April 10, 2013
With the recent weakness in the market, I keep seeing articles from unknown investors and brokers giving their bearish outlooks and their utterly meaningless predictions about where the market will be a year from now. Ironically, it will be these same investors who will turn around and become bullish with the next 300 point up day on the Sensex. My point is that your time is better spent trying to identify individual investment opportunities rather than fixating on the level of the stock market. The global macro outlook remains ugly. The events in Cyprus are mind numbing. Imagine waking up one morning and going to your local ICICI ATM and finding out your savings have now been cut by 40%. I think the implications are going to be drastic for the Eurozone as a whole. Additionally, the outlook for the domestic Indian economy is not that bright. Inflation and the Current Account Deficit are too high, which leaves limited scope for the RBI to cut interest rates in order to boost growth. I personally think we’re facing a range-bound market where earnings still increase but overall P/E levels decline as investors pay back for the excess returns derived from the preceding bull market.
The reality is that the market will fluctuate on a daily, weekly, monthly and quarterly basis. The value of your portfolio will also vary greatly along with the gyrations of the overall market. However, the wild volatility will always provide opportunities for value and fundamentally driven investors. I’m by no means a market timer. However, by sticking with my investment methodology and remaining picky about investment opportunities the Value Investing India Report (VIIR) model portfolio is currently 75% in cash. You can see from the chart below that the VIIR portfolio is essentially flat year-to-date. More importantly, the VIIR portfolio has vastly outperformed the Sensex and crushed both the mid-cap and small-cap indices.
We all know that Buffett’s rule #1 is to never lose money. The table below shows how difficult it is to compound your wealth following negative returns in your portfolio. If you sustain a (20%) loss in your portfolio you only need a subsequent gain of 25% to breakeven. However, as your losses compound it becomes increasingly difficult to recover. Following a 50% loss, your portfolio has to double for you to just recoup your prior losses.
The key to success in the current market environment is to remain extremely focused on downside risks. There will be opportunities to purchase great businesses at large discounts to intrinsic value. As Vitaliy Katsenelson wrote in his book Active Value Investing, you need to time stocks and not the market. What’s the difference? In his book he explains as follows:
Timing stocks is not much different from what you are accustomed to doing, except it has to be more proactive. If you don’t like the word timing, call it pricing—you need to price individual stocks. Then you actively engage in a strategy that helps you buy when they are undervalued and sell when they approach becoming fully valued. As a market timer your cash balance is a function of what you think the market is about to do. However, the stock timer’s (pricer’s) cash balance is a by-product of investment opportunities you see in the market.
I actually wrote a full review on Vitaliy’s book, you can read it here, if you’re interested. My cash position in the VIIR portfolio was a function of limited investment opportunities as the market rallied in 4Q12. On a more positive note, I’m now seeing some great businesses trading at significant discounts. As usual, I’m going to highlight them first to my premium access subscribers in upcoming issues of the Value Investing India Report. If you would like to find out more about my investment process and the VIIR portfolio you can click on the following link.
I’ll end by saying that I’m not a professional blogger and don’t make my living off advertising revenue. Neither am I professional author. I’m an investor, who manages my own personal capital. I view the Value Investing India Report as an opportunity to provide my research services to others, without the headache of actually managing 3rd party money. If you’ve ever been a professional fund manager you’ll know exactly where I’m coming from. I’ve also found that by teaching and writing about investing topics, it helps me clarify my own viewpoints and hopefully makes me a better investor at the end of the day.