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”

BIBLIOPHILE: THE MOST IMPORTANT THING BY HOWARD MARKS “Combating Negative Influences”

Posted on September 10, 2017 by Jimit Zaveri under BIBLIOPHILE: THE MOST IMPORTANT THING BY HOWARD MARKS

In this article, I am going to discuss regarding the psychological factors which affect our decisions negatively.

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Market many times provide us an opportunities to earn superior performance through inefficiencies, mispricing, misperception, mistakes of other people.

But the question is why such opportunities come? What makes us different from other people? Why mistakes do occurs?

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We need to analyze data and reach the conclusion. In investing errors occurs not due to analytical factors but errors mainly come from psychological factors.

Let’s look at the few psychological elements which affecting the investment decisions.

First emotion is GREED – Desire for money.

Most of us are making an investment for making more money. If we don’t care about the making more money than we are not going to make an investment.
And also there is nothing wrong with trying to make money. The market and economy run because of our desire to make money. But we should remain careful with a transformation of desire towards greed.

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Real estate

Real estate sector in India in the year 2007-08 creates a bubble and huge jump in the optimism by everyone. Such situation resulted under the sharp fall in the value of the sector.

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Due to an impact of greed, people hope that their strategies help them to produce higher returns without taking higher risk for forever. And due to this hope, many times people hold highly priced securities with expectations of more appreciation can be possible. Many times such expectations went wrong and prove that expectations were unrealistic and people have ignored the risk.

Opposite of Greed is FEAR. As similar to the greed, excess fear is also harmful to the investors. Excess of fear stops us from taking a constructive decision while actually, we require taking such decisions. Due to fear, many a time we cannot able to make a good investment and also lose the opportunity.

The third factor is PEOPLE’S TENDENCY TO DISMISS LOGIC.
Generally, it happens that people stop using logical thinking and they start doing work with an irrational mindset. Many a time, we are not ready to accept logical reasoning for the situations and work as per unrealistic scenario. We do not apply what we have learned in the past but get easily deviate from those learning.

When market or a particular strategy starts generating higher returns for a while, then we started believing that it will continuously generate such returns without an involvement of risk.

Howard Marks called such situations as “Silver bullet”, the Holy Grail.

But is it really same strategy keeps on generating higher returns without risk?

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As Warren Buffett mentioned, when prices started rising then it affects to the reasoning power of the people. It led to mania and situations of mania results towards the bubble.

The fourth factor is THE TENDENCY TO CONFORM TO THE VIEW OF THE HERD RATHER THAN RESIST.

Many a time, we started Believing to the crowd and starts to take an action as per the crowd behavior. Though behavior of the crowd is harmful and dangerous to us.

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The fifth factor is ENVY. Envy comes into the picture when we are comparing ourselves with others. And envy works as a negative force which affects our decisions.

When we see that our investment is growing then we remain happy. But the time we start comparing our investment returns with investment returns of others then we become sad. Now, envy starts showing its color and we make decisions which we may not take or which may be harmful to the financial health.

It is very difficult to see the higher growth of other compared to our growth.

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The sixth factor is EGO. Ego gets satisfaction while we generated higher returns compared to others. And we are keeps on evaluating our return in the short term. While we should focus on the longer horizon returns rather than keeps on tracking returns in the short term and also try to get out of the trap of ego. Ego can be harmful to the financial health. We keep on demonstrates that how much we know much compared to others rather than focusing on how much we know and how much we do not know.

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The seventh factor is the CAPITULATION. It means investors give up towards the situations while economic and psychological pressure becomes irresistible.

Many a time, overpriced assets become more overpriced, and underpriced assets become more and cheaper. This scenario affects to the psychology of investors and repetitions of such situations inspired investors to give up towards the situations and make investment decisions without using logical reasoning.

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When few or all the factors combined then it affects to the investor’s decision making and that affects the market. This resulted in the mistakes and those can be expensive for our financial health.

Psychology in IPO is funny. When our friend is applying to IPO and we asked for the business then he doesn’t know about the business. But he is applying for getting good returns. And he continuously getting higher returns and such higher returns earned by our friend attracts us to make an investment into the IPO. And such situations keep on repeating & more people get involved into the IPOs.

IPOs