Market Update 28/12/2015

Before we begin analyzing the markets we would like to make clear the following-

1. The attempt of these market updates will be to look at the market in easily identifiable quantitative terms that should help in bringing about more informed investment decision making.

2. These posts are not going to assign reasons for short terms trends. They would rather look at long term trends based on quantitative parameters and this writer's macro-analysis.

3. There will be a mix of technical (study of graph patterns) as well as fundamental analysis used in these studies.  

4. We will also look back at past market updates to 'check' on how we've been doing.

The markets are up slightly from the last post (dated 23/11/2015). For the month however the Sensex is down slightly by about 0.4%. The Sensex is currently at around 26,000. It came close to 25,000 in early December before bouncing back. 

The momentum indicators suggested a small bounce back in the last update. Right now the momentum indicators are in equilibrium suggesting that the market might have found some "short-term" stability. 25,000 on the Sensex is a clear technical 'support'. 26,300 seems to be a short-term resistance. The technicals suggest that the markets look 'range-bound' for the near term.

The Sensex trail PE ratio is at 19.8. This is down from 20.47 in last month's update. It is still, however, above our long-term average of 18.5. The Return on Equity (RoE) for Sensex companies is 15.58% and the Return on Capital Employed (RoCE) is 7.8%. The spread for RoCE vs the 10 year G-Sec is marginal. 

From the technical and fundamental readings of the equity markets we believe that the markets are still 'over-valued'. We would recommend that we continue to prune the allocation to equities. The over-all allocation to equities for investors with a very long-time frame should be brought down  slightly below their risk-profile based allocations to the asset class.

The benchmark 10 year G-Sec is at 7.76 currently. Up slightly from the last market update. It was a very volatile period in the debt markets with the US announcing an interest rate hike in early Dec. The benchmark went up all the way to 7.8 before prices recovered slightly. 

There still is a comfortable spread between the inflation rate and the repo rate (nearly 110 basis points). This will give RBI the opportunity to reduce rates going forward. We will still continue to remain slightly over-weight in duration strategies in our portfolios. 

Crude prices continue their free-fall. Brent crude is currently trading at $37 per barrel. This could imply concerns over weakening global growth as well as a strengthening of the US dollar (in the wake of interest rate hikes). 

Gold continues to remain at around $1070/oz. While fall in crude as well as gold prices are sort of giving out contradicting signals regarding the global economy we would like to believe that the indicators are that the general sentiment is weak but the worry is not of catastrophe for the global economy.  

Market Update- 23/11/2015

The equity markets have had a tough time last month with both the benchmarks Nifty and Sensex down between 5.5% - 6%.

Technically the market seems to be in a bear trend with the daily moving averages (50, 100 & 200) all appearing in descending order. The momentum indicators indicate some kind of bounce-back in the short term. The market also seems to have achieved some kind of equilibrium with the prices right now somewhere in the central region of the Bollinger band.

Fundamentally the Sensex is valued at 20.47 trail earnings. This is still higher than the long term average of around 18.5. There is talk of companies moving in and out of the index and the earnings ratio is expected to come down to 19.5 or thereabouts at current prices. This is still above our historical average.

Our outlook on the equity markets are therefore that they remain slightly over-valued at this point of time. We would therefore recommend to not over-allocate in to equities. Our technical reading at this point of time is that the markets could be range-bound. Should they remain range-bound then a time correction of valuations should take place and will give us opportunities to pick up more equity.

In debt, the benchmark 10 year G-Sec closed at 7.7% today. This is up from 7.55% a month back. Duration strategies have taken a knocking. While we are looking at a rate cut cycle certain events have lead speculators to expect a temporary halt in the reduction cycle. News from the US Fed that rates in America could increase as early Dec (based on better than expected economic data) has increased the value of the dollar and has had an inverse effect on the value of bond prices in the world as well as in India.

While the up-move in rates has affected prices in bonds we still remain confident of an RBI interest rate cut cycle over the long term. The targeted inflation is 6% for Jan 2016 and 5% for Jan 2017. The Consumer Price Index (CPI) currently is at 5% which will keep the RBI comfortable. The macro-economic situation is also more or less in control with the Current Account Deficit and Fiscal Deficit all at manageable levels. The economy also has been slowing down which makes it an ideal scenario for reducing interest rates. The RBI will have to watch developments in the global economy.

Brent Crude is currently trading at $45/ barrel. This is helpful to the Indian economy in the short term. However, the fall in crude in the last year could also signal weakness in the global economy and could raise concerns on global growth especially for economies not yet out of the woods.

Gold is at it's 6 year low in the international market. Currently trading at $1070/ oz, gold has been in a bearish phase for some time now. This signals that it's not all gloom and doom for the global economy.

Dealing with Uncertainty

I’m sure all of us have gone through the- “Will she? Or won’t she?” dilemma at some point in our lives. Ah…to be a fool in love (or as some would say needn’t mention ‘fool’).

I’ve tossed coins, played ‘flame’, tallied names, plucked petals from flowers, even stared at the moon, all in the hope for some ‘divine revelation’. Did any of it work? Well, I’ve had my fair share of both. She said ‘yes’ because the 7^th toss came out heads and she said ‘no’ because of the petals in the flower.

It is an interesting habit that we all have of ’assigning superfluous reasons’ to phenomena that we don’t fully comprehend. And, the funny thing is, if for some reason we meet with success using, to put it mildly, ‘out of the box thinking’ then we tend to repeat it. For example, if the first time the ‘coin-toss’ worked then in the next adventure I would use the same system.

George Soros explains this in his “Theory of Reflexivity”. There is a part of thinking that is forever trying to ‘manipulate’ the external environment. This manipulation is of course fraught with risks because you don’t have sufficient information to make informed decisions. You judge the manipulation based on the result(s). He calls this a ‘feedback loop’. A positive feedback would mean that you would repeat and maybe even enforce the process (imagine me tossing a coin for all of life’s important decisions because it’s worked ‘so far’) and a negative feedback would mean that you suddenly doubt the validity of the action/ manipulation (imagine me looking at the coin and scratching my head). A positive feedback tends to distort reality even further whereas a negative feedback tends to bring you back to reality.

Look at it like this, if the coin-toss worked, I would continuously be tossing. I would develop a quirk to deal with uncertainty. You can almost see how religion, rituals and other dogma came in to existence because of the same system being applied by everyone.  

Well, so the ‘wiser’ me has figured that, for example, while the coin tossed in the air my heart would beat a lot harder and in the process revealing to me what my ‘true fear was’. In other words it would reveal my ‘anxiety’ to me.

Now, assume a young man in love has come to you for advice. How would you approach advising him? Remember, you’re not trying to out-guess him, you can’t. You don’t have sufficient information unless, of course, you know the young woman responsible for the poor boy’s condition. Assume that you don’t know her. Then the primary aim should be to help the young man ‘handle his anxiety’.

I would approach advising him primarily from two sources- one is an ancient Greek philosophy known as stoicism (or pessimism) and other is from a wonderful book that I recently read called “How to stop worrying and start living”-by Dale Carnegie ( I strongly recommend it).

The first step is to get the guy to understand that there is an ‘uncertainty’ and ‘accept it’. This is the most basic requirement and there can be no progress if we can’t drill this in to his head. What we have to do now is to help him ‘deal with his uncertainty’.

The next step is to understand the various outcomes (think probability in statistics). This is a straight forward case with two probabilities and we can apply a 50-50 chance to each outcome.

Now, we need to look at ways of improving the odds. Can we use evolutionary psychology, for example, in wooing the lady? Can we try poetry, gifts, singing, etc.? (Try doing direct things instead of esoteric stuff like tossing coins and picking flower petals.)

And now, this is where stoicism will come in, despite the young man’s best efforts the result could still be a negative. He needs to be prepared for that. If he can ‘accept failure’ or even if he’s aware of it then he can be better prepared for it. In management parlance they call this a Plan B. What is the plan B? It needs to be clearly defined.

This has more to it than meets the eye. Practise of stoicism is tough but it makes you tougher to handle the knocks that you’re bound to get in life. By keeping the right mental attitude (Dale Carnegie) one can then-

a.       Look forward.

b.      Create more flexibility.

c.       Play with more confidence.

d.      Have peace of mind (and handle your anxiety).

Simple right? We’ve dealt with uncertainty in 4 simple steps. Is there a corollary to this same process in the investment world? I’ll leave you with that.

What you should look for in a Financial Advisor

“It's not what you look at that matters, it's what you see.”

-Henry David Thoreau

Some financial advisors are wise, others are otherwise. And over the course of your investing career (which is lifelong) your investments will go through quite a few ups and downs which will make you wiser about your advisor(s). As Jean Racine- the famous French dramatist from the 17^th century, once said- “There are no secrets that time does not reveal”.

However, the challenge is to spot a good advisor without having to go through the pain of delayed realization. How should one go about that?

There are two key aspects to the delivery of financial advice. One is “service” and the other is “knowledge”. If your advisor is able to service your requirements well then that is a good portion of the battle one. Service is also easier to judge and predict. It is the knowledge component that becomes tricky for the client to breakdown and judge. The attempt of this note is to break down the knowledge component for you to be better able to understand the ability of your advisor.

I’m realizing more and more that a good financial advisor is also a ‘wise financial advisor.’ Therefore, the knowledge aspect has more to do with ‘worldly wisdom’ than it has to do with strutting facts about markets and GDP data. Why is this so?

One of my senior colleagues has this wonderful way of connecting the vagaries of life with the markets.  He’s always able to break-down my challenges for me and relate it to the movements of security prices. Investments are after-all a human endeavour and therefore it must be expected that all the challenges that one faces in other human endeavours are equally true about the markets. The only way to approach life’s challenges is through the continuous application of time tested principles and values. What we simply call ‘wisdom’.

Patience is one of the key-pillars of financial advice. You should, as a rule, stay away from anyone promising results quickly. If good results happen in a short period then this is more to do with luck than any amount of skill. A good advisor should be able to admit to this. It takes time for the efforts of a good advisor to show.

A good advisor should also be willing to invest in you just as you are investing with him. Don’t construe this to mean that you should “slowly test the waters”. Quite often we find that clients are slow in investing with their advisor. Today’s economics demands a “certain viable” size for a mutually beneficial relationship. You must understand this. Also if you have a good financial advisor and you don’t back him early then you could suffer from what in financial terms we call “opportunity cost” and in layman terms we call “regret”.

When I say ‘invest in you’ I mean he should follow a process and take the time and efforts to understand your current situation and requirements completely before proceeding to advice on investments. He needs to present his findings, explain his plans and take the time to break it down for you. And, most importantly, he should be looking at a long-term relationship.

Another aspect of financial advice is discipline. He should be able to stick to his processes and evaluate the performance of his strategy in a timely manner. He should also stick to his long-term strategy no matter the ‘noise’ coming from the markets. He should also, and this is extremely important, get you disciplined. As in all other human endeavours discipline is the key to creating long-term wealth.

You should also evaluate the intelligence of your financial advisor. Throw him off-guard asking him random (but relevant please!) questions. Evaluate his responses. Try and judge how well he understands the “basics”. Also, extremely important, evaluate the strategy that he plans for your investments. You evaluate a strategy not based on past performance but on the flexibility of the portfolio if things were to go wrong and also on the underlying investment philosophy in terms of what opportunities is he trying to exploit with your investments. Remember that he has to always be thinking about the “long-term”. Also, see how he incorporates “tax-planning” in to your over-all investments.

And lastly you should evaluate his commitment to the cause of your wealth. Are his incentives aligned to your “long-term wealth creation” or is it otherwise? How much effort and time is he willing to put in to making sure that your wealth is preserved as well as increased? Is he constantly updating his skills?    

Good advisors are like good opportunities- a rare species. When you find a good advisor you should back him to the hilt and it will make all the difference in your wealth.