Its just mean Baby!

Any trend usually tends to converge to its mean. In stock markets the index which represent weightage average of basket of stocks is no different. Indexes are made of individual stock prices. Stock price is a measure of valuation of the company's business. It simply says what investors are willing to pay for an equal pieces of residual interest in that company's business. Residual interest is the value left for common shareholders after all the debt and other obligations are paid to respective holders. So its a value of the company's business and sum total of all such companies businesses give an indication of what economy of a country is worth, or at least the trend of that economy. That is, if in long run companies are more profitable than previous years, economy would more or less be positive and these companies would attract increasing valuation or higher stock price as time goes. So in a nutshell the trend of economic growth and stock markets growth should co-relate in long term.

Our country's economy is usually measured by GDP numbers. GDP comprises of agricultural sector, services sector and industrial sector. Most of the companies listed in stock exchange are in services or industrial sector which today comprises 80 - 85% of GDP numbers. Thus any trend of stock market index should match the trend of GDP growth. However we all know this is far from true. Stock marks gyrate from huge bullish rallies to great bearish depression. How can we use this gyration to our advantage in making investments decision. Answers lies in 'return to mean'. Any significant deviation from the mean is followed by reversal which converges towards that mean.

Before showing on how this is valid or how we can use it, first let us approximate the mean growth of business of companies which would translate to growth rate of stock market's index. Our GDP would grow at an average rate of 7 - 9% for foreseeable time in future. Even long term average of past 15 years of growth is around these range. We add to that 4 - 5% of average inflation. That makes growth in business of companies around say 13%. Which is roughly the rate at which one should expect stock market indexes to grow.

Now lets see how as our Stock Market's most prominent index, BSE - Sensex has performed since start of 1991.
Blue line is the index value and red line is what index should have been if it strictly followed the 13% growth.
So you can see at times it was greatly above this red line and at times was much below it. However every time is crossed this mean, it eventually reverted.

1992 - 1994 were bullish times followed by a bearish market 1997 to 1998. Markets again turned bullish briefly during 2000 (dot com bubble) and then engulfed in a prolonged bearish market during recession of 2001 - 2004. We again saw economic revival post 2004, thanks to trillions of dollars pumped into the market by central banks across the world. This money trickled into India via FIIs and then we saw an unprecedented bull market which lasted till 2008. During this time markets deviated from its mean like never before. What was the result, as markets deviated from its mean like never before, they fell towards that mean like never before. The recession of later half of 2000 caused panic worldwide. If somehow we could have avoided the temptation to commit ourselves at start of 2006 when this frenzy began and had lot of patience then we would have again had the oppertunity to make some wonderful investments three years later. Anyway hindsight is always 20/20, but does offer some lessons.
Come start of 2009, we were at last seeing some sanity towards valuations of companies. However they were still not at those juicy level witnessed in 2002 - 2003 (just look how low below mean markets fell that time). However this sanity lasted only few months, thanks to next round of even bigger chunks of money pumped by the very same central banks. Much of this money was pumped in to revive the economies worldwide and now this money is moving into the emerging markets like India. As you see markets have again bounced back away from the mean. So when would they return back to the mean, no one knows, but as history has shown they eventually would.

As an investors what we can do is, be wary of lofty promises and projections made by some companies to eat up this new pumped in capital. You would get a chance in future where once again you could buy pieces of wonderful businesses at attractive prices. There are good businesses around even now, however your returns from investments are largely dependent on the price you pay. If you are paying too much price for a piece of good business you may still loose money or better still your recovery horizon may last far longer than hoped for. So by stretching the time, why lower the rate of return.

I think what has been mentioned so far is nothing new. It has been iterated many time before and is something very simple to understand. So is investment, its simple but needs lot of temperament and patience. Its very easy to be swayed by next bull market, by looking at your neighbor making pile of money by dabbling in worthless stocks, but that's not a winners strategy. What would lead you greater wealth is stay clam, have a realistic expectations and do your homework right.

Remember:
It is more important to say "no" to an opportunity, than to say "yes".

Sachin

Investing - the web 2.0 way

We are using web 2.0 to collaborate, network and share ideas increasingly in our lives. We would be members of some or other social networking sites, registered to some or other groups and forums based on our interests. These activities may or may not help us in our professional and personal lives. All depends on how effectively we use the tools provided these platforms. Here is a look through on how web 2.0 can help us in making investments decision.

Firstly, join few forums or groups that have active discussions related to stock markets and investments in general. These may be found on some or other social networking platforms or sites that hosts forums and groups (like Yahoo and Google) or sites dedicated to stock markets itself.

Next, start screaming your stock tips in these boards, luring investors or traders to invest in your stock tips. This would lead to run (up) in the prices of the stocks you recommended. When they have sufficiently run (up) offload your holdings making a decent profit. (Ha Ha, just kidding)

Markets are usually gripped with excessive optimism or excessive pessimism. There are times when investors are ready to pay anything to get a piece of that worthless stock, and at times they are ready sell for anything to get rid of that blue chip stock. Market's behavior is very erratic and sudden. It takes no time to reverse the sentiment. If somehow we are able to watch and measure this very behavior we stand to make right investments decisions.

So how can web 2.0 help us here. In this connected world, news and sentiments travel quickly. By being part of right forums and groups, you can get access to information about markets. This would include personal views and opinions of fellow members, links to new articles mentioning what experts are saying that time and then many research reports by various investment houses. These give you holistic view point of what market mood is. Key lies in measuring the market mood. Its very much like thermometer is used to measure the body temperature, these forums and groups measure the markets temperature - how heated or how cold market is.

If you would have paid attention from start 2006 to end of 2007, views were generally optimistic in these forums and groups:
1. There were more board members participating.
2. There were more and more personal opinions and so called stock tips.
3. The links which posted (so called) experts take on market were generally positive.
4. Research reports in some or other twisted way project much higher growth and optimistic targets.
In short the good times were here to stay forever. This was different (was the undertone)
Such signs usually indicate market temperature is running high and time is to stop making further commitments (without much deliberation) into the market.

Come later half of 2008 to couple of months back, views were almost pessimistic now:
1. There was declining to the point absolutely nil participation from board members.
2. Every one was predicting doom and you could hear sad stories of they portfolios.
3. The links which posted (so called) experts take on market were now revised to new (further) lows.
4. Research reports in some or other twisted way project everything to a lower level than what currently was.
In short it was like end of the world has come and we are going to stagnate forever.
Such signs usually indicate market temperature is running low and time is to start making further commitments (with deliberation of course!) into the market.
So those who gauged the market sentiments correctly and did invest when no one was investing sure must be feeling lucky and happy today.

Also you would notice that now market temperature is slowly rising as the activities in these groups and forums is coming back to previous highs (so are the markets!). Whereas economy has still not recovered.

So being glued to right piece of information on web 2.0 and using that information in making investments decision helps (or not), only time would tell. In my personal opinion this does help. You don't need to watch those TV channels or spend time and money on countless seminars and workshops, just the ubiquitous web 2.o is enough to bring everything to your screen. Whats important is how you like to use that information.

I end by famous quote by Mr. Warren E. Buffet:
Be fearful when others are greedy and greedy only when others are fearful.

Sachin

Second tsunami of greenbacks

Stock markets worldwide are booming. They have notched up record gains since march this year after a record free fall since start of last year. As usual markets participants and observers are divided in two camps. One say that this rally is for real and is going to continue, the others say that its nothing but suckers rally. Both have put forth cogent arguments to prove their points and its hard to side with one. One thing I have learnt in stock markets is that its a very futile and dangerous exercise to predict the direction or quantum of market movement. Your chances or being right are around 50%, which is as good as a coin tossing experiment. What we can do instead is to analyze the causes of market movements. That does help is in taking informed decisions for future.

Last bull rally ended somewhere in 2000 - 2001, with the burst of tech bubble coupled with social/political disturbances around the world, caused markets across the globe to fall. There was an economic slowdown and the central banks responded to this by lowering the interest rates and pumping in lot of money. Leader in doing this was the central banking system of USA, commonly known as the "Fed". It lowered the interest rates to record low of 1% and pumped in lot of greenbacks. From a negative issue of T-Bills in past 4 years preceding 2002, it issued around $1 Trillion T-Bills in next three years from 2002 to 2004. (And I am not including other GSE backed securities like raised by Fredi and Fannie and muni bonds). With so much of money raised, it started percolating into the system, where it should not have gone. First it went down the lane of less credit worthy borrowers, which today we all know as sub-prime and Alt-A mortgage crisis. There was still lot of money supply left and it then started moving into emerging markets. These markets which usually ran a thrifty economy, were not used so much of "hot" money into their system. All this barrage of freshly minted greenbacks created a sort of tsunami in their economies. Asset prices of all types of assets rose to dizzying heights. We all remember crude at $150 per barrel and not to speak of property prices in your neighborhoods.

This eventually led to inflation and then to combat inflation central bankers fired another arrow from their quivers. This was raising interest rates to suck the abundant liquidity. This had another fallout, which resulted in huge default in mortgage loans, as the interest payment rose, and this led to sub-prime crises. With asset prices falling world wide, interest rates rising, one thing lead to another and soon we were in another economic crises (worldwide). Economies across globe went into tailspin around mid of 2007, with some countries even declaring bankruptcies. Crises which emerged from developed economies actually affected emerging and under developed economies far more that developed ones. This recession was (or is) much deeper than the last one of early 2000's and some drawing parallels with the great depression on 1930s.

So it looks like the life came back in full circle to bite us in the rear. Once again central banks resorted to lowering the interest rates to all time low. Much lower than the previous recession. Even the money pumped into the system by central bankers was far more that last time. Some estimate that around $4 trillion has been pumped world wide so far. The issue of T-Bills by Fed itself amount to $1.5 - $2 trillion in past two years. This so far has done some work (or at least have appeared to) have done some work in ameliorating the disastrous impact of this economic crisis. So the question here is, once again doing the same things which were done last time which resulted in even a bigger crises, won't lead to a even bigger crises next time.

All this money, now in the system is finding ways to be allocated. In west especially US, credit worthy borrowers don't need loans. Lenders being just bitten from the sub-prime bug don't want to lend to credit worthless borrowers. So again all these greenbacks floating in the system are waiting to hit the emerging economies. Is a second tsunami of greenbacks waiting to happen? We have got some trailer of this in past two - three months with stock market indexes rising as much as 75%. Around 30% in just this month alone! Question we need to ask is won't it lead to another inflation bubble and to combat that once again excess liquidity would be sucked so again money would move out of these economies leading to another crash.

When would this happen (if at all it would happen), what would be the story next time (like sub-prime last time), no one knows. What we do know is similar experiment is past yielded some results and those are the results we should watch out for or anticipate for, or at least worry for.

Happy new world!

Sachin