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Actions in the Fog of war – Redux

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The following note was published to all our clients today


We have feelings of Déjà vu. To know why, read these two updates from March 2020

Actions in the Fog of war

And

How do i execute ?

The first post was written deep into the Covid crisis. I used the term ‘Actions in the fog of war’ as a metaphor for decision making under extreme uncertainty. This term is used by generals who make major decisions with uncertain and conflicting information in the middle of a war

We are a literally in a war, except its an economic war on a global scale. It started last week when the US announced tariffs on all countries around the globe. There is a lot of analysis and commentary on it and I will not rehash or analyze it.

I personally think it will do us no good as this is a very fluid situation and who knows how all of this plays out. This could get resolved soon with each side declaring victory, spiral into something worse or we keep muddling through this chaos for the next few years. No one can put any probabilities against each scenario for now. Its too early to tell

Not burying head in the sand

We are however not advocating burying our head in the sand. As we shared at the start of the year, we decided to pull back and went into cash as part of the risk management process.

As the market zigzagged over the last few months, we have rejigged our portfolio a bit and added some positions. In other words, we have not been in a hurry and will take our time.

That said, we laid out a few action items in our posts in 2020, which remain true today. Let me share the same with minor edits

  • Please ensure that you have at least 6-9 months of cash or FDs so that you can take care of your expenses if there is a loss of income. This will help you remain rational and avoid panic selling to meet expenses.
  • It is going to emotionally tough and gut wrenching to remain invested. Your mind and emotions will scream at you to get out. It will be a torture to put money into the market and lose 20-30% in a matter of weeks
  • We maintain a list of 200+ companies which we track from time to time. The buy candidates will be from this list. We are in no hurry to rush in.
  • It is a given that we will get the timing wrong. we will either buy too early or too late. I hope you have already realized that and are fine with it

On the question on how to execute, we laid out the following points which remain true today

  • Please review your asset allocation (yourself or with your financial advisor) and plan how much you are willing to allocate to equities. This allocation is based on individual situation and there is no fixed percentage. That said, one should not exceed this allocation.
  • Once you know the amount you can allocate, one of the options is to invest it as per the model portfolio. If that is the case, the amount per position is based on the position size in the model portfolio (multiply position size % with the amount you want to invest)
  • If the current price is below the buy price , you can add that position to your portfolio.
  • I would suggest going for a staggered approach. Start with 25% of the final size and keep adding to it over the next few weeks/months (as long as it is below the buy price). You won’t get the absolute bottom for each position, but should get a decent average price

There is no assurance that things will work out equally well, but history shows that equities offer the best long term returns when there is a lot of uncertainty.

Agency and Fun

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I came across this word recently and resonated with me. On reading about it, I realized that I have always admired this behavior and strived for it. So what is agency?

As per google,

In a person, “agency” refers to the capacity to act independently, make free choices, and exert power to shape one’s own life and experiences. It’s about having control and influence over one’s actions and the outcomes they produce

In India, we call this jugaad

As I look back on my own life and those around me who have done well, I find almost all have had high agency – a drive to improve their life

In my generation, India had started opening up and we experienced the first technology revolution – Internet. A lot of young people in the late 90s joined IT services companies (making switches from other careers), some started online businesses, some moved to the US and some like me started a blog on investing on a whim

I enjoyed reading and investing. Pre-internet it meant getting annual reports from brokers and reading the newspaper. There were no Indian blogs (only US based such as the Motley fool bulletin boards). When I found this new medium, I started writing my own thoughts for no particular reason

Today its called content marketing, but then it felt like writing to myself with no one reading it

One thing led to another – I eventually started an advisory with my friend – Kedar which we have been running for 12 years. I still get surprised to hear from people that they have followed me for years and were reading what I was writing. I never realized that this would happen

The new revolution

We now have another shift in the making – Artificial intelligence. I am equally excited about it. As in the late 90s I get the same tingly Spidey sense of something exciting.

How will it evolve and where will it lead us?

I don’t know, but as I did earlier, I am learning about it and playing with it

I am sure it will be an exciting and fun journey as it happened with the internet. I keep saying to anyone willing to listen to do the same but be less timid

The wrong questions

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We wrote the following to our subscribers


When and at what level will the market bottom?

what should be the cash level in the portfolio to ride out the bear market?

These are wrong questions to ask. Let me explain –

I wrote about preparing for a downturn in my prior note. We have developed a process based on the study of the past bear markets and our failures. The key point is that we ignored some risks in the past which hurt us when the market cycle turned.

We have identified the following risks and managed them as they intensified towards the second half of 2024

  1. Valuation risk: We exited/trimmed several positions in tranches as stocks went from under-valued to fairly and then overvalued. We did not exit these positions in one shot as we wanted to take advantage of the momentum
  2. Position size risk: There are positions we want to hold through the cycle. However, this poses the risk of opportunity loss if the size is too large. We trimmed some of these positions so that we can hold the balance with less stress
  3. Sector concentration: we reduced positions if they were based on the same theme and sector. When a sector goes out of favor, it can impact the stock for a long time
  4. Poor performance: In some cases, the performance of the company was weakening and we exited as the risk reward was no longer attractive

One additional element this time was to review the indices and breadth to gauge the market cycle. As the cycle weakened in Q4, we actively reduced our risk.

In summary, we were focused on managing risk and not predicting what will happen to the market.

Half the battle

We are now at 45%+ cash level which is the highest ever and it is NOT burning a hole in our pocket. This cash level is an outcome of the process

It is easy to feel smug at this point. However, this is only half the battle. Equally important is to re-enter the market and not get locked into a bearish outlook.

We will not depend on market forecast or expert views for it. We have looked at this phase of the market too in the past cycles and have a process of initiating or raising our positions. Some of you have asked how long will it take?

We don’t know. That can only be known if you can predict the market (We can’t)

Graded entry and exit

We had a gradual exit out of several positions to reduce the aggregate risk as the market weakened.  We will re-enter in a gradual manner too driven by our buy process

The buy process for a stock will be based on its fundamentals and risk reward equation. It does not require for us to forecast when and at what level the market will bottom. Fixating on the market level is a waste of time. We are focused on refining and executing our process of finding and entering new positions

This time around, the cash level will also be a result of executing this process

Preparing for a downturn

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We published this note to all our subscribers today


I have been doing a detailed analysis of the past bear markets of 2008, 2016, 2018, 2020 and 2022. I looked at the indices, individual stocks and our past holdings during this period. It has allowed to me understand context of the market and mistakes I made during these periods.

I am listing a few learnings from this study. This should give you a context of our actions in the recent months during which our cash levels rose from 6% to 33% now

The current market reminds me most of the 2007/early 2008 and 2017/early 2018 period. It does not mean that we will have a financial crisis later this year. Please keep in mind that it is about similarities with these periods, but you cannot use it to forecast the market

A few learnings

No one can predict the market but often there are signs of froth, and it makes sense to become cautious. One can guess ‘what’ may happen, even if you cannot figure out when it will happen

  • Valuation extremes: In the past, when valuations hit the extremes, it took months for the excesses to be wrung out of the system. Valuations are now at their 10+ year high in the small cap/mid cap space. Promoters have been launching IPO/QIP etc to raise capital when it is cheap
  • Deep corrections: Theme stocks of the current cycle, no matter how good the prospects, get hit the most and can easily drop 50% or more. Other stocks will not be spared as indices drop 10-30% from peak to trough
  • Nowhere to hide: During deep corrections, there is no place to hide, and all stocks will be impacted. The key is to remain invested in those companies with a robust business model and good growth prospects for the next 2-3 years

Mistakes from the past

We made the following mistakes which I am trying to avoid now

  • We were concentrated in a few sectors/ stocks in the previous downcycle. When these stocks were hit, our portfolio had a big impact
  • We kept buying or held on to stocks which were in continuous down trend. A lot of these companies did not recover for another 2-3 years
  • Heavy losses made us risk averse and we were not prepared enough when the market turned

Some recent actions

  1. Reduce valuation risk – We have reduced or eliminated positions where the valuation was much higher than the median. This was to reduce the valuation risk in the portfolio
  2. Reduce concentration risk – We have reduced the size of some positions which are fairly valued. This was done to reduce the concentration risk
  3. Exit weak sectors – We have exited some stocks where the stock and the sector seem to be topping off and growth is slowing such as the FMCG space

Go forward plan

We have not started a new position for some time.  As we have shared in the past, we will not invest to show activity from our side and justify our fees. We will act only when the risk reward is favorable

Just because the market is down 10% does not mean that it’s a good time to buy. If you expect steady stream of ideas, you will be disappointed as markets don’t work that way. There are times to be active and then times to just wait and prepare

We continue to monitor all our positions and will not hesitate to exit or reduce some of them if the risk reward is not great. Just because a stock is already down, or a turnaround is around the corner is not the right way to make decision.

Experience in prior bear market has taught us that hope is a bad strategy. Take your hits, clean the slate and conserve your financial and mental capital. We will be ready whenever the market turns

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