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When in doubt, just stay out

Posted by Yogesh on Friday, 19 September, 2008

For some time now, there has been a spate of comments on the MT blog, much in line with the market mood and the painful erosion in the NAVs of both our model portfolios. As is to be expected, disapproval, rejection, anguish and anger are the emotions reflected in these comments.

Wealth zoom portfolio

Wealth zoom portfolio

Barring the occasional pat on the back from a sympathetic reader, your fund manager is at the peak (hopefully!) of unpopularity, as the readers are frustrated with inaction—and the huge cash holdings—over the past six weeks.

The NAVs of the two portfolios have inched up marginally over the past two weeks. Safe Wealth is up by 1.47%, while Wealth Zoom is up by 0.81%.

While I have given my reasons for staying in cash (we have over 52% cash and cash equivalents right now in both portfolios) on more than one occasion, I think it makes sense to quickly recount them for a better perspective.

The rise of oil: At $100 a barrel, it’s still five times more than what it was five years ago.

Credit crisis: Bernanke’s gone, the easy money party is over and the mess is nowhere near solution. Noticed the Lehmann crisis and the Freddie Mac, Fannie Mae bailouts?

Inflation: The ill effects of high oil, metals and soft commodities continue to push up prices.

Worsening global macros: Europe, Japan, China — everybody is catching a ride on the slowdown bus even as we go to press.

Interest rates: The enemy of PEs. Even as you make money in equities when PEs expand in tandem with earnings, prepare to lose money as interest rates rise and push down PEs to deliver a double whammy on your stocks.

Redemption pressures: Yes, I have found out from several investment bankers that investors are chickening out.at arguably the wrong time, yet again.

Fiscal stress: The government finances are stretched, to put it mildly, after the oil shock, the Sixth Pay Commission, fertiliser subsidies and farm loan write-offs.

Weak currency: Don’t rush to buy IT stocks; a weak currency might push exports, but ends up impoverishing net importer countries such as ours.

Socio-political deterioration: Not that things were hunky dory earlier, but the cauldron does look like it’s boiling over—Kashmir, Orissa, Pakistan, US elections, Mamata, etc.

Government in a limbo: There’s a policy and administrative paralysis in the run up to the general elections.

The India story is a valid story, but for the last few quarters, it has been under a stress test. And so the elephant is stumbling and fumbling. Will it be able to pick itself up and trot again? I have no doubt it will, and there is no need to recount the reasons for this conviction in India’s economic future. But the pain that has entered the system (from both internal and external sources) has to play itself out first.

What’s the upside risk? It’s enough to make you fidget uncomfortably. Oil can crash (it’s already 30% off the peak and continues to defy prediction). This can bring down a bulk of the fiscal stress, at least in India’s case, and provide a solid economic rationale for markets to look up. Second, global headwinds might cool off as the US takes firm steps to stem the rot in its financial tinderbox.

From a technical perspective, a bull run will genuinely begin only when the low-conviction investors are squeezed out. And that, too, at the bottom of the bear trap! I have no idea whether it will be at 10k, 12k or 14k. But it hasn’t happened yet. There’s still too much “longterm conviction” being mouthed by “short-term punters”. And that tells me we have to wait. Patiently.

Another sore point with many readers: isn’t it obvious that we are trying to “time” the market? Actually, we are not. If we were, I’d put 100% of our portfolios in cash and just wait. The fact is nobody knows what’s going to happen next in the market. The level of stocks should roughly correspond to the fund manager’s level of confidence in the market. Right now, that’s in the region of 50%. Which is just another way of saying: folks, I don’t know. Things are looking tough, but that doesn’t mean the markets can’t rise (however irrational it might seem to me) for a while. If they do, we’ll sell some more. Believe me, we will.

And finally, the million dollar question, whose answer I will postpone to the next fortnight: what will we buy should the crack actually occur? Some 20 stocks fit the bill, but only at the right price. I’ll let you know in advance, for sure. Just stay tuned.

Readers’ Response

Equities are the real hedge against inflation. Yes, they are volatile but our fund manager is getting it wrong by keeping 50% invested outside this asset class. Thus, he is missing the wood for the trees. What every investor needs is a better stomach and a mindset. Stock markets are for the long term, not for the short term. This is the point that the majority gets wrong.
—Lakshmikanth

I appreciate Dipen Sheth’s frankness and willingness to embrace criticism. That’s the positive. The negative is that he is definitely trying to time the market by keeping cash. It is the right thing to do in my opinion, but what surprises me is that Sheth is not trying out any short-term trading strategies with 5-10% of the money. Perhaps, he should go short on Nifty after it zooms 5% in a single day if he is so sure of an impending crash. Or maybe, just hedge currency futures if FII flows turn negative. This whole exercise is meant to help readers learn something. Source Money Today

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