05-Apr-12 Leave a comment
Among the many misconceptions/myths prevalent, one is that you should be an active trader if you want to make money from equity markets. Well, ‘active’ does not mean actively buying or selling – but active in being knowledgeable about the economy/markets etc. Not every ball should be hit – good batsmen realize that some balls outside the off-stump should be left alone.
Traditional finance theory have always recommended that individual investors simply buy and hold the market portfolio, or at least a well diversified portfolio of stocks. The typical retail investor doesn’t hold a well diversified portfolio nor does he desist from churning his portfolio every now and then. The attached paper delves into the subject and concludes that younger and male investors trade more aggressively than older and female investors.
In addition to overconfidence and gender, the more frequently individuals invest in information, the more they trade. To stretch the point further, investor psychology research has also pointed out that trading behaviour is also sensitive to the sources of information used by investors. Overconfident investors trade more frequently when they collect information directly using specialized sources. Investors getting stock related information from banks and/or brokers tend to trade more frequently than those who interact socially and are informed via friends and family or those who use non-specialized media like newspapers, financial magazines etc.
News, ‘hot tips’, brokerage reports et al are like deadly vortexes that can suck in an average investor and sink his portfolio hard. When you play information (budget announcements, RBI will come out with a rate cut, employment figures, economic survey etc) you are playing a game which is dominated by the big boys. Big players use news events to trade. In fact, some of them may even not be above ‘creating’ news if there is no ‘real’ news available. I recollect myself buying a share nearly concomitant to the release of a nice upbeat equity research report on the stock only to realise that it was all downhill from there on. May not happen always and maybe i was just plain unlucky and that things are not so murky in the world of equity research, but it pays to be very, very paranoid if you a small chap. In any case, smart money gets to see the research report first before mainline media catches it and sends it out for the universe to consume. Furthermore, when the big players trade, they trade such large holdings that when they initiate trades, they typically move markets. If you are the sucker who’s caught the other end of the rope, chances are very high that you’re the small fry who has come in attracted by the recent news blurb on the stock and are entering the room just as the party’s ending and the biggies are leaving. Best bet for the little ones – do not rush into acting on every thing that you hear or read.
Worst off are the ones caught in the middle – i.e. ones between the retail rats and the fat cats; the higher net worth individuals who do not consider themselves to be small and ergo turn over their capital to professional wealth managers or bank/broker dealers. Sometimes, unbeknownst to them, their money managers may resort to excessive churning of the portfolio in the lure of commissions. In this regard, the stock turnover ratio has been commonly used to measure and keep tabs on such fleet footedness, but really it is another ratio – the commission to equity ratio which is a better way of measuring the impact of excessive trading in a very direct way, i.e. the cost impact.
The chart above shows how often I have traded over the past 10 years.
09-Mar-12 Leave a comment
The latest RBI working paper invites public comments on the topic “Gold Prices and Financial Stability in India“. The paper notes the recent sharp rise in international old prices; examines inter-linkages between desi and international gold prices and finally brings out the emperical observation that the implication of a correction in gold prices on the Indian financial markets is likely to be muted. I also picked up this interesting chart from the paper which compares the real and nominal prices of gold right from 1971. Interesting to note that the precious metal has never “really” breached the USD800/ounce mark, though it came very close to challenging that limit, during 1979/80 and 2011. The nominal price high has been ~$1,900 which came in Nov’11.
Shiploads worth of unaccounted wealth has always kept the demand for gold very high in India, making even someone like John Maynard Keynes liken our desi fixation for it as a ‘ruinous love of a barbaric relic‘. The paper notes this pre-historic Indian yearing for gold but then it makes a point which I don’t quite follow: the authors (of the paper) measure some important macro-economic parameters and restate them in gold terms; and observe that the value of these indicators has actually fallen in gold terms and therefore they conclude that gold must not be in ‘bubble territory’. Duh. Anyways, the paper also notes the fact that the really devastating asset bubbles are the ones that take the banking sector down with it – the dot-com bust has certainly caused lesser damage than the sub-prime crisis. I read up on some literature on the internet on this notion of complicity of the banking sector in global recessions and noted the events that have lead us to today’s line of monetary thinking:
By the 1830s, in England, it was generally believed that the mere legal requirement that the liabilities of the banking system (i.e. public deposits) be convertible to gold on demand was not sufficient to prevent various economic crises. So, in 1844 they introduced the Bank Charter Act which established a currency board – based on gold – to eliminate the banking system’s ability to create fluctuations in money supply. Between prices and money supply, it was firmly believed that prices were the effect and the supply of money was the cause. However, economic crises continued to persist in England in 1847, 1853 and 1865. The prime reason cited for these crises was that the framers of economic policy had not paid much attention to the role of bank deposits in the monetary system.
So, as a result of this, by the 1870s, monetary thinking brought in the concept of the Bank of England being the ‘lender of last resort’ . Gold convertibility was never in question and though financial crises did occur in England from time to time, none involved bank failures. The British experience was well known to observers in the US, where crises involving bank failures were a regular feature of the financial landscape until 1914 – this provided an important impetus for the founding of the Federal Reserve System and there onwards to the following 4 phases:
1. Classical Gold Standard (1880 – 1914): Governments accorded the highest priority to maintaining fixed prices of their currencies in terms of gold.
2. Interwar Gold Exchange Standard (1925 – 39): The techniques developed during the era of convertibility under the gold standard proved insufficient when the need of the hour was to ensure and provide domestic macro stability – ultimately resulting in the Great Depression. Countries cared little about their ‘neighbours’ and freely debased their currencies in order to make exports more attractive in order to grab a slice of the post war economy rebuilding opportunities.
3. The Bretton Woods International Monetary System (1944 – 71): Post WWII, ex Allied nations favoured a regulated system of fixed exchage rates, indirectly disciplined by the USD, which in turn was pegged to gold. All agreed on the need for tight controls. ‘Beggar thy neighbour’ no more.
4. Managed Float (current): The great inflation of the 70s made policy makers re-emphasize the goal of low inflation and to commit themselves to convertibility-rule like behaviour. USA broke away from the Bretton Wood fetters and freed up the USD from the gold overhang. USD thus became a fully fiat currency.
So the cycle continues and gold (in real terms) has again risen to levels that it earlier saw during the runaway inflation levels of the 70s. Gold has always been central to monetary thinking - even in its divorce from monetary planning in recent times, the need for gold is as important as before – by proxy. When a currency becomes fiat – it derives its value from it’s issuer country’s regulations and policies. The modern economic policy of low inflation and mindless credit expansion has all but effectively debased these fiat currencies (USD and EURO). Therefore, the growing interest (and price increase) in gold under the hope that the current regime of managed float will end and we will move back to the era of tighter monetary regulations backed by gold. According to me, if that happens then fluctuations in the price of gold will most certainly impact prices and financial stability. The probability of occurrence of that happening anytime soon is incomprehensible to me. You need an expert to opine on that – but I’d just say that the world revolves around the USD – fiat or not.
The banking sector has very much been in the eye of the storm during the current economic crisis and therefore no one would play blind on a bet that gold may not breach the $900 psychological mark…
29-Feb-12 Leave a comment
This is what I’ve been telling some people around me these days…
Now that we all know that the latest quarterly GDP growth number is 6.1%, I guess my thoughts on inflation & interest rates (here) will turn true and the RBI will start easing down policy rates. I guess if that happens then I will finally be able to redeeem the Axis Banks and the HDFC Banks that I have on my books.
What’s a good bond fund to go long on now? Need to find out. I resolve everytime not to practise the ‘trapper’ style of investing, but always fall prey to it.
A ‘trapper’ style of investing is a personal term I’ve created to remind me on the numerous opportunity losses I have incurred investing on a hunch and waiting for that event to play out, snaring my capital in the process - not to mention some real losses as well. I guess. An example is the big hue and cry around the possibility of IFCI being converted into a bank. I had given in to the temptation and put in a modest amount, laid the ‘trap’ and waited, waited, waited for the poor animals that make our financial jungle to fall into it. I guess the only trap that played out here was that my capital got trapped. 
I can recollect so many other examples from my personal trading journal – the government is about to come out with a favourable policy on cement and lift the restriction on cement prices: so lets pick a clinker crusher or two and wait by the trap! Ditto with sugar stocks some time back. Even before there was that shine which many had taken to PSUs under the hope that they’ll be monetized by the Government’s disinvestment program. Cut to today – have you noticed all those articles and pop-ups, emails, even sms’ and tweets advising “stocks to buy ahead of the budget”, “hot sectors during budget 2012″ etc etc. Avoid this noise please. If you remember conditional probabilities and Baye’s Theorem from your maths classes, your chances of making money are highly conditional – probability of (BEL going up) given that budget makes provision/announcement regarding defence etc etc.
