06 – THE CYCLE IN PROFITS – Mastering The Market Cycle

Posted on February 9, 2020 by Jimit Zaveri under Bibliophile: Mastering The Market Cycle

As we have seen that the economy moves in a cyclical way and if the economy moves in a cycle then the industry will get affected by the cycle and due to that corporates also getting affected. The profitability of corporate earnings has been affected by the economic cycle. But such effects vary from company to company as per the inherent capability of the company.

Corporate profits rise and fall more compared to the GDP growth and we need to focus on factors that cause such cyclical trends.

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And when GDP shows weakness

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So corporate profits also getting affected by the economic cycle. We can argue that food, beverages, pharmaceuticals do not have any impact on the economic cycle. Yes, not high but during a recessionary environment, people tend to save more than what they earlier used to. People prefer to eat at home rather than to go out to a restaurant. People prefer to cut costs while experiencing a tough time.

Durable products majorly affected by the economic downturn because such goods can last longer and people can defer spending on such goods.

We should not have to directly consider that increases in the sales will similarly result in the increase in profits. This is because of the operating leverage. Cost mainly remains fixed and few costs increase with the sales.

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In general, it’s higher for companies for whom a larger percentage of costs are fixed and lower for the ones whose costs are more variable. Operating leverage helps the companies when the economy is in good shape and sales rising. But when the economy and sales are in bad shape, profits fall more than sales.

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Other than these, there are few other factors which can also affect the profitability of the companies such as management’s decisions regarding inventories, production levels, and capital investment; technological advancements (on the part of a company, its industry competitors); changes in regulation and taxation; and even developments exogenous to the industry or war, weather, etc.

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The technological disruption led cycle such as streaming has killed the DVDs culture so that those businesses which does not welcome technological changes, they all get out of the business. Nokia & Kodak are also the biggest examples of got the worst hit on business.

Disclosure – Companies mentioned in the article are just for an example & educational purpose. It is not a buy/sell/ hold recommendation.

Read for more detail: Mastering The Market Cycle: Getting the odds on your side by Mr.Howard Marks

04 – THE ECONOMIC CYCLE – Mastering The Market Cycle

Posted on January 26, 2020 by Jimit Zaveri under Bibliophile: Mastering The Market Cycle

The economy also moves into the long term and short-term cycle as an industry, stock market and everything else moves which are explained further.

Long-Term cycle

We know that the growing economy graph going upwards in the long term but it has short-term ups and downs.

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Long term straight line is made up of small cyclical ups and downs of the economic cycle of recession and recovery, slowdown and prosperity. These are part of any economy.

Everyone gets agree with the above point but we also need to understand that long-term trends also having a cyclical move as same as the short term. Here we also need to put a focus.

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We can see that the GDP of India has moved from US$ 0.04 trillion to US$ 2.72 trillion which shows long-term up moves but if we see shorter-term momentum of growth rate than it shows highly fluctuating with ups & downs.

When Population growing it will lead to more consumption and that encourages more production. For producing more, companies need more working hours and that will be converted into more GDP.

So, population growth remains key to the growth of an economy. If growth converts to degrowth then economy starting to shrink.

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When the growth of population changes, it affects the GDP growth for a longer period of time. When a child gets born then it takes around 20-22 years for a child to become an employee. Also, migration from other countries replaces the birth rate of the country. Migration from other countries also enhances consumption and productivity which resulted in growth in GDP.

Another factor that affects GDP growth is productivity. As productive can be raised despite any growth in the population, then GDP also grows or getting slow with the slower or declining in productivity. We have seen the growth of productivity when human labour replaced by machines, new automobiles, electricity, and computer has introduced. But these all have taken decades of time to affect the GDP. So, for the year to year productivity remains steady. This is not a change that will come overnight and disrupt everything rather it will slowly create changes over a long period.

The aspiration to live a better life encourages people to work hard and produce more. Educational people contribute more to the economy but if people do not like to be educated then it will affect negatively the economy. Such negative effects need to be overcome by the migrated.

Technologies that introduce new businesses and replaced the older. Also, it affects employment.

Automation might have an effect on reducing employment, and thus income and consumption will also decline which again affects the GDP growth.

Globalization provides a chance to export to the other economies which enhances the GDP growth. But the impact negative to the economy which only relies on the import from the other economies.

Short-term cycle

We have seen that many factors take time to affect a long-term trend of GDP. Then why short-term fluctuations occur and why we need to focus on it?

There are factors that cause short-term fluctuations in GDP growth. We always need to focus on those factors to get an edge to our investment. The actual investment game is to getting superior returns than average. We should not focus on the correct forecast but should focus on the superior forecast.

Many of the economists extrapolate current trends and publish reports on it. Such information is available with every so that it does not add much value. Also, we do not get superior returns by doing the same what the majority is doing. It is easy to make any forecast on the excel sheet but it is very difficult to keep it near to reality.

Spending patterns of the individual affect the production of the companies and that has an impact on the GDP growth.

Similarly, companies feel that demand remains robust then they keep on producing more and more but what happens when demand does not come. These unsold goods added to the inventories and companies has to cut production until inventory does not come back at a normal level.

Recession in an automobile has impacted the inventories of OEMs

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Few events also affect the performance of GDP such as war, changes in tax rate & trade barriers by government, cartels in the price of commodity, drought, flood, hurricane, and earthquake.

Superior forecast where we identify the deviation from the long-term trend and recent status of it. Identifying such deviation provides us with an edge. But identifying such is not an easy task and not all unconventional deviation also gets correct. We remember people for their correct unconventional prediction but they also have many failed predictions.

These all short-term factors affect GDP growth in a shorter time frame but that also helps us to get an edge into our investment. So that we require to have a keen understanding of all and focus on it for taking benefits.

Disclosure – Companies mentioned in the article are just for an example & educational purpose. It is not a buy/sell/ hold recommendation.

Read for more detail: Mastering The Market Cycle: Getting the odds on your side by Mr.Howard Marks

Interest rate cuts: Does it provide long-term benefits?

Posted on August 11, 2019 by Jimit Zaveri under Investment Philosophy

When rate cuts happen, people think that the economy is weak so that it required a rate cut. The reduced rate provides stimulus to the economy which resulted in the stronger GDP, higher corporate profits and higher stock prices. This is the first-level thinking.

Rather second-level thinker thinks that –

Why do rate cuts happen?
The economy is weak or weakening?
What damage can occur if rate cuts not happen?
How much worse it is?
Does this rate cut help to revive things?
Shouldn’t we need to take rate cut as a worrisome scenario?

A very nice example quoted by Mr. Marks that when we visit a doctor for our weak health and then he works on healing us through higher treatment, should not this worrisome for us?

First level thinker takes it as this treatment heal us and we will get all right soon

Whereas second-level thinker take it as –

how much worse it is that such high treatment is required? Or the situation is worsening highly?
Does it resolve the issue?
Is this treatment sufficient?

We need to think that the doctor has to bring a higher treatment that means simple treatment does not go to work for healing us. This means either issue is big enough or it is on the way to becoming bigger. So that when we have a bypass that means chest pain is not because of a gas problem but actually, we have a heart attack.

What can lead to growth at a lower interest rate?

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Lower cost of borrowing – lower interest on EMI – more savings leads to more spending on the consumer front and that resulted in the GDP growth
Lower cost of borrowing – encourage businesses to make an investment – lower cost leads to more cash left with businesses to make further Capex – earning starts growing – more dividends or stock buyback enhance cash inflow to the investors – more spending – that increases GDP
Consumer spending increases – demand increases – encourage businesses to invest – more employment opportunities – more wages – increase consumers spending – GDP increases

The most important thing is that when interest rates go down then we reduce discount rates also. So that lower discount rates resulted in the higher assets prices. And lower rates encourage investors to take more risk to earn more return in the low return world.

Rate cuts provide hints for future rate cuts. And the above cycle keeps repeating.

There are many situations where lower rates are undesirable –

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Low rates increase the inflation (some inflation is required for the growth but excessive can kill) – too much inflation increases cost of living – it makes hard for people to spend more money – lower rates reduces the return on the cash, money market investments, high-grade bonds so that people make an investment into the risky products to earn more return – people take more leverage to make an investment – this creates an assets bubble & some point of time it will burst.

Due to the lower interest rates, we provide lower discount rates to the assets which have increased the price of the assets and when the bubble burst interest rate increases which creates huge damage to the prices of the assets.

This is like painkillers which cure pain for now but harmful to health over a longer period if we continue with taking painkillers frequently for immediate relief then it can destroy our health in the future. So, we need to be careful while taking a painkiller for curing pain at the time.

We need to focus that whether growth is natural or artificial stimulating growth. If growth is not natural then central bank and government have to take measures to boost growth. Such kind of growth does not survive for long without stimulation.

As current slowdown is not only cured through rate cuts but the government need to bring further measures which can provide long-term domestic growth without any temporary stimulation. Temporary stimulation brings future demand in the current period or till the stimulation remains in the force. After that demand starts getting dry up. Such a stimulus can be more harmful and lead to huge damage to the economy at whole.

Inspired from Howard Marks memo – “On the other hand”