Don’t confuse brains with a bull market – 16 – MASTERING THE MARKET CYCLE

When there is unusual profitability, higher return ratios command by a business then such businesses attract the incremental capital from others. This incremental capital results into the stiff competition and particular business become crowded where such unusual profitability and higher return ratio gone for a toss.

Reversely, businesses which are not able to generate huge profitability, higher return ratios, huge capital requirements etc. then such businesses fail to attract the attention of the new capital so that fewer players remain in the industry and due to challenging business environment, those few also reduces. This consolidation results in moving a cycle of profitability and return ratios to the improvement level.

Examples – high profitability and return ratios become lower (Telecom) and

Airtel-min

Merely 2-3 telecom operators to ~14 telecom operators and then again reach to strong 2 telecom operators. This journey suggests the rise and fall of companies.

lower profitability and return ratios become higher (Paint)

Asian Paints-min

So that we need to understand that business does not grow to the sky. They all have a cycle. Also, we need to keep in mind that best investors do not get successful all the time. Our human nature makes our success and that also moves in a cycle.

MMC16 01-min

Success changes the people and they start thinking that they are smarter. Success has a negative consequence also where people become richer and motivation level of them started reducing. Unconventional thinking transforms into conventional thinking. Rather we should know our limitations and also, need to understand that we can fail though we become successful investors.

Successful investors believe that they are mastered in the investing and they have less self-doubt, the worry about being wrong and risk of losses. This invites the risky situations.

We have to keep in mind that – “Don’t confuse brains with a bull market.”

Success teaches us to make money and failure teaches us an important of the risk aversion. We always have to focus on risk while balancing between the aggressiveness and defensiveness. When there is a bull market, everyone gives us a piece of advice. But the quality of advice getting checked during the bear market only.

Making money in the market is always an easy task but keeping secured that earned money is a difficult task.

MMC16 02-min

We keep doing hard work and keep learning for achieving success in the investing journey. One success does not make us a successful investor.

If we have earned an Rs.100 cr but we do not have the skill to keep it secure then it will not take time to again reach at zero.

We have seen that when the asset is not accepted by the crowd and all are uncomfortable to hold then the particular asset will be available at a bargain. Similar to us, when we start getting popular, everyone wants to make contact with us, everyone accepts our thoughts then we will not be available at a bargain. We also become crowded. We have to keep ourselves grounded and keep reminding ourselves that no rule, no strategy will work forever.

MMC16 03-min

When risky assets are penalized by the market and due to that, it will be available at the valuation where it will be no riskier.

MMC16 04-min

When there is a monopoly of the business, business generating good return ratios, decent profitability etc. These invites a competition, these plants a seed of failure. Reversely, when everything seems to be worst, then seeds for success getting planted.

Examples – monopoly kind of business worsening due to competition (Auto OEM) and

HeroMoto good to bad-min

Competitive business turns out to be good (Footwear)

Bata-min

We believe that a good time will follow more good times but actually, we forget the cyclical nature of everything especially success. So that good time itself having a seed for the bad time and bad time itself having a seed for the good time.

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

Checklist about market cycle – 13 -MASTERING THE MARKET CYCLE

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.

MMC13 01-min

It’s not always what we buy that matters but at what price we are buying that matters a lot.

MMC13 02-min

MMC13 03-minMMC13 04-minMMC13 05-min

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”.

MMC13 06-min

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

Auto Good-min

The current scenario in the year 2019-20

Auto Worst-min

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.

Infobeam & 8K-min

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.

MMC13 07-min

Example – one of the E-Commerce company of India

Infibeam-min

Infibeam Chart-min

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.

MMC13 08-min

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.

MMC13 09-min

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. 

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