Vijay Kumar Gaba

The financial market regulators (RBI and SEBI) have repeatedly cautioned investors and intermediaries in the past few months. However, regulators’ cautions mostly went unheeded as both intermediaries and investors continued to ignore fundamentals, moved with the momentum, and exceeded their limits – regulatory and financial. Consequently, the regulators have begun affirmative action. Following some preventive and corrective actions the regulators took, there is palpable panic amongst the market participants.

There are a lot of queries, especially from small investors, who are usually gullible and easily get misled by the manipulative tactics used by the devious operators and end up buying junk stocks at high prices. The queries usually include – “should I buy more to average my cost?”; “it’s already down 40% from high, how much more could it fall?”; “The stock is falling daily, should I sell it now and buy lower?”

I do not have any specific answers to these queries. However, from my experience of over three decades, and having seen multiple instances of such manipulative euphoria and subsequent meltdown, I would say as follows:

Cost Averaging

Cost averaging in an individual stock is not a prudent idea, especially for small investors with limited resources. Investors need to aim to earn a return on their total investment. To maximize their return, they need to decide at the time of investing, which investment has the best return potential. If it is one of the stocks they are already holding, they should add to that holding. If it is some other investment option, they should invest in such a better option. Buying more of an underperforming stock if there are better options available would be a bad strategy. It might result in the dissipation of scarce resources (money), compounding of losses, and missing good opportunities.

Catching a falling knife

Not long ago, Future Retail Limited (FRL) was a famous company. The promoter of the company was considered a genius. He pioneered the organized retail business in India. Learning from global retail majors like Walmart (USA) and Asda (UK), he built a strong business in India. However, failure to manage growth and excessive debt created problems for FRL and several other group companies, eventually leading to insolvency. The problems for the group had started after the global financial crisis, but it survived for a few years through selling of assets and business restructuring. Covid-19 hit the company hard and it could never recover from that shock.

Post restructuring of the group in 2016, FRL hit a high of ~Rs634 in November 2017 and has been on a steady decline since then. At the time of Covid-19 breakout (February 2020) the stock of FRL was trading close to Rs350.

Tracking the stock movement from the high of 2017, we get this.

·         The Stock price fell 22% (635-493) in one year from November 2017 to November 2018.

·         If one got tempted to buy it in November 2018, it was down another 33% in the next year (November 2018-November 2019) from 493 to 330.

·         If one averaged it in 2019, it was down another 79% in the next year, from Rs 330 to Rs68.

·         In November 2020, if you thought that the stock is down 90 from its 2017 highs, and how much more it could fall, it was down another 29% in the next year to Rs48.

·         If one believed that it is now available at a dirt-cheap price and bought it, he would have lost 92% of his investment in the next year as the stock touched Rs4 on November 22.

·         If in November 2022, you thought there is not much to lose in this, the investments made in November 2022 are down by 50% as the current stock price is ~Rs2.

·         The investment made at this “lottery” price can still potentially lose 50% to 100%.

FRL is only one example. There are hundreds of stocks that were very popular at one point in time, fell 90-99.9% from their euphoric highs, and never recovered.

Therefore, before cost averaging, investors must understand that a stock down 90% from its high, is a stock that has fallen 25% from its immediate previous price eight consecutive times (100-75-56-42-32-24-18-13-10). If at any point of this journey, you thought that it has already fallen so much, how much more this can fall – the answer is it can still fall another 90-100%.

Selling to buy lower

An investor needs to understand his/her limitations. Most investors do not possess the skills required to be a successful trader in the market. So, it is better to avoid trying these kinds of adventures. If you are comfortable with the fundamentals of the company, ignore day-to-day price movements and stay put. If you are not comfortable with the fundamentals of the company, ignore day to day price movements and exit at once.

I shared my investment strategy with readers in December 2020. I expected 2021 to be one of the most difficult years for investors in terms of high volatility, poor expected returns from diversified portfolios and continued low return expectations from cash and debt. After 3months into the year, I am even more confident about my view.

I continue to believe that to generate normal return on the financial asset portfolio one would need to maintain a certain degree of flexibility in portfolio. A part of the portfolio may be dedicated to active trading, at least in 1HFY22. I am therefore not changing my investment strategy for next 6months at least.

I may share my current investment strategy as follows:

Asset allocation

I shall continue to maintain high flexibility in my portfolio, by keeping 30% of my portfolio as floating, while maintaining an UW stance of equity and debt.

Large floating allocation implies that I shall be trading actively in equity.

(a)   The fixed equity allocation would be 40% against 60% standard.

(b)   The fixed debt investment would be 20% against 30% standard.

(c)    I would park 10% in cash/money market funds.

(d)   30% of portfolio would be used for active trading in equities and debt instruments.

My target return for overall financial asset portfolio for FY22 would be ~7 to 7.5%.

Equity investment strategy

I would continue to focus on a mix of large and mid cap stocks. The criteria for large cap stocks would be growth in earnings; while for midcaps it will be mix of solvency & profitability ratios and operating leverage.

(a)   Target 6% price appreciation from my equity portfolio;

(b)   I shall be overweight on IT, Insurance, Healthcare, Agri input and large Realty stocks. I shall maintain my underweight stance on lenders for at least 1HFY22.

(c)    For trading I will focus on large cap liquid stocks.

Miscellaneous

I have assumed a relatively stable INR (Average around INR74/USD) and slightly higher short term rates in investment decisions. Any change in these assumptions may lead to change in strategy midway.

I would have preferred to invest in Bitcoin, but I am not considering it in my investment strategy due to inconvenience and unease of investing.

Factor that may require urgent change in strategy

·       Material rise in inflation

·       Material change in lending rates

FY21 in retrospect

Whereas the investors have enough good opportunities to invest in markets, the traders are facing many challenges. The biggest challenge is that most trading opportunities are available in the cyclical businesses like commodities and automobile. The price movements in these stocks are sharp and quick on both sides.

Since most of these stocks (metals, sugar, paper, cement, textile, power, auto etc.) have already gained significantly from their recent lows and are no longer available at cheap valuations, the margin of safety in trading these stocks is obviously low. In past couple of decades, the commodity cycles have been short and deep. If this cycle also turns out to be a usual cycle, against a super cycle as widely assumed, the corrections could be quick and deep.

In these circumstances, most of the traders, especially the smaller ones, are forced to trade with small quantities. The holding period is much smaller, mostly less than a week. Profits/losses are booked at much smaller amount. The number of stocks traded is much larger and the quality of stocks being traded is deteriorating with every rise in the prices.

Some readers and trader friends have asked for my views on trading opportunities in the market. I must say, trading in stocks is certainly not my domain of expertise. This requires completely different skills and training. Nonetheless, since a question has been put to me, I must try to answer with whatever knowledge and experience I have. In my view—

·         In past one month the benchmark indices have been mostly directionless. However, we have witnessed heightened volatility in this period. Usually, this phenomenon is witnessed close to the top or bottom of the market cycle. We may not be close to the peak of the market, but certainly we are not close to the bottom either.

·         The risk reward for the traders is negative. The market upside may be limited to 5-7%, whereas the downside could be in the range of 18-20%, even if the indices retrace 35-40% of the up move from lows of March 2020.

·         The traditional signals for correction – Market to GDP, yield differential, EBIDTA Margins peaking, distance from 200EDMA – are clearly visible but being ignored by the market.

·         The rally in commodities is totally counterintuitive and may be driven more by hopes of continuing supply constraints. The inventory buildup may in fact hurt both the hoarder and the financier in mid-term.

·         Most of the IPOs to be launched in 2021 are new economy businesses. The structure of the market is clearly shifting away from the conventional cyclical businesses, in line with the global trends. Tech enables financial services (Fintech), E-Commerce platforms, ITeS, AI etc are likely to get maximum allocation of new money. Intuitively, the market activity shall be dominated by the non-cyclical technology driven businesses. Healthcare and financials may also continue to remain in the trading arena. But commodities and utilities should logically be waiting on the sidelines for another decade at least.