We have seen superior results with superior insights. But for getting these skills, we also need to know the limitations and how difficult it is to acquire them.
If we are going to identify what will be going to happen tomorrow or the day after tomorrow or next week, next month then we are not going to get success in identifying cycle. Identifying cycle is never easy, it requires a greater effort to capture a cycle in a better way which provides us with an advantage.
Disclosure – Companies mentioned in the article are just for an example & educational purpose. It is not a buy/sell/ hold recommendation.
It is always important to be defensive and aggressive over a different period of time. We cannot be defensive for every time or aggressive all the time. The most important is when we should become defensive and when we should become aggressive, it matters a lot. If we become defensive at the bottom of the cycle and aggressive at the top of the cycle then it will be dangerous for our wealth.
We require aggressiveness, timing and skills for achieving success. Aggressiveness at the right time creates a fortune.
For getting success, we have to focus on key elements mentioned by Mr Marks.
Risk in our portfolio in the cycle, which assets we are holding in the portfolio and among those which are overweight or underweight.
Aggressiveness such as holding second-grade assets, leverage, macro dependent investment, putting more capital at risk. Defensive investment such as holding cash than securities, safer assets, avoid leverage. Selection from above both depends on where we stand at the cycle and what can be a future market development.
The skill requires to make a balanced decision. Luck required when randomness has more effects on the events. Skills help us to make a decision in the portfolio but luck can fail our right decision or proven to succeed in our wrong decision in the short run. Skills win the battle in the long run.
When we found that we are positioned in the cycle where pessimism at lowest, the economy has better development, etc. and we have become aggressive towards portfolio positioning then it will reward us with greater profits while the market does well as per our assumption. And also incur losses if the market does not work as per our assumption.
Being right is not into the control of anyone due to the involvement of randomness and luck factors.
When we found that the economy started being optimistic, the psychology of investors started optimistic, good news started flowing then we need to cut position in our portfolio which we feel overpriced. This effort helps us to reduce risk when slowdown or recession occurs. But this decision requires a skill set otherwise we will underperform the market at whole.
We always have to keep in mind that when the market is low in the cycle then the probability of losses is low and the probability of making profits is higher. Reversely, when the market is high in the cycle then the probability of incurring losses is higher and the probability of making profits is lower. We cannot predict the outcome but we can take advantage of the cycle by making an assumption of it.
After identifying the market cycle, we need to make a selection of the assets. If the price of the asset is lower compared to its intrinsic value then it will do better than other assets. And if the price of the assets is higher compared to its intrinsic value then it will not do much better than other assets. We also should focus that whether the intrinsic value of the assets has scope for further growth or not.
Theoretically, it quoted that the market is efficient and all the information is available with everyone so that no one can make profits from it. But reality shows something different. It shows that few people can think differently from the crowd and get above average than all. This is called second-level thinking where we need to think wise and differently from the crowd. Those who use second-level thinking they can do above average than consensus. This is key to assets selection.
Winners have a tendency to fall less than the market and during the rising market, they meet the market. And those who do not have a skill, they fall more than the market and does not have a higher return when market raises.
Aggressive investors with superior insights, fall slightly more than market in falling time but raise more than market in good time. Whereas defensive investors with superior insights, outperform in the worst time and underperformed the market in good time. We need to keep a balance between both. The person who can make a balance between both aggressive and defensive with superior insights, that investors outperform the market at the worst time as well as in the good time also.
Disclosure – Companies mentioned in the article are just for an example & educational purpose. It is not a buy/sell/ hold recommendation.
We cannot predict the future and cannot see the future so that can we prepare for the future? How can we be positioning our investments? Answers to these questions lie in the understanding of the cycle and at where we stand at the current cycle.
It’s not always what we buy that matters but at what price we are buying that matters a lot.
These checklists help us to an understanding regarding cycle and where we stand at the cycle. That understanding helps us with what we should do and what can be the portfolio positioning. These checklists also help us to remove some mistakes such as buying little when risk is low so that capital allocation decision also can be improved. The capital allocation also one of the key elements to becoming a successful investor.
We all see the everyday events which were covered by the media but we also need to put effort to understand that what it is going to indicate to us. These efforts help a lot to us. I got saved in recent market turmoil due to understanding of the cycle which I have practised after reading “The Most Important Things”.
I want to quote my learning from the most important things here to explain this concept with a few additions.
The earlier scene in the year 2017-18
The current scenario in the year 2019-20
We need to focus on the current scenario what it is indicating to us, not to worry about the future. If the current scenario tells us to stay away and we are into the third phase of the bull market then we need to adjust our portfolio accordingly. And if the current scenario suggests the third phase of the bear market then we need to adjust our portfolio positioning accordingly. We cannot track each and every information flowing around the world but we need to understand which of them are important and help us to reach the conclusion.
When market and psychology of the investors flying then do not care for the valuations. People argue that old valuation techniques do not work in the current period. Another argument is that we should look at the business, not stock so that valuation does not matter. But what happens to this logic when bear take a charge?
Old technique again starts taking place. Higher P/E looks as an unhygienic for the health of the portfolio and low P/E tempted to the investors.
We can see that during the bull period even non-qualitative companies also traded at the multiple of quality companies.
There are qualitative and quantitative two phenomena which we can study to understand where we stand in the cycle. We always need to ask the question to ourselves how the assets priced and how the investors around us behave? That means the quantitative part refers to the valuation of the assets. And qualitative part refers to the behaviour of investors around us & understand it.
Example – one of the E-Commerce company of India
When the market is booming, the psychology of investors is positive, economy growing, people are eager to make an investment then low-quality securities also getting issued by providing a better rating.
We have to be contrarian, have to learn to go against the wind prevailing in the market.
When market falling, people tend to stay away from it. They argue that keep away from catching a falling knife. But when dust gets settled and we realize that the final bottom has made, a bargain will also be gone.
There is no way to know when and at what price exact bottom has made. We come to know about the bottom only after it has made.
We should avoid buying with leverage money because when pendulum moves towards extreme pessimism then we cannot able to know where it will stop and we get a margin call, due to the leverage. We get a disastrous outcome of such an act.
John Maynard Keynes is reputed to have said: “The market can remain irrational longer than you can remain solvent.”
When the economy is in a troublesome period and investors psychology also negative then only, we get a good asset at a bargain price.
We have a two-risk scenario – one is a risk of losing money and the other one is a risk of missing out an opportunity. Investors have to make a balance between the risk. When market moving higher in the cycle, we have to focus more on the risk of losing money and when market-moving lower in the cycle, we have to focus on the risk of losing the opportunity. When there is a high chance of losing money then we have to play defensively and when there is a chance of missing out an opportunity then we need to play aggressively.
The cycle is going to happen and how we respond to it is the key matter. Successful investors are those who have survived under the different market cycle and that cycle makes them more thoughtful.
Disclosure – Companies mentioned in the article are just for an example & educational purpose. It is not a buy/sell/ hold recommendation.
As an investor, we have to deal with the prices of assets and evaluate where currently its standing and what can be in the future. Prices of assets are getting affected by fundamental and psychology.
Psychology of the people does not remain the same forever. It will change for any of the reasons for millions of reasons.
Rising prices of the assets make investors’ psychology in the optimistic area and falling prices of the assets make investors’ psychology in the pessimistic area. The reason and result for the occurrence of the cycle do not remain the same with all the cycle but it is sure to a repetition of a cycle. Performance numbers are already recorded and sometimes, we require skill to understand it thoroughly. This is a past and we are not able to predict the future. It is essential to roughly think about the future to protect our investment. Second-level thinking also help us to understand the psychology of the market participants and act according to our conclusions.
There are few factors which influence and force cycle to occur.
Confirmation bias where investors seek for a piece of information or events which supports the thesis or not.
The tendency toward non-linear utility where we value a money loss is far greater than money made.
The gullibility is which influence the investors to swallow tales at good times which have the potential to gain at a good time and the excessive scepticism that makes them reject all possibility of gains in bad times.
Risk tolerance and risk aversion which investor ask for risk premium for the incremental risk.
Herd behaviour indicates to act with keep in mind that what the other people are doing.
One of the highly influential bias is to see other people making money with the idea which we have rejected initially. We do not resist such situations and left with the buying those assets which resulted in a boost to the asset bubble. Also, we generally do not select an unpopular idea and prefer to go with the herd.
All such biases lastly transform into the greed for more, envy of the money others is making, and fear of loss.
A bull market where prices of assets risen, rising or will raise and bear market where prices of assets fallen, falling or will going to fall.
But there are three-phase of the bull market –
In the first phase, growth and better improvement are invisible to most of the investors. Because it does not have a huge price appreciation, also occurs after the crash, wipeout of the prices has affected the psychology of investors.
In the last phase, prices of assets have risen, improvements are visible & started a long back. This improves the mood of the market and investors where they are ready to pay any price for the assets.
It is obvious that those who buy assets in the first phase, those got assets are at bargain prices and the probability of making money is huge. Whereas those who buy assets are at last phase then assets are available at costlier prices so that probability of losses are higher.
“What the wise man does in the beginning, the fool does in the end.”
Warren Buffett has said much the same thing even more concisely: “First the innovator, then the imitator, then the idiot.”
As we have seen three phases of a bull market, there is also a three phases bear market.
We have to see the problem behind the scene. Because an excess of good things always invites trouble. And an excess of pessimism gives birth to the new era of optimism. We need to focus on each little thing happening into the surrounding which helps us to recognize problem or opportunity earlier than others.
People always get pain when they see others are making money so that they fear continuing of trend and they will miss out on an opportunity. Thus, they also join the trend. Such influence affects the investors who have rightly enter at the first phase and by affecting the psychology, they again enter the last phase where they involve doing the wrong things. The most brilliant person also can fall under such psychological influences.
We also have to understand that the bubble is not always where the market raises and also not bust where the market falls.
If the company is good in quality then also it has taken around six years to reach the same price but if assets are not good quality then it gets disappear after the bubble get burst.
No assets are good enough that it will never be going to become overvalued. Price does not matter and borrowing money to make an investment are a sign of building a bubble. I have met a few of the people who take a loan on credit card, use credit period to trade in the market. Such is a sign of the bubble. This was an incident of late 2017 and starting of 2018.
We can see that good news, maximum availability of the credit, maximum optimism in psychology, maximum prices, minimum potential returns, etc. All come at the same time, which is a signal for the identification of the bubble.
Reversed to the top, the bottom has an inability to get credits, falling in the asset’s prices, maximum pessimism, bad news flows, minimum risk.
Disclosure – Companies mentioned in the article are just for an example & educational purpose. It is not a buy/sell/ hold recommendation.
