BIBLIOPHILE: THE MOST IMPORTANT THING BY HOWARD MARKS “AWARENESS OF THE PENDULUM”

Posted on August 28, 2017 by Jimit Zaveri under BIBLIOPHILE: THE MOST IMPORTANT THING BY HOWARD MARKS

In the previous article, we have seen that everything moves in a cycle. And if we cannot able to understand the cycle, then we must pay for it. In this article, I am going to discuss on moments of the pendulum and how we can take benefits of its moments.

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We have seen pendulum and its moments. Generally, pendulums do not always remain to the extremes, majority time pendulum stays near to its main point. And whenever pendulum moves towards its extreme then again it will come back towards either extreme. The force of the swing of the pendulum itself responsible for its reversal.

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Generally, our behavior towards the situation is responsible for the swing of the pendulum towards extremes and also responsible for coming back towards its mean point. Investors see the situation with either greed or fear and reach to the conclusion. When people are greedy, they become more optimistic toward the situation and they want to pay any premium for getting that situation favorable. Vice-versa, when people feel fear, then they are not ready to buy the stock at the cheapest value.

Excess greed creates risk taking behavior and excess fear creates a risk aversion among the people.

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As there are two major risks in investing – 1) Risk of losing our capital and, 2) Risk of losing opportunities. But when pendulum moves towards the extreme end, then one of the above risks will dominate our investment decisions.

When pendulum at extreme bullish situation then

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And when the pendulum nears to the extreme bearish situation then

When things happen in a good manner, then people become more greedy and confident about the situations which bring optimism towards the particular situations. People forget the involvement of risk and ready to pay anything for getting the assets. Vice-versa when things not happening in a good manner, then people are more fearful towards the situations and realize the inherent risk. Such situations bring bargains for the assets.

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Sugar prices

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We can able to see that when prices of sugar were low, people not ready to make an investment in the sector, etc. at such situations provide us a bargain opportunities and when things start getting well, we can able to make a good return. Vice-versa when everyone knows about the story, then that story is there in the price. We cannot able to make an abnormal return or chances are high to lose of our capital.

Wise people recognize the bargain first, then others will follow them and run behind the assets for buying it at any premium price.

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We have seen three phases of the bull market. As similar to it, the bear market also has three phases.

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When everyone fears with the negative news, events and they start thinking that such worst situations remain forever. Major bottom occurs over such situations. When everyone forgets that tide can again come in and such situations provide us a bargain opportunity. Vice-versa when everyone thinks that good time never going to end and they can generate higher returns easily, people forget that tide can go out then major top gets formed.

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Those people who understand swing of the pendulum then they have protected their capital as well as made the huge return during the year 2009 and year 2014.

When everyone fears from the situations and think such worst remain forever. When such situations arise then the person who analyses and conclude that things can go better he can generate a better return with lower risk. Vice-versa when everyone thinks that things remain better forever than that is a period of painful losses.

The pendulum never continues to swing towards an extreme, it will be reversed from extreme. Extreme swing of the pendulum is itself responsible for the swing towards the opposite direction of the pendulum.

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Read for more detail: The Most Important Thing Illuminated by Howard Marks

BIBLIOPHILE: THE MOST IMPORTANT THING BY HOWARD MARKS “BEING ATTENTIVE TO CYCLES”

Posted on August 20, 2017 by Jimit Zaveri under BIBLIOPHILE: THE MOST IMPORTANT THING BY HOWARD MARKS

In this article, I am going to discuss on cycles and reasons for the occurrence of the cycle. For becoming a successful investor, we need to understand cyclicity of the market, earnings, business, etc., then only we can able to protect ourselves from the destruction of our wealth as well as we can able to grow our wealth.

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We as a human also born, grow up and die. These cycles keep on continue. And like that company also came into existence, grow up and once it will close or might get some revolution.

(Click here for human life cycle – https://www.youtube.com/watch?v=SdprpVCIhu0)

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As like our life, Economy, businesses, products, earnings of businesses, etc. also rise and fall. It also moves in a cycle. Many a time people forget that everything moves in a cycle and that situation provides us an opportunity for protecting and creating a wealth. We should always keep in mind that nothing in the world keeps on rising in a straightway. It will rise to an extreme level and falls to an extreme level.

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The margin of the company increases when the price of the iron ore increases and margin fall with the fall in the price of the iron ore. We must have to understand the cycle for protecting our wealth.

The main reason for the cyclical behavior of the economy is human involvement. Human nature is not mechanical but humans are emotional and inconsistent. Many a time Humans take the decision based on their feelings, emotions which itself cyclical in nature.

When we feel good, we remain optimistic about the situations and reverse when we feel bad then remain pessimistic about the situations. Our psychological involvement pushes cycle to the extreme points and after that extreme point, cycle corrects itself to the reverse direction and then again come to the mean value.

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If we see carefully, then we can able to understand that more worst loan given at a good time rather at the bad time. Because people forget the cyclical nature of the economy, industries, businesses, etc. also the credit available at cheaper rate. And additionally, people break discipline. They start to borrow extensively which will be resulted into the burst of the credit cycle.

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Credit cycle –

When we are happy then we might get happier for some period and then our mood turns to the sad and vice-versa. Our mood also keeps on fluctuating and that turns out to be our happiness or sadness. Sometimes we become extremely happy or sad, but that situation does not remain similar for forever. It will change, it will get normalized.

So, if the cycle is in a good phase, then it might be remaining more good for the period and then correct for the bad phase and vice-versa. It will not remain good or bad for forever. It will come to the mean value at some point in time.

The cycle only stops occurring while people take all decisions by being unemotional and rational. But it is not always happening and such human decisions which will be resulted in the cyclical behavior of the market /economy. And this is only the major reason for keeps on occurring cycles.

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High profit into the business attracts the competition. This competition will turn high-profit margin into the low-profit margin. And business will fall into the problem. Many players get close and get out of the business. Consolidation of among the players will happen and few players survived in the business. Those survived players will again be getting a good amount of business and the again cycle starts moving. No business keeps on growing for forever with the same pace of growth.

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The growth of Indian IT is falling compared to initial days. Also, players among the industry and startup are rising rapidly.

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We always need to keep in mind that everything moves in a cycle and when we forget it, we will be at the risk of losing our capital.

Read for more detail: The Most Important Thing Illuminated by Howard Marks

BIBLIOPHILE: THE MOST IMPORTANT THING BY HOWARD MARKS “CONTROLLING RISK”

Posted on July 16, 2017 by Jimit Zaveri under BIBLIOPHILE: THE MOST IMPORTANT THING BY HOWARD MARKS

In the last article, we have talked about the identifying risk and recognizing risk. Now, in the current article, we discuss regarding controlling the risk. Generally, in the market, we put much emphasis on the higher absolute return instead of superior risk-adjusted return. But the great investors are those who focus on the risk and generate moderate returns with low risk or high return with moderate risk.

Generating higher returns with the higher risk for a long time is rare in the market. The risk of losing money arises when our investment meets adverse situations and Loss does not occur till the negative events occur. We should always focus on controlling the risk because we do not know that when the negative situation arises and we met losses.

When we bought the home, we check that the home is constructed in a way which can be protected by earthquake or not. The similarly, we should focus on our investment. We should focus on the situations where the occurrence of such negative situations can destroy our wealth. And work as an earthquake in our financial position.

It can be possible that an earthquake will never happen in life long, but we bought the home which can be protected with an earthquake. Similarly, it may be possible that adverse situations will not arise during our investment time, but we should focus on raising of adverse situations and how we can able to protect our wealth from such situations.

The risk is not always easily visible. If our surrounding environment is positive, then we start thinking that negative situation may not arise due to the influence of that positive environment. But in fact, the risk is always present in the good environment also. And anytime good environment can easily turn out to the bad environment. Such transformation does not come to us with the prior intimation. We must have to be ready properly with such considerations before making investment decisions. Even controlling risk is becoming essential into the good environment because nobody is talking about risk and in a bad environment, risk takes care of itself because everyone fearing of risk.

Generating superior return compared to benchmark with the similar risk nature is a good performance. But, a good value addition is while we generate a return which is like the benchmark return with the lowest risk and with proper controlling of the risk. Such scenario is even better.

When the environment is positive, everyone rides the wave and we cannot able to say which one is better. (Good article – Doubled your Money in Last 3 Years ? Skill or Luck ?)

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So that we should always focus on the controlling risk, whether it will rise or not. Because we cannot able to really predict the occurrence of the risk.

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Careful investors always know that they cannot able to know the future so that they try to focus on controlling risk and try to factor the risk of loss of capital while they make any investment decisions.

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We start avoiding focusing on risk as the environment is going positive. Initially, we might put weight on risk, but many times that risk might not get triggered. So that we start avoiding it and started believing that there is a no risk into the environment. Such risk will not occur and we saved from the negative situation.

As we have seen in Russian Roulette with 100 chances, we may save for 99 times, but the 1 time can kill us. Or if we are lucky we can be saved all the 100 times. It doesn’t mean that there is no risk or risk may not arise in the future.

Example – THE EVENTUAL CONSEQUENCES OF RISK SEEKING OR RISK BLIND BEHAVIOR

We constructed belief in our mind from our past experiences. If we have seen the positive environment, then we have made belief that negative situations never come. We should always keep in mind that occasionally extreme situations can arise and that can be out of our all belief.

In the year 2007, also welcome structured products, huge capital inflows, etc.

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We should not run from the risk but should manage risk intelligently. We should take the risk, but at the appropriate time and most importantly at an appropriate price.

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When we walk on a road with keeping our eyes closed and we do not meet an accident, then it’s not our talent, it’s a pure luck which plays out. We are a real blind if we consider such situation as our own skill. And such risky situations do not stay rewarding for a long period and we must walk on the road with keeping our eyes open.

Read for more detail: The Most Important Thing Illuminated by Howard Marks

BIBLIOPHILE: THE MOST IMPORTANT THING BY HOWARD MARKS “RECOGNIZING RISK”

Posted on June 25, 2017 by Jimit Zaveri under BIBLIOPHILE: THE MOST IMPORTANT THING BY HOWARD MARKS

We have seen the process for the identification of risk in the previous article of the same series. In the current issue, I am going to discuss regarding recognizing of the risk.

For the successful investing, we must have to focus on the generating return with having a proper control on risk. And for the controlling risk, we require to identifying and recognizing the risk.

The risk is always being at a much higher where we are too much optimistic towards the particular scenario and also paying a much higher price for the buying particular asset. But we should focus on When odds turn out against us than how we can able to protect ourselves or get out of such scenario with least damage. So, for the protecting ourselves, we need to avoid paying too high prices and also keep ourselves away from the extreme level of optimistic sentiment.

Click for Video — Auction scene

We always forget the real worth of the assets in the bull phase and start chasing that asset class. Such behavior is dangerous for the health of our wealth. This increases the risk while we are purchasing assets more than its worth.

The market always works in a pendulum and people generally forget the nature of the pendulum. The pendulum always moves towards the both extreme directions.

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Whenever pendulum moves towards the bullish extreme, many of us forget that such situations will not stay forever. Many of us forget about the risk which involves during the bull phase. And start taking higher risk for generating higher returns; which invites further huge amount of risk. At bullish sentiment, people generally buy assets at the highest valuations multiple and that invites the risk to the particular asset class. This scenario has a very high chance of getting damage to our wealth compared to generating a higher return.

Reverse to such scenario, whenever the pendulum moves towards extreme bearish phase, then generally people start recognizing the risk and start avoiding to invest in the particular asset class; which take out the risk from that particular asset class. Such scenario is the appropriate time for capturing the opportunities because in such scenario we have very less chance to lose.

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Many a time due to bullish sentiment, we think that the risk is very low, we start taking more risky situations, also start taking leverage and from that time risk starts taking its shape. Our behavior towards particular asset class invites risk.

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Risk will be only low if we as an investor behave in a careful and wise manner. We cannot eliminate the risk, but we can able to control its effect. We have to analyze risk in every scenario. Risk always has its presence, though we are having a bullish sentiment. And according to me, the risk is much higher while having a bullish sentiment.

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At the extreme bullish sentiment, we forget to worry, fear of loss and instead of it, we think about to miss the opportunity. We think that all others will earn the money and we remain without earning money. We start taking much leverage and believe that we are living in a low-risk world.

Click for Video — Bull phase in auction

We have seen in the above video that the person who doesn’t want to purchase a horse for the Rs.5 lakh; same person bought the horse for the Rs.5 lakh due to the influence of the increasing value of the bid for the horse. The person doesn’t want to lose the horse and cannot see others to take that horse.

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