Dr CKN's Blog

BITE THE BULLET
Or, why we should take a loss and move on.                        

In trading there is a maxim that says “The first loss is the best loss”. I didn’t think the day would come when this maxim would start become applicable to investments too. But that is what happened today. Well, you learn something new everyday in the market!

On Monday 25 Feb, we saw something exceptional happen. A stock like Core Education fell an astounding 70% in a single session! This was of course accompanied by a score of other stocks declining variously between a 5 and 20%. This really makes you wonder whether the fundamentals shown by companies like these (and who knows how many more?) are really of any value. Core, for example, has declared net profits of 111, 225 and 323 cr as net profit for the last three years. This sets up an EPS of 56,103 and 143 for the past three years on equity of 22 cr.  Now, which normal investor would not get impressed with those kind of numbers. After all, this is what most investors look at. They don’t have any access to managements but go by published information.

What value of these numbers to someone who has been pretty sanguine about his holding in this stock, content that it is steady around 300 levels. And then, wham! It is down to 100 in a single session. The back is broken in such cases. Not that Core is a stranger to such moves. This is the third such occasion when the stock has dropped at such stomach-churning rates. The other stocks are not too different from Core. Most of them report great numbers and have been holding steady or rising over time. But try telling that to someone who was holding it as of yesterday evening!

Pledged share unloading is said to be one of the reasons behind this decline. This has happened several occasions in recent times. This issue of pledged shares has become a menace to investors these days. No company is safe it seems, from the devastating hit that such sales create on the price trends of the stocks. Just look at the fate of Glodyne or Parekh Alum or Bilpower etc. They have all been totally unable to get up even a bit ever since the death blow was effected. It is quite probable that the same fate may befall some of the names that set off into declines today.

The best way to deal with these stocks is to simply abandon. At market rates. Don’t bother with any pullback. Don’t rationalize or justify holding it. Don’t procrastinate the decision to exit in toto from these stocks. OK, some of them may not wilt as badly. But can you really afford to take the chance? On the first day of selling, Glodyne dropped to 220. Today it is 17. That about tells the story for those who delayed selling!

Market and life is too big to mourn these kinds of mischiefs. They are a part and parcel of the game. If we got caught in them, somewhere along the way, our audit process was not good enough. The fault is our own. Accept. Take the loss. And move on.

People look at the index and feel that all must be well with the market. After all, the index is back trading near the all-time highs and hence a bull market must be in progress, is their line of thinking. But the facts remain otherwise. The associated elements of the market are actually suggesting that we may quite be at the opposite end of a trend!

Data indicates that over the past many months, investors have continuously exited from their equity schemes and moved money either away from the mutual funds or into other fixed return type schemes. Fresh inflows into funds are next to nil. I read somewhere that it is for the first time in many years that the mutual fund industry’s AUM has actually shrunk this year! Now that doesn’t sound like a bull market does it?

Data indicates that brokerage houses have been shutting down franchises and branches all across the country. The reduction is said to be pretty drastic at some brokerage houses. Alongside, brokerage rates continue to hit the skids and now are reaching levels where terminals are being given out ‘on rent’. Traders and investors, on their part, are smelling blood and pushing for even lower rates. High cost business verticals like Institution broking are shutting down. None of these are bull market indicators.

Data indicates that traders are slowly dropping off because of lack of success. There is nothing new about traders losing money- that is an old story. But drop in volumes is noticeable and shrinkage in the volatility is palpable. There is nothing that kills a trading environment like a drop in volatility. Small range volatility kills traders trying to play for a trend. Absence of follow thru action on trend signals kills momentum players. High valuations prevent longer term investors from turning aggressive. Without a larger time frame player stepping in, shorter time frame players cannot make money. So, the volumes dwindle and keep dwindling as interest slowly evaporates.  This is not a bull market scenario.

Data indicates that Index option and futures open interest is moving overseas. SGX reports a value that is almost three times the value of the open interest at the NSE! Obviously, when profit making becomes difficult, cost cutting will happen. But this shift has a big effect on our local markets and drop in IV has led to the Vix trading down into multi year lows. Option traders are therefore being forced to move towards the more risky stock options area (risky because of lack of volumes and consistency of participation). In bull markets people are searching enthusiastically for new areas to work their money- not forced towards it by circumstances.

Data shows that mid and small cap indices are lagging behind the large cap index by yards. Typical bull market scenario has substantial surge in the volumes and participation of midcap and smallcap stocks. Trading volumes dominate and delivery percentages remain low. So much so that the Finance minister remarked about it recently!

And finally, our own balance sheets tell a different story. In bull markets we all are counting how much we have made- thru some trades, thru the value of our investments having gone up, thru the excitement of what we are going to make etc. But here everyone is trying to see how he can prevent making a loss!  A bull market wall papers our mistakes and makes us feel that we are doing well. It is  bearish phases that grossify your mistakes. Don’t be misled by the index chimera.

THE B&F SYNDROME
Or, The ability of the market to keep you fooled.

Every now and then some friend will call up and talk about some stock which he heard – mostly from some sources deemed to be authorities- is good for what is colloquially known as “ buying and forgetting”.  This sounds so ‘good-old-days-ish’ now. There were times in the past when one could do this. Indeed, a lot of people made money from this approach and have therefore come to think of this as the only wise thing to do in the market. Alas, for such people and for a lot of others weaned on that talk, this philosophy seems like not working for a decade now! Leaving aside the tremendously trended market of 2004-2007 (when absolutely “anything” would have worked equally well), this buy and forget thing has become a nightmare. Portfolios are now so full of NPAs that people have simply given up.  An evidence of that was the news element in yesterday’s paper about the sharp drop in STT collection. Investors -and more recently traders- seem to have just about given up.

Nothing in the market quite stays without something else replacing it. Technical based trading has replaced fundamental investing. This is the reason why TV channels are full of TAs and papers are carrying trading advice and websites are full of levels to trade! But like any cycle of the market, this too shall pass. Everything in life is after all cyclical and the markets are no different. Bull markets gave way to bear which gave way to consolidations. Eventually, they will give way to a new bull market too. But until then, the mantra would remain trading. The mantra of buy and forget (B&F for short) is the thing to forget or at least shelve until the new bull market comes along!

Since most cannot forecast as to when that would be seen, proponents of the B&F approach aver that it is foolish to predict it. Since their time will indeed come, they say, it is better to continue with the approach. No doubt that too is a credible logic and it gets accepted because it is so easy to do! In fact, that aspect has more to do with the adoption of the B&F than any other! Most investors are lazy and want to make the buck the easy way. B&F is just about the right recipe. What could be better- let someone else do the work, you hear, then make one phone call and then sit back to enjoy the money! Sigh. If only things were that simple. In the market the cliché would be what you do is what you get! Since the B&F guys do nothing that is what they will get too! Once in a while, the market comes along and does a lot and the B&F guys get something, perhaps a lot. This fools them into thinking that it is their not doing that really got them the gains!  Talk about misplaced convictions! The world of investments is changing rapidly with destructive as well as enabling technology. It is not the 1960s any more!

Market is a thinking man’s game. Don’t get lost in worn out cliché’s that have far outlived their usefulness. Don’t listen to experts who are still steeped in those archaic times. The world is changing. Change with it. The proactive investor will be the winning investor of the future.

THIS HAPPENS ONLY IN INDIA?
Or, Will the FII money continue to pour in?

We have all been surprised by the consistency of the FII inflow into our country and markets. Considering that it has managed to sustain our index a good deal thru recent months, not many have complaints with it. Except perhaps BNP which came out with a report questioning the source of this money. The report seemed to suggest that current conditions are not conducive enough to warrant such consistent inflow o f money. You cannot but agree, however reluctantly, with this logic. There are many who look at the current levels of the INR and the fact that Swiss banks having pushed to Sept end their announcement regarding account holders, as a conspiracy theory. Again, most would find difficult to disbelieve that conspiracy theory either. Times are such that we are ready to believe the worst of anything!

But the most worrying question that people pose in the market is whether this inflow will continue? Its not as though corporate earnings are great or that our GDP is scorching the growth path. Also, other economies are no less cheap or attractive. We may argue that our own forward PE around 13-14 times is great value but take a look at the others. The Shanghai Composite’s price-to-earnings (SHCOMP) ratio has dropped to 11.5 from an average of 25 during the past decade and a 2007 high of 46, according to data compiled by Bloomberg. The MSCI Emerging Markets Index (MXEF) is valued at 12 times profit while the Bovespa index in Brazil, the second-biggest emerging market after China, trades for 14.6 times. Most other Asian market PE is also around the 10-14 range. So nothing significant about India, right? Hence, where is the catch- if there is one?

People have been finding value and buying into stocks for many months now and have nothing to show. That is why I feel technical analysis shows me better signals about when to invest and when to trade. Right now, I am still distinctly in the ‘trade’ market and not in the ‘invest’ market.  This is not to mean that there are no investments out there that won’t make us money. Our own fundamental division has had an excellent run this year with a great 43% return on our investment picks! That is certainly not a random event, I can tell you!

So, I am guessing here that it’s really all about the kind of stocks that you pick. I have always been a votary of finding momentum in value. The way our technical picks seeking value (Techni 200) or our fundamental picks seeking momentum (Cross Point) have been faring over recent months, continues to keep me a votary of the active investing approach. Passive investing is for the lazy and refuse-to-be-informed variety of investors. Those are the guys we should be taking money from. Make sure you are not one of them.

In the meanwhile, we shall continue to hope that FII inflow continues. The domestics have also turned buyers now. Let the good times roll!

And One More Budget Goes By….
Or,The useless pursuit of reason for acting in the market.

We were all heated up about the budget this time. “Last budget to do something before the last one in 2013 when they will not be able to do anything” said many. How do they know? I am sure they don’t but they say it anyway. Sounds good, perhaps. Or maybe, sound impressive, knowledgable, smart! Whatever. Then there are the perennial pessimists. “ This or any budget cannot do anything for the country. We are all gone. All these politicians are out to ruin us” Or words to that effect. But we have to forgive them for they know not what they say. They are stuck in a time and event warp of their own making and will see a witch in their mother too if they were allowed to run free!

But at the end of all that heat generation which, contrary to physics does not convert into any other form of energy, what are we left with? Nothing. Except volatility. And lots of it. This brought to mind something that I had read some time ago. There is this gent named Jeremy Siegel (a Wharton Professor) who did this fantastic work of researching data from 1801-2001 (that is 200 years, dude) on price movements and reasons behind them. I think he needs to be given a Nobel prize or something. In my view he did more yeomen service to Investors and Traders than anybody else in the field of economics has ever done. Siegel found in his research that upto 75% of price moves, across a 200 year time frame, could not be attributed to any reason!!! However, we hardly hear much of what he has done. Why is that, you wonder? It’s because his work strikes at the very heart of what all of us believe- that there is an explanation for all price movements of financial instruments!  Can you imagine the fallout of this if it became a popular view and gasp,gasp, an accepted one?

To all but a few, that is blasphemy. He might have as well called the Pope an Imam or something and even that would be less heretic! For starters, all financial journalists would be out of a job. So too TV anchors of financial channels. What about analysts? Much of that tribe would be toast too. No wonder then that Siegel didn’t really get much airtime with that view.

While Mr. Siegel, I am sure, used that information from a different angle in his book (Stocks for the long run) but I think it applies very much to our everyday life in the markets. We keep seeking reasons for every move in the market or keep ascribing something to it even if we don’t know for sure. This produces the volatility as different people rush in different directions with their half or quarter baked views. Events like Budget take us all into overdrive, where we spin our views like Turkish dervishes!

Traders in particular should get out of this necessity to know the reason behind a move or every trade that they are going to take or have taken. A good grounding in technical analysis should provide that learning and habit formation. No, that is not mentioned in Mr.Siegel’s book but I think it’s something which fits very well with that great piece of research.

Time For a Market Rise..
Or How fundamentals and technical are most divergent at market extremes?

One of the maxims of the market is that fundamental and technical analysis will differ markedly at market extremes. During the mid phase of a trend, they are quite in sync. I have seen this on the chart often enough to know that this maxim is true (for me). With the market down about a year plus, I thought this might be a good time to put this maxim to test one more time.

For comparison, I picked one of the biggest broking houses of the market, one that prides itself on world class fundamental research. I reckoned that if their research is indeed world class (as they claim) then they should be unaffected by the maxim. To compare, I used the technical views produced by my own set of analysts.  The time period was Oct 2010 to Dec 2011.

The broking house chief was on CNBC in Oct 2010 and spoke very convincingly about the existence and sustainability of the bull market into 2011. The view was that there was a 90% probability for an index level of 25000 Sensex.  No problem with that. Everyone is entitled to his or her own view on the markets. He was not alone either in this opinion. Most of the other broking houses including almost all the FII houses were of the uniform view that 22000-30000 index was inevitable.

I compared this with what we had written in our weekly newsletter in Oct 2010. Here is a quote from Oct 18, 2010 letter, “Given the stage of the trend and the levels that have been reached, there is little doubt that we should be on guard. This is even more so as we are getting into the time zone that had been indicated long ago”. Now, that is certainly not the same language as the broking houses, is it? Well, here is another one, from issue dated Oct 25, 2010, “The next TCD is due on 29th Oct and following that Nov 5. We need to be watching the highs and the lows around those dates to see if there is any acceleration upward (top formation) or break of support zones (down trend launch).”  It might interest you all to know that the market top was on Nov 5, 2011!

It is difficult to know on the day of the top but here is some more quotes from our issue dated Nov 8, 2010, “Given that we have measured move targets being reached and that a time count is coming thru by Wednesday, we should be ready for a reaction”. Finally, we sounded the death knell for the trend with this in our letter of Nov 22, 2010 (i.e. within two weeks from the top of Nov 5), “This will now confirm the divergence pattern on the RSI at the Nov 5 top and make it an intermediate top for the moment. Once the support trendline on daily charts at 5830-20 gets violated, this warning will turn into a bearish signal too.”

In the meanwhile, the said broking house came out with more world class research. Their top picks (for their Premium clients, that too!) comprised about 10 large caps and 5 mid caps. All respectable companies and no one would have doubted that investments “must” be made into them.  Logical reasons were given in a 45 page report about why they qualify. No stoploss points were mentioned of course- after all they are for those “traders” and not for the true blue investor! Well, I checked the fate of those stocks after one year. By last week, all but one was losing heavily. The “best” performer was a loss of 22% while the worst was down 79%. One stock out of the entire list of 15 made it to the gainer list! Contrast that to our concluding view in the same issue (22 Nov) – “Give investing a rest”. And this one, from our letter dated Dec 27, 2010, “players can even consider letting go of investments on rallies for a while (at least next 3-4 months).” Clearly, end 2010, the technical indicators were almost unanimous in signaling an exit from the market and not a push to new highs!

Just to recheck on the status, I looked at another video of the same broking house around third week of December, 2011. Once again, their view was for 12000-13000 Sensex levels, saying that we would remain down ‘for sure’ over the next few months.  The spokesperson cited all the bearish factors present in the markets right now as the reason while holding out that there isn’t much to look forward to either in the next year.  Curious, I thought, as I had just last week (Dec 26) written in our weekly letter that it is time to start buying the dips! This was based on the evidence that had showed up on the charts, which suggested that the markets may actually be bottoming! I reconfirmed that status in our letter for Jan 02, 2012.

Looks like the old adage of technical and fundamentals being at variance the most at market extremes is about to come true. Once again.
Happy New Year!

Our Editor, V Raja adds:
In case any reader would like to refer to the letters mentioned by Dr Narayan in the above blog, they are welcome to contact me at the office and I will be happy to provide them a copy of Trend Trader, our weekly newsletter. Dr Narayan writes the Index analysis for this letter – which is in continuous publication for the past 20 years plus!!