At times he feels euphoric and can 
see only the favorable factors affecting the business.  When in 
that mood, he names a very high buy-sell price because he fears 
that you will snap up his interest and rob him of imminent gains.  
At other times he is depressed and can see nothing but trouble 
ahead for both the business and the world.  On these occasions he 
will name a very low price, since he is terrified that you will 
unload your interest on him. 

     Mr. Market has another endearing characteristic: He doesn't 
mind being ignored.  If his quotation is uninteresting to you 
today, he will be back with a new one tomorrow.  Transactions are 
strictly at your option.  Under these conditions, the more manic-
depressive his behavior, the better for you. 

     But, like Cinderella at the ball, you must heed one warning 
or everything will turn into pumpkins and mice: Mr. Market is 
there to serve you, not to guide you.  It is his pocketbook, not 
his wisdom, that you will find useful.  If he shows up some day 
in a particularly foolish mood, you are free to either ignore him 
or to take advantage of him, but it will be disastrous if you 
fall under his influence.  Indeed, if you aren't certain that you 
understand and can value your business far better than Mr. 
Market, you don't belong in the game.  As they say in poker, "If 
you've been in the game 30 minutes and you don't know who the 
patsy is, you're the patsy."

I’ve been buying stocks myself during the past few days and will continue to buy them in the coming days and add more with every little crash, and it is useful to keep these things in mind.

This is a useful reminder as the most recent quarterly results are not exactly sanguine but not very depressing either. If I can hold on to my shares for a very long period of time, then if nothing else, inflation would help boost nominal values.

A time to disinvest?

Rupee has been in a free fall for quite some time now and the government and RBI reaction to the daily price movement is far more frustrating than the Rupee fall itself.

From banning TV imports to squeezing out liquidity – the authorities have not taken a single step to address the structural problems that exist in the economy.

The stock market is also in a free fall since the past few days, and disinvestment is the last thing on anyone’s mind right now. Like most other things, disinvestment has been a total failure in the past few years not just for the money it raised but also because of the nature of divestments that the government has done so far.

Because of the deficit situation the focus on disinvestment has become getting the most money out of share sales, and somehow privatization has been completely forgotten.

If you look at the coal situation, and not even think about Coalgate, even then the whole environment is completely ridiculous.You have a monopoly in Coal India that is the world’s largest producer of coal but the demand is such that India imports massive amounts of coal and these imports have grown this year draining the forex reserves. Why should there be a government monopoly in coal production, and would there ever be a good time to disinvest? Isn’t it better to let private players take charge and have many companies operating in this important sector?

Perhaps the government is not ready to disinvest or privatize big stakes in companies like Coal India but what about companies like Scooters India? Why does the government need to be involved in manufacturing three wheelers and isn’t it better privatize such companies to raise cash instead of creating funds to help sick PSU – it’s not like the government is flush with cash anyway.

No one wants to talk about disinvestment or privatization right now, but a few steps in the direction of privatization and showing that the government is getting out of business will send positive signals, and will be better than increasing import duties on televisions.

Plan for a second stream of income before retirement

Vivek posted the following question on the Suggest a Topic page the other day:

Vivek August 19, 2013 at 3:31 pm

One interesting post would be as an advice to a lot of folks in their 30s to 40s on how to create a secure second income through safe investments so that they can quit their jobs and attempt to chase their passion / dreams or do a startup commercial venture. This is technically not retirement (as most retirement plans tend to be) but more of temporary suspension of income and how it can be offset in the most efficient way.

This is an interesting topic and is something that I’ve given some thought to myself. I won’t restrict myself to the question about the second stream of income, but share some things about this topic that people who have taken this course have told me about, and I feel are important as well.

You need to save to invest

Let’s start with the basics, which I find is hard for a lot of people to do. If you have credit card payments due or have a big car loan or home loan that has an installment due every month then you are probably not saving very much money. If you aren’t saving a lot of money then you can’t invest anything to create a second stream of income in the first place.

You can only save money when your expenses are low, so I believe low expenses are the foundation of this attempt.

Not all earned money is equal

Since we are so used to paying taxes, often we don’t realize how big of a piece the government actually takes. So when you save money that’s actually worth a lot more than making that much extra money in salary because you don’t pay taxes on savings.

Similarly taxes on mutual fund capital gains and FMPs are less than the marginal rate so any income you get from that source is worth a lot more than your salary.

Lastly, when you do a calculation of how much your startup income should be to replace your salary income, consider your take home pay, and not your gross salary. From your take home pay deduct your savings, and usually this should be a comforting number because it is a lot less than simply dividing your gross salary by 12 and hoping your new enterprise makes that much in the very first year itself.

Be prepared to dip into your savings

I don’t think it is practical to think that you can save enough to completely replace your salary at such a young age so if you want to take a sabbatical of sorts to try out your hand in a new venture then be prepared to dip in your savings.

This means that some part (a significant one I would imagine) of your money is invested in assets that you can liquidate easily. If you are invested in FMPs, infrastructure bonds, PPF, NSCs or any other investment which has a long gestation period then you have to ensure that you have other assets that allow you to liquidate them if you need money. Here, you have to remember what instruments truly have a lock in period. Most tax free bonds have a 10 or 15 year time frame for redemption but they trade on the market so if you needed the money you could sell them off fairly easily.

Tax free and tax saving instruments

Don’t invest a lot in tax free or tax saving instruments. For example, tax free bonds are a great source of tax free income when you are in the 30% tax bracket but you don’t need that if you aren’t going to be hitting that level every year, so you don’t need to give up compounding for that (tax free bonds pay out yearly interest that you can’t reinvest in the same thing). A fixed deposit that compounds and reinvests might be a much better option.

Equity investments

Due to the volatile nature of Indian equities, they can make for a great investment if you take advantage of the crashes and stick to an investment plan. Although your first instinct would be to avoid such a volatile investment option since you need money in a medium to short run, I think it is best to have exposure to equities even with this type of a need.

Work part time before you quit completely

I have a few friends who have taken the entrepreneurial route and it is a mix of people who just left their jobs as well as people who worked part time, made some money on the side and then quit their jobs. It’s not always possible to work part time on the side but wherever possible that is definitely the better option. You get to experiment with what you are doing without risking a lot and you get a fair sense of whether it will work or not and then the plunge full time is a lot less stressful. That you already have cash coming in is a tremendously huge plus.

Conclusion

I feel a good strategy to approach this situation is to save a lot of money, make sure your credit cards are zero and you don’t have any other big EMIs due every month and then invest the rest in medium term instruments that have good liquidity and generate a decent return. There are not many instruments that fit this bill and a mix of dynamic bond funds, equity mutual funds and the good old fixed deposits will help you go a long way in achieving this.

Finally, I know a lot of readers fit this bill as well, and I would request them to leave comments here and share their insights on how they managed money when they switched from full time employment to their own venture.

Thoughts on Current Indian Equity Environment

Indian stocks have done terribly in the past few years, and the only people who are up on their equity investments are those who have invested in stocks heavily during market crashes, or the ones who added money to their SIPs during the crashes. Other than that everyone has had negative returns on their stocks.

The government and RBI announces one terrible policy after the other relentlessly, and the people pay the price for these by literally paying higher prices for everything they buy.

There is no indication that these terrible policies are going to change any time soon. No matter what coalition comes to power next year, there is simply no party that truly believes in liberalization, and economic reform.

What then should someone who invests in the stock market do?

Selling off shares in such a time is disastrous because they are already down a lot from where you would have bought it and you don’t want to sell them all at a loss. Buying more is increasingly difficult because of the painful feeling of watching your recent purchases go down 4 or 5 % in a week.

What then should give someone confidence to buy more shares or just stop from selling their existing holding?

The first thing that I remind myself during these times is that every time the market falls like this – you start feeling that this time the game is definitely over, and all hell will break lose now. The 2008 crisis always comes to mind because not only did it feel like Indian economy will reel for a long time, it felt like the whole world will be like that for a long time to come.

The second thing to remember is that it always feels like a lot worse than it actually is. In real time it is hard to be objective about what has been going around you. If at the beginning of the year – you would have asked me what I would say if the market were down 7% half way through the year – I would have probably laughed – what’s there to say? Come back if the market falls that much in one day. But that’s more or less where we are today but somehow it “feels” a lot worse than that.

Take a look at the yearly returns for the past few years and 2013 till date yourself.

Nifty Annual Returns

For me, the main takeaway from the chart above is the need to remain invested in the market. I’ve heard several people say that they will start investing when the market situation improves, and they want to wait for the bottom to hit or the uncertainty to subside, but guess what – you will never know when the bottom was hit, and there will always be uncertainty around you. It just doesn’t work that way.

As long as you are diversified – you don’t have all your eggs in the equity basket, and you’re in it for the long haul you should be able to go through these tough times and then book profits when the going is good.

Why Good News for US Economy is a Bad News for Indian Economy, Indian Rupee & Indian Markets?

This post is written by Shiv Kukreja, who is a Certified Financial Planner and runs a financial planning firm, Ojas Capital in Delhi/NCR. He can be reached at skukreja@investitude.co.in

US economy is recovering fast and probably faster than most of the analysts had expected a few months back. Earlier these analysts had a view that though the US economy is recovering, the recovery would be fragile till the time the employment situation improves. The US Bureau of Labor Statistics on friday released the Non-Farm Payroll numbers and the numbers were extremely good. After adding 195,000 jobs in May, this number got released at 195,000 again for June. So, is the US economic growth back on track and if yes, why is it bad for the emerging markets including India?

The immediate effect of this strong uptick in the US jobs growth is that the US Dollar has further strengthened and US bond yields have risen substantially in an anticipation of a further strengthening of US growth in the near future. The 10-year US treasury bond yield jumped 9.42% on friday itself, from 2.50% to 2.74%. This is a very steep rise in a single day. If we look at the yield movement since May 1, 2013, it has risen from 1.62% to 2.74%, a rapid jump of 68% in just over two months.

1-Year Chart of US 10-year Govt. Treasury Bond Yield

Source: Bloomberg.com

Earlier in June, the US Federal Reserve announced its intention to start tapering quantitative easing (QE) and thereby cut back on its unprecedented asset purchases. This mere announcement of a possible gradual withdrawal of quantitative easing sent all the major international financial markets into a tizzy, as it made the institutional investors sell their holdings quite heavily in almost all the markets, especially in emerging markets like India, massively increase their cash holdings and rethink their investment strategies and asset allocation region-wise.

Foreign Institutional Investors (FIIs), who had pumped in a huge amount of money into the Indian markets till May 2013 this year, pulled out heavily from the Indian debt markets and equity markets in June, to the tune of $5.68 billion and $1.85 billion respectively. This huge pullout by FIIs, good prospects of US economic growth, strengthening of USD, no relief from the bad GDP growth numbers & deficit numbers here in India etc., all have resulted in a steep fall in the value of Indian rupee and hardening of bond yields.

After hitting a low of 7.09% immediately after its auction in May, the 10-year 7.16% benchmark govt. bond yield has risen quite swiftly to 7.49% by friday. With the US non-farm payroll numbers announced on friday, the yield is expected to rise further here in monday’s trading. Similarly, the rupee is expected to cross 61 level mark against the US dollar on monday.

With the yields moving higher and the rupee getting weaker, the case for the RBI to cut interest rates has got very weak. So much weak that some of the analysts have started issuing reports predicting the inflation to take a U-turn once again and the RBI to raise its policy rates to stem the rupee fall and contain prices of imported goods. It is again going to put a lot of pressure on some of the struggling debt-heavy manufacturing companies.

So, at a time when Indian economy badly requires foreign money inflows to bridge their current account deficit and to strengthen the falling Indian currency, there is a big threat that the FIIs are thinking otherwise. FIIs are ready to move their money back to the US debt and equity markets at the slightest of signs of US growth getting stronger and Indian growth not moving out of the mire.

So, what should the Indian investors do in the current situation? – I think the declining trend in India’s economic fundamentals should take a U-turn very soon, probably in the next few days or few weeks. Indian govt bond yields, which had fallen down quite sharply in May, have risen with a similar intensity in June and should top out sometime this week from a short-term perspective. The investors, who are sitting on the sidelines to invest in the gilt funds or income funds to make money due to interest rate fall, should put a certain percentage of their investible surplus into these funds sometime this week itself.

Though not easily visible, some of the Indian economic fundamentals have also started improving. As the US growth returning back to some normal levels is a good news for the global economies including Indian economy in the long-term, I expect the equity markets also to do well from medium-term to long-term perspective. The investors are advised to go stock specific and do a thorough research before committing their hard-earned money to any of the stocks. Probably I am sounding too optimistic on the Indian markets than the actual picture at the ground level, but only the investors, who invest in markets in advance before they actually make a turnaround, make good money in these markets.

REITs in India

REIT stands for Real Estate Investment Trust and is a type of a mutual fund. REITs are fairly common in the US and while SEBI had a proposal to allow them in India a few years ago, not much progress has been made since then.

Just like any other mutual fund – the REIT operators will get the money from the public and then invest it in real estate with the primary motive of earning income on it. In the US, they have to distribute most of their income as dividends and that would probably be how they work in India as well.

In an American context, this works great because the interest on fixed deposits is zero, and rental yield is decent but India is very different from the US in that way. Here the rental yields are low, and the fixed deposit rates are high so a REIT’s appeal will be more by way of capital gains than yields.

Right now, those who can afford it — buy houses with the hope of capital appreciation, and they don’t care about rental incomes at all. I would imagine that if REITs were traded in India then the same will be true for those also.

People who buy REITs will be interested in capital appreciation rather than looking for any type of yield or steady income.

I think the idea behind allowing REITs in India is to get money flowing in real estate and getting real estate developed with this money so that the demand and supply gap is bridged.

However, I think the gap is not so much because there is shortage of money but because of other administrative problems like land acquisition and clearances so to that extent the introduction of REITs may not help with that.

There was some hope that there will be something about REITs in the budget this year but there wasn’t and I haven’t read anything else that suggests that it is likely to materialize in the near future.

If there is something, I’ll do another post with the details of regulation and how they are likely to function, but I honestly don’t feel that they will have a lot of utility in India.

This post was from the Suggest a Topic page.