How to tread in today's market

In today’s market, the advice would be not to get too comfortable with excesses.
By Larissa Fernand |  03-10-17 | 
 
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Larissa Fernand is Website Editor for Morningstar.in. She would like to hear from you and welcomes your feedback.

This post initially appeared in Moneycontrol.com 

In Morgan Housel’s various writings, of which I am a great fan, he has mentioned a point which I would like to dwell upon here — Few things have as much impact on your lifetime investment returns as the decisions you make during bubbles.

Conversely, that logic can be extended to include that decisions made during a market downturn are as impactful. Note, there is no reference to good or bad. If you choose wisely, it could make you wealthy. If you choose rashly, you could lose heavily. Both are impactful.

This is how Housel puts it.

Imagine yourself in the middle of a galloping bull run. You decide to rebalance your portfolio by offloading your profitable equity holdings. That is a good rebalancing move. You will profit from your sale of equity. And you will become wealthier. On the other hand, you get caught up in the euphoria and decide to throw caution to the wind and keep buying at stretched valuations fully convinced that the market will keep rising. You are treading very precariously and letting greed egg you on. Your decision could do severe damage to your portfolio.

Let’s extend this to a bear market.

You lose if you sell out of panic and flee to fixed deposits or savings accounts. But, you could gain tremendously if you look for solid companies whose stocks are available at great bargains. Buy stocks trading way below their intrinsic worth. Sit tight. Be patient (it should take years for a revival). Not easy. As billionaire hedge fund manager David Tepper observes: “Sometimes the hardest thing to do is to do nothing.” But markets move in cycles. The inevitable rise will take place. If you bought wisely, you make a killing.

All this sounds wonderful when reading a post. Reality is different.

We all like to think we are rational. But, let the value of your investments drop by 50% and suddenly emotion gets the better of you. And all your rationality and objectivity flies in the face of traditional and fundamental stock analysis which tells you that “out of favour” is not “wrong”. If you want to be a successful stock investor, the distinction must be made.

In today’s market, the advice would be not to get too comfortable with excesses.

Here is some wisdom from world-renowned investor Seth Klarman to keep in mind.

1. The real success of an investment must not be confused with its success in the stock market.

2. A rise in the stock price does not ensure that the underlying business is doing well or that the price increase is justified by a corresponding increase in underlying value.

3. The latest trade of a stock creates a dangerous illusion that its market price approximates its true value. This mirage is especially dangerous during periods of market exuberance.

4. The value in relation to price, not price alone, must determine your investment decisions. The cheapest security in an overvalued market may still be overvalued.

5. An investment must be purchased at a discount from underlying worth. This makes it a good absolute value.

6. Being a good absolute value alone, however, is not sufficient for investors must choose only the best absolute values among those that are currently available. A stock trading at one-half of its underlying value may be attractive, but another trading at one-fourth of its worth is a better bargain. This dual discipline compounds the difficulty of the investment task for value investors compared with most others.

7. You may not want to sell believing that the market may go higher and you could lose out on those incremental gains. Nowhere does it say that investors should strive to make every last dollar of potential profit; consideration of risk must never take a backseat to return.

8. An investor who is too worried about missing out on the upside of a potential investment may be exposing himself to substantial downside risk precisely when valuation is extended. A thoughtful investment approach focuses at least as much on risk as on return. But in the moment-by-moment frenzy of the markets, all the pressure is on generating returns, risk be damned.

9. Price is perhaps the single most important criterion in sound investment decision-making. Every security or asset is a "buy" at one price, a “hold” at a higher price, and a "sell" at some still higher price. Yet most investors prefer what is performing well to what has recently lagged, often regardless of price. They prefer full buildings and trophy properties to fixer-uppers that need to be filled, even though empty or unloved buildings may be the far more compelling, and even safer, investments.

10. Most investors take comfort from calm, steadily rising markets; roiling markets can drive investor panic. But these conventional reactions are inverted. When all feels calm and prices surge, the markets may feel safe; but, in fact, they are dangerous because few investors are focusing on risk. When one feels in the pit of one's stomach the fear that accompanies plunging market prices, risk-taking becomes considerably less risky, because the risk is often priced into an asset's lower market valuation.

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SV Prasad
Oct 11 2017 02:56 PM
Decisions made during market downturns (such as to remain invested and identify and replace the ones that have relatively much less visibility of growth potential) have infact more profound impact rather than the decisions we make during good times. An insightful article..keep dwelling on such finer aspects of the investment skills for reader enlightenment
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