Wednesday, March 31, 2010

Hard Wired Traders?


There is some good news on the trading horizon. At last, you have a way to literally shock your brain into doing the right thing. All traders have known for ages what the right thing is; take your losses, sit on your profits, so on and so forth; but succumb to temptation.

New research indicates that "maturity" (or lack thereof) of the pre-frontal cortex is to blame for people falling to temptation (try this Yahoo link for the full story). This has fairly strong implications for people who want to become active traders or investors. It is no longer a matter of following some standard advice on 'taking your losses'. It boils down to whether you are wired or not for taking the high pressure situations this profession puts you into.

Ability to delay gratification or to withstand temptation is a core measure of maturity of a person. The trait is valuable across the board. It is the best predictor of future success at an early age. It can determine whether you live a healthy, well adjusted life or will indulge in self-destructive behavior. It is at the heart of decisions like whether to get up early in the morning to exercise, give up that next drink so that you can drive home safely or give up the dessert after dinner despite being presented with truly sinful but delicious option. It also has implications like whether you will diligently plan your finances or will run budget-busting credit card bills. But nowhere is this more visible than in investing and financial markets.

Trading and investing (I do not necessarily differentiate between the two, it is just the time horizon that separates a trade from an investment) definitely requires an ability to give up short term pleasure, even bear extreme pain (remember the last stop-loss that you took?) for long term gain. From start to finish, trading is all about sticking to the discipline of doing the right thing.

This advice has sounded very easy to follow. But real world stands testimony to how difficult it is to practice. Barely 1% of traders are profitable in the long run. The usual explanation for this has been 'trading talent', but it has remained elusive what this talent is all about. How do you differentiate who will be a good trader and who will wilt under the temptation of letting that loss-making trade run just a little bit longer in hope of salvaging something?

Surely, trading involves a lot more than just brutally enforcing your stop losses. It requires diligent research, a sharp and keen mind and a great run of luck. Still, some of us could use just a little bit more of that discipline to make the difference.

So where does this lead us? Shall we all wrap electrodes around our heads and start "stimulating" the correct regions of the brain? May be not so fast. More on that later.

Tuesday, March 30, 2010

A Strong Sense of Entitlement, or Something Else?


Last week, there were two very interesting headlines Times of India's Delhi Edition had on its front page (of course, hidden behind the annoying half page of advertisement that simply kills the pleasure of picking up a paper in the morning). The first one was on the fire in a building in Kolkata. The story writer ranted on 'unapproved additions to the building', lack of safety norms and so on. The conclusion was that the civic authorities had failed completely in their duty.

This is not interesting on its own. The interesting part was the second story. Again, the writer ranted on cancellation of day one of fashion week in Delhi. The arguments were on the lines of authorities having been informed sufficiently in advance, people waiting in queue, authorities not getting their act together, etc. Buried somewhere in the story was the fact that the organizers were not able to meet all safety guidelines and that delayed approval.

So there you are. As a society, we are heading to a situation where we cannot tolerate even a minor disruption of what we want to have. We want our gratification, right away. Somebody else owes it to us and we will shamelessly lash out even when we are at fault for delay.

That attitude kills an investor or a trader more than anything else. In this game, there is nothing worse than getting into the ring (figuratively, now that everything is electronic) with a strong sense that the market owes it to you. Even a small dose of this poison can do irreparable harm to portfolios carefully nurtured over long periods of time.

For a trader, it is even more dangerous. You cannot blame market analysts, policy makers, the government, media or anyone for anything. The trader has to take responsibility for all that happens to her position. The trader cannot blame even the tools, so what if a tested technical pattern did not hold out on a particular day and you lose money? The market does not owe you anything, nor do Mr. Head and Shoulder, Mr. Double Bottom or Ms. Third Wave.

Why am I writing all this? Because after years of reminding ourselves over and over again, there still is a day when the stop losses get hit and we just cannot help cursing that analyst whose 'advice' provided that extra bit of justification needed for putting on a trade. You can laugh at them, berate them or otherwise disagree; but you cannot blame them. The blame lies squarely with you, the Trader.

Monday, March 29, 2010

Waiting for the Breakthrough


The market is stuck at a strong barrier, the strong resistance of getting past a previous high in the recent past. The general prediction in the market seems to be that the resistance is too strong and this is the time to take profits. Is it really?

Let us consider the pure momentum argument. This market has had a lot thrown at it over past one month. High inflation in India, tightening stance by RBI, possibly higher interest rates, international risks (e.g., possible Greek meltdown) and so on. The result? The market barely blinked.

On top of that, we have had a sizeable portion of the market yelling that the market is ripe for a break and it is time to take profits. Still, the market has refused to break down.

Instead, the market has spent considerable time getting consolidated in each "resistance" range. And then breakouts have happened, very quick movement and then you get stuck again at the next "resistance".

All this means only one thing, the "resistance" is the last stand of the bearish crowd who have made tons of money in the past taking similar positions and are waiting for another repeat of the "same old thing".

I do not know whether this "repeat" will happen or the market will break through this time. I am completely agnostic to either. But given the strong amount of resistance at the moment, any break from here is going to probably pause only once (may be 5500?) before the last barrier is broken and the floodgates open. Once that happens, this market might not stop before revisiting its all time highs. Who knows?

Friday, March 12, 2010

Who is right?


Globally, things are in a flux. There seems to be some consensus that the economy is on the path to recovery. Still, global economy is going through a lackluster phase and the net data flow is neutral at best. This is perhaps the best time to observe what predictions people make and how those predictions pan out (and most of them will end up doing something pretty "rude" to themselves, that is an almost foregone conclusion).

As usual, when things are finely balanced, opinion gets split in the middle. With one half seeing catastrophe ahead and the other seeing recovery, where does the market end up? The most likely answer is 'nowhere'. Performance gets lackluster and things do not look like moving. Rangebound movement is usually the result and whipsaw is frequent. But what is the prognosis?

For a trader, the best thing to do is to admit that no one knows a damn thing about the future at such a juncture. That includes the trader himself/herself. It is like driving blindfolded and is probably the most interesting (though very bank-balance destroying) trading experience.

Some things can work. Including running very tight stop losses and trading ranges. Some things cannot, as this is the worst possible time for trend followers. As the trend in the global market will take some time to emerge, there is some time for money for trend followers to show up.

The implications for Indian market are clear. Any sustained upmove in the interim period is going to be amplified by global funds as people chase higher returns. Also to be expected is a higher churn as money moves due to the shifting sectoral share in growth. While currently the Indian market is also very dull, this clarity will start dawning sooner rather than later and an amplified move can be seen emerging any time over next month or month and a half.

Good time for people who believe in accumulating stock slowly and make good money in a sustained upmove.

But keep one thing in mind; no one knows.

Thursday, March 11, 2010

What not to touch in the markets?


While the market has started moving in a direction that looks more positive, there are several danger signs that need to be watched out for. Also, many sectors in the economy are going to put in a lackluster performance and some are secular laggards over next few years. Here is the list of things that you need to avoid in the coming one year.

  • FMCG. All said and done, where is the growth for the sector? The only answer to that is the rural market. The food component of the business will continue to grow as the economy accelerates but the rest is not likely to grow too fast. How many soaps can you consume in a day? How much extra can you get from the same consumer for the same set of products? What do you do about the low cost competition from the unorganized sector? These are the questions that made FMCG a big underperformer in the previous bull run. Nothing has changed now to make it an outperformer.
  • PSUs. Other than infrastructure and perhaps banking, there isn't any sector where PSUs provide a superior growth story versus the private sector counterparts.
  • IT and BPO. Regardless of what people thought, reality is that a recession in the west is not a dampener for most of outsourcing related work. As firms seek to cut costs, there is countercyclical force in favor of outsourcing based businesses that dampens the effect. Now the situation has changed with anti-outsourcing sentiment as strong as ever, pressure to outsource ebbing and a currency that is strengthening; the attractiveness of the sector would be at an all time low; no matter how many "signature deals" you see. It is no longer a "growth industry". You are looking at a mature industry with moderate growth rates and valuations it deserves are more like FMCG and less like renewable energy.
  • Retail. The model that fueled runaway growth has failed. Period. Like the internet boom of early this decade, the industry is going to be around, just not in the same shape with the same value proposition. Rejigging the model takes time. So watch out for retail's comeback, only not in 2010.
  • Textiles, garments and other also rans. With the policy dice heavily loaded against this sector; little hope of a comeback. A real pity though, this is the sector with highest employment generation potential with just a little amount of training (unlike software that takes years of education). No wonder every developing country has this sector on top priority. But Indians do things just differently…

Avoiding these sectors is important for the health of the portfolio. But a winning strategy takes more than just a list of stocks to buy and to avoid. More on this later.

Monday, March 8, 2010

Time for a Secular Bull Run? Part - III


The theme for past one year has been dominated by consumption growth (led by rural demand) and resumption of the commodity cycle. Metals were poised to gain the maximum from this theme. So were two wheelers, telecom and other consumption led sectors.

This part of growth story is not going to be as strong for next two months. The effects of bad monsoon will take some time to clear up. The disposable income delivery by the agri-sector would have happened in 4QFY10. The sector has turned out to be weak and the resulting impact on disposable income will dampen demand from this sector.

At the same time, the changing fundamentals of the economy are likely to kick-in over next 12 months. I want to caution that all the positives we have identified are slow acting and none of them is going to deliver a sharp jump up in the markets. Still, a slightly positive bias is likely to rule for next 12 months.

Which sectors are likely to lead the charge over next 12 months? There are quite a few, which provides very good diversification options to investors and traders alike (though traders will need to trade with a longer time horizon than usual to gain from this).

  • Banking. Favorite whipping boy of the bear runs, will likely get back in the forefront over next 12 months. Several positives, stable interest rates will not steal the wind from bond portfolio sails, rising credit offtake (particularly from housing sector), lower threat of bad loans to name the few. Some banking stocks are a "must own" in any balanced portfolio.
  • Real Estate. Finally out of the woods, the sector is likely to limp back to its footing over next few months. The recent withdrawal of "teaser rates" is actually a vote of confidence in the sector by the anxious bankers. They no longer feel the need to offer sops to borrowers (a "not so important/risky" set of customers) to make sure the riskier and more lucrative set (builders) stay solvent and afloat. Back to the times of rising greed and runaway prices?
  • Capital Goods. Must own over next 12 months. Like it or not, capacity expansion theme is here to stay. Last 18 months have seen capacity expansion disappear as "captains" of industry turned into anxiety–ridden wimps. Now that the scare is over, sooner or later, everyone is going to get the scare on the other side: "we are not poised for growth anymore".
  • Auto: Mildly positive. Caution needs to be exercised, with an eye on next monsoon. If it turns out to be good, two-wheelers will gain only at the fag end as rural income growth comes back.
  • Media: As confidence goes up, the lifeblood of the sector, AdEx, should also start rising.
  • Infrastructure and related (cement, etc.): Make no mistake about it, India is so starved of infrastructure today, any project is likely to make money. One of the best bets if you want safe, assured returns as a big ticket investor. The only question is, can the government get out of the way fast enough?

Along with these sectors, there are some that need to be kept at a distance. A note of caution, since they are not likely to do much over next 12 months does not mean they are easy shorts. Instead, they are more likely to be lackluster, yielding gains to neither bulls nor bears. A detailed look at some of them tomorrow.

Friday, March 5, 2010

Time for a Secular Bull Run? Part - II


The consolidation mode markets went into over past few months has hidden a major shift in underlying fundamentals of the economy. A number of things have happened in this period.

  • Fiscal profligacy has come down. All said and done, the government did not fall for unlimited stimulus. I suspect a strong underlying theme would have been food inflation. Whatever the reason, a very wise decision.
  • Economy is recovering, though not out of the woods yet. Still, recovery sans major fiscal stimulus flowing into the economy is impressive and means that the economy can grow from here.
  • Liquidity. Helped in no small part by forex inflows. Government borrowing has also not gone to the level of crowding out everything else. Bond yields, as a result, have stabilized and are likely to either stay there or slowly tick down from there.

There are several negatives also, though it is better to view them as leading a 'shift' rather than pure negatives.

  • Failed monsoon. The impact will linger for some time. For past one year, the economy has grown on the back of a strong rural consumption story (as I continuously pointed out in my posts exactly one year ago) and negative growth in agriculture puts a spanner in that. While things should recover, rural disposable incomes will stay depressed for next six months. That shifts the focus away from consumption theme for next six months.
  • Low capex. A worrying trend has been the low capacity addition in the economy. It means current growth is the result of higher capacity utilization instead of capacity creation. Does not bode well for medium term growth.
  • High interest rates. Will take some time to come down. They are high despite good liquidity in the system and a stable sentiment. Which means any reduction in rates will be based on a slow, gradual reduction in the proportion of governments borrowings in total debt in the market.

The interesting part is that none of this makes for a drastic rise or fall in the stock markets or the fortunes of the economy. Instead, this makes for a slow and steady movement where things improve (or deteriorate) slowly.

This does not do any good to the rampant bull (or bear). At the same time, it makes for a steady secular slightly bullish market in the medium term where interest rates are either stable or slowly ticking down, economy is growing, liquidity is comfortable and consumption gradually improves as agriculture/capital goods sector gets out of the woods and capacity addition resumes.

My last year's picks, metals, auto in general and two-wheelers in particular, telecom, etc., turned out to be exactly the right picks for the market. But the changed market requires a complete reassessment of which sectors to be in. That analysis follows.

Thursday, March 4, 2010

Time for a Secular Bull Run? Part - I


We have had an extended sideways trade going on in the Indian stock market for some time. While I did anticipate December and possibly January to be a slow month, the market just continued to be dull for longer than anyone had anticipated. In hindsight, it looks just logical for it to have been like this.

On the surface, it looks like the market was waiting for the budget to come out and the fiscal stance of the government to be clearer. And it also looks like that the budget provided some clarity that has seen the market attempt to break out of the long held trading range.

In reality, the doldrums stem from another factor. It is now clear that the government started the task of fiscal consolidation long before the budget. It shows in the expenditure numbers and fiscal deficit estimates. It probably won't do much good for advocates of "stimulus" who have been clamoring for more. But it does a lot of good for the long term health of the economy.

There lies the bind the market has been in. The economy has been growing all the while when government spending has been in check. Tax level sops will probably continue for some more time to come, but low spending means there is very little "real stimulus" flowing into the economy. So there you are, the recovery is definitely there, though not on a sure footing yet. That would keep the markets from tanking outright. On the other side, there is very little "push" coming from the fiscal side. That would prevent a massive upmove also till the time things stay unclear.

The budget has brought a lot of clarity indeed, from the macro numbers point of view. It is now clear that fiscal deficit is not expanding as rapidly as some of the market participants have been factoring in. With disinvestment proceeds and 3G auction money flowing in, the need for the government borrowing drops drastically in the coming year. The government being committed to an aggressive debt-to-GDP ratio target in the medium term also points to reduced borrowings in the market.

This changes the dynamics underlying the market for a number of reasons. Working out the new market drivers for next one year would be essential for making money in the next one year. A detailed analysis follows in the next post.

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