Ashu Dutt’s “The Boom & Bust Journal” – May 15,2009 from www.ashudutt.com

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Ashu Dutt’s “The Boom & Bust Journal” – May 15,2009 Edition

CONTENTS
- The “Call”
- The Big Picture
- Technicals
- Smoke Signals
- The Good, The Bad, The Ugly
- Investment Themes
- Random Moorings

THE CALL
If the retail crowd has not entered as yet (and they decide they have “missed” the bus in their own wisdom), then the chances that we will get another 25-30% upside in the markets is very real.
The flip side also become equally true. If the retail crowd does not play ball, then all the built up positions must necessarily find support from the economy failing which, we have an equally dangerous downside.
So what should one do. The worst combination/scenario to buy stocks is when there is a “scarcity” and “competition” i.e. we are after a stock that has upward circuits and everyone wants to get in. Empirically, there is not a chance in hell to make money in the long run in such a scenario. Same holds for IPOs. By their very nature (“scarcity” and “competition”), they should be avoided. Rarely do they make long term sense.
Now, if you were trading, it’s a whole different ball game. Exactly the same reasons why you should not buy for investing should be the reasons to buy for trading. Once a stock has high demand and the floating stock is low, chances are that droves of money chasing it will create a cycle of rising prices which brings in more traders. A trader’s decision is then to enter just such stocks. On a practical level then, it does not matter what the stock is or why it is rising, just that it is rising. Traders avoid making judgement calls on management, companies, performance etc. All they watch is the ticker. If it indicates increasing “scarcity” and “competition”(as in demand), they dive in.
I am wary of non ferrous metals, steel and oil. No matter what we have in terms of news right now, the China story is not clear. Exports fell again (at an even faster pace) in April. The only reason China is still growing is the government’s “pumping up” of the economy. But where is the money going? In fixed assets? Who is using these assets? Who knows. But in centralized systems the risk of “blowouts” is very real. As supply is created artificially, it is almost impossible to know how far away from demand it has stretched. We do know that such command economies end up in blowouts. What does that mean for Aluminum, copper, steel, oil? In the short term, it is the market’s mood that could decide that (and it seems bullish right now as we collect enough corroborative evidence to back our current beliefs of recovery). In the long run though, no market can hold without the underlying economics matching up.

THE BIG PICTURE
“Much of the real world is controlled as much by the “tails” of distributions as by means or averages: by the exceptional, not the mean; by the catastrophe, not the steady drip; by the very rich, not the ‘middle class’. We need to free ourselves from “average” thinking.”
- Philip Anderson, Noble (Physics), “Some Thoughts about Distribution in Economics”
“Missed the rally”. The whole concept is absurd. But fact is, for fund managers it is fatal to be wrong. While we expect them to be long term, they get money based on what they deliver this month, this quarter, this year. This pressure is telling and while they may not agree it is a “right time”(or a “wrong time”), their reactions have to be based on the amount of money coming in/going out. But this can be used to our advantage. If fund managers are going to have to buy (and by definition, they don’t get paid to be an ‘outlier’ (ie. Buying when things are down and out and selling at peaks but to sell when things are down and out and buy when we head to the peaks), then the retail crowd must be getting in the “herd” mood. Don’t need rocket science to figure out that north is the direction.

TECHNICALS
The wave will turn into a tsunami should we see the retail part of the market (and mutual funds funded by retail) get back into buying
The probabilities I am looking at right now are as follows:20% + : Probability is 40%10% + : Probability is 10%-20% : Probability is 40%-30% : Probability is 10%
For a more detailed Technical Analysis, please see Ashu Dutt’s “THE CHARTIST’S ALMANAC”- May 7th Edition

THE GOOD, BAD AND THE UGLY
THE GOOD
Fund Managers cannot “miss the rally” and cannot “miss the fall”. Their behaviour infact, is injurious to any portfolio. They seem closer to traders than value investors. Take for example a fund manager who never bought at 8,000 or 9,000 or 10,000 or 12,000 on the sensex. He missed out a full 50% rally. How does he look compared to other fund managers? (that’s if he still holds his job). So what does he do? As markets rise, he has a “double dumb” impact. He gets more money (and has to join in the rally) and even if he does not think the market will hold, he has to invest.
As we stand in the markets today, there are 2 possibilities. He continues to get more money and he makes more investments and the rise of the market becomes a self fulfilling prophecy (just the same way as it became on the way down. As redemptions went up, fund managers had to sell stock no matter what they thought about value). This is the likely scenario. Liquidity will push prices up and higher prices will prompt fund managers and the virtuous cycle takes the markets up and up.
Now lets say, we hit the brakes (seems unlikely unless there are few more economic shockers), then the downside can be equally serious.
THE BAD
As it did in October, the market is running ahead of economic news. While economies move with “lags”, markets move on emotions. And most emotional decisions are “split second” or atleast impulsive. So are the markets very high or low? I don’t know. I do know the overall index, no matter what it is, delivers “mediocre” returns. And what do I define as “mediocre” returns. Returns of 15-20%. Why? Because there are several (and I mean several) opportunities in the markets (and I don’t believe those in the markets should dwell on esoteric academic thought processes or archaic measures like PE etc as the data is only as good as the managements) where positive “outliers’ abound. How do we find which ones they are. I have given a few in “The Chartist’s Almanac” – May 7, 2009 edition
THE UGLY
What we have to avoid is the expectations of “repeats” in stocks where a new world is opening up and excessive liquidity finds its way in chasing that new world and ends up overpricing assets severely. Real Estate stocks present just such a case. If the expectation is that we may find the same levels as about a year earlier, that may be very tough. Indian Real Estate was a new world for most global investors and local investors. Individuals and Institutions acting in the individual wisdom and not wishing to miss the boat make several collective mistakes and mispriced real estate stocks way above where they should have been (once again a case of “scarcity” and “competition” for a group of stocks creating nonsensical prices). While we may see a rise, it is critical in this round to be choosy. Just as the Infosys, TCS and Wipro emerged from the crowd after the dot com bubble (and consequently enjoyed exponential reach and growth) as compared to others in the same boat before the bubble, a few real estate companies will come out shining. For most though, it is the end of the road (as far as significant gains in their stock prices are concerned (note that I consider a 15-20% return “mediocre”.)

INVESTMENT THEMES
“The most direct consequence of more rapid business evolution is that the time an average company can sustain a competitive advantage-that is generate an economic return in excess of its cost of capital – is shorter than it was in the past. This trend has potentially important implications for investors in areas such as valuation, portfolio turnover, and diversification”
- Michael Mauboussin in “More than you know”
The whole concept of “Long Term” needs to be rewritten. Innovation is squeezing the business cycle so fast that we cannot hold stocks for over 3 years. Take a look at the growth of Google or Facebook. They did in 5 years what television took 50 years to do. A holding of beyond 1-3 years is by and large futile.
A few new portfolio strategies merit thinking. Instead of buying stocks in the “bell curve” like Infosys or Wipor (or SBI) and then further mediocritizing returns by diversifying, should the portfolio not be made up of “blowout” stocks? For example, it would have made at one point to buy real estate stocks or internet stocks etc and get out before the blowout.

RANDOM MOORINGS
I would argue that there is no real benefit of buying into an Infosys or SBI. These are “commoditized stories” reaching the end of their “S” curves and can at best deliver 10-15% returns.
So what can be the strategy? One option could be a portfolio which is 90% in Government bonds(held to maturity) and then 10% in extreme plays. Companies with a management of driving their stocks high (usually as high as 10-20 times). Get out before it ends. i.e. 20% off their highs with falling volumes of around 50%.
Or companies with very low floating stocks (and by this I don’t mean institutional investors). Only floating stock with retail investors or mutual funds.
The “fallacy of buy and hold”. If you bought Infosys in 2004 and held it till April 2009, you would have made zilch. Ditto for Wipro. That’s why “buy and hold” is such baloney. No one follows it. Neither fund managers nor most smart investors. Avoid it.