Business Standard agrees with me!!

Business Standard seems to agree with me on my previous post. Today morning's cover story in the paper is regarding the Crisis of Confidence!!

Crisis of Confidence

It is so interesting to see investors oscillating between optimism and pessimism within a span of a few months. A few months ago, everything was fine. US was getting out of recession, although slowly. And small insignificant countries like Greece had some issues with their debt. Now, the reverse seems to be true. US is already in a recession (double dip, with ketchup, if I may add!!), as commented by George Soros and Euro is near disintegration!!

I, as a Munger devotee, think that a "Lollapalooza Effect" is happening here. There are too many negative external stimuli happening together. This is probably making it difficult for people make sense of the market. The major negative external stimuli at this point in time are:

• US recession (single dip, double dip, who knows!!)
• S&P downgrade of US debt
• Eurozone crisis and possible default by Greece
• Slowdown in emerging markets (India, China, Brazil the whole lot)
• Policy paralysis in India
• Rise in interest rates in the India
• Continued inflation

People are not able to understand the implications of all these individual events are are running scared of possible worst case scenarios for all of them.


I think that the whole issue can be boiled down to a small phrase - "Crisis of Confidence". There is a lack of confidence in the political leaders throughout the world. Americans don't have confidence in their leaders to get to a solution without printing dollars or crippling the economy. Europeans don't have confidence that their leaders can sit together and thrash out an agreement to really do something. Indians have never really had confidence in their leaders post-independence, so nothing really has changed. But, this current UPA-II is fighting hard to be the worst government of all time - a government which does not govern!!


I think what will happen now is that the political class will start to get their act together. They have their back to their respective walls right now. In India, I am hopeful that some policy reforms may be announced along with some market friendly announcements to boost investor confidence. 

Till then, buckle up. The ride is going to get rougher.

Guru Speak: Seth Klarman interviewed by Jason Zweig

I have been a great admirer of Seth Klarman since the time I read his book "Margin of Safety". recently, I came across a transcript of an interview that Jason Zweig of the Wall Street Journal conducted in May 2010. Here are some of the important snippets from the interview.

JZ: What went wrong in 2008, and how did so many Value Investors get hammered?
SK: Value investing doesn’t work all the time, you need to expect periods of underperformance.  In the Pre 08 period, the world was valued on an invisible LBO Model.  Stocks were not allowed to get cheap because of an underlying expected LBO bid.  But when the model got fragmented, the template no longer made sense.  So in order to do well, equity minded investors needed to be more agile in 07/08 and have an opinion on subprime mortgages and the ripple effect.  Bank stocks looked cheap unless you thought their capital would be destroyed.  Also the modern day pressure to be fully invested and on short term performance didn’t help.


JZ: In 1932, Benjamin Graham wrote in Forbes, “Those with the enterprise lack the money and those with the money lack the enterprise to buy stocks when they are cheap.” How did you have the courage, was it easy to step up and buy in the fall of 2008?
SK: “Yes, it was easy.” The critical thing to understand is that securities are not pieces of paper that fluctuate in price tick by tick, instead they are in fact claims on earnings or assets of businesses. If you have conviction in your analysis, you will hold and buy more.  So what do we do to give us conviction? 

1.) Find compelling bargains, not slight bargains. 

2.) Test everything with sensitivity analysis.  

3.) Prepare to be wrong.  

It’s not courage, it’s arrogance, when you buy something, you’re saying you’re smarter than everyone else.  We realize we have lots of smart competition and temper our arrogance with
humility to realize that many things could go wrong.  Our own confidence matters, and we’re highly disciplined buyers and sellers to avoid round trips and take advantage of short term sell offs. Courage is a function of process.

JZ: In Margin of Safety, you were critical of Indexing, is that still the case?
SK: There is no perfect answer.  Yes, I still believe indexing is a horrible idea.  Stocks trade up when they’re added to the index so the index investor is paying up.  I’m more likely to buy the companies kicked out of the index.  For the average person, however, they don’t do enough research to own individual stocks.  The idea of owning stocks for the long run is a disservice to investors, because many of the people are not there for the long run.  Many got out in 2008 when they should have been buying, because the entry point matters most.

JZ: In Margin of Safety, you said commodities were not investments since they do not
produce cash flows, one possible exception being gold.  Do you still feel this way?
SK: I haven’t changed my mind, but that statement was in reference to rare stamps, or fine art, etc.   Valuing collectibles based on a future sale to a greater fool is speculating.  There is no way to analyze what it will be worth in the future.  Land is complicated because it will be valuable to future buyers and it can have cash flows. Gold has been thought of as a store of value but it is just a commodity and therefore it is a speculation.  I own gold because I want exposure to a devaluation of all paper monies.

JZ: Everyone says it’s never the analyst’s fault, but often they don’t stick to this when something goes wrong. How do you screen for Intellectual Honesty in your hiring process?
SK: We ask about their biggest mistake, which doesn’t have to be investing related. But if you say your biggest mistake is wearing mis-matched socks one day, then that’s likely not being intellectually honest.  We ask ethical questions, ask them how they’d respond in morally ambiguous situations, we want to see that they realize conflicts can exist.  We want people who fit in.  One key thing is idea fluency, if I present a thesis I want people to immediately come up with 10 places to look to exploit it, I don’t want them sitting at their desk thinking, “hmm, where should I look?"

JZ: What about the individual investors whose sell orders went off at $0.01? {This question was in relation to computer-based short selling.}
SK: Never use market orders. You’re not a seller at the market, the market changes
too fast.

JZ: Can you define a Value Stock and what is your average holding period?
SK: As for a Holding Period, we buy expecting to hold a bond to maturity and a stock forever.  Now we may turn over quicker if there’s rapid appreciation and the return from the current price doesn’t seem to compensate for the risks anymore.  There’s no such thing as a Value Company.  Price is all that matters. At some price, an asset is a buy, at another it’s a hold, and at another it’s a sell.

JZ: Any Book Recommendations (besides Margin of Safety and Security Analysis, of
course)?
SK: Read as much as you can about the markets, economy, and financial history. Never stop reading.  Specific book recommendations include "The Intelligent Investor", Greenblatt’s "You Can Be A Stock Market Genius", Whitman’s "Aggressive Conservative Investor", Anything from Jim Grant (he’s a great thinker, even if his predictions may not turn out right), Roger Lowenstein has not written a bad book, anything from him. Also Michael Lewis, who also hasn’t written a bad book either, but specifically "MoneyBall" which will go down as a definitive book on investing.  Also "Too Big to Fail" is good.
JZ: I’ll add "How to Lie with Statistics".

GuruSpeak: George Soros on Euro

The legendary investor George Soroshas some radical views on the Euro and Euro zone.

Angela Merkel then declared that the guarantee should be exercised by each European state individually, not by the European Union or the eurozone acting as a whole. This sowed the seeds of the euro crisis because it revealed and activated a hidden weakness in the construction of the euro: the lack of a common treasury. The crisis itself erupted more than a year later, in 2010.

... at present in the eurozone one of these authorities, the common treasury, has yet to be brought into existence. This requires a political process involving a number of sovereign states. That is what has made the problem so severe.

The outlines of the missing ingredient, namely a common treasury, are beginning to emerge. They are to be found in the European Financial Stability Facility (EFSF)—agreed on by twenty-seven member states of the EU in May 2010—and its successor, after 2013, the European Stability Mechanism (ESM). But the EFSF is not adequately capitalized and its functions are not adequately defined. It is supposed to provide a safety net for the eurozone as a whole, but in practice it has been tailored to finance the rescue packages for three small countries: Greece, Portugal, and Ireland; it is not large enough to support bigger countries like Spain or Italy. Nor was it originally meant to deal with the problems of the banking system, although its scope has subsequently been extended to include banks as well as sovereign states. Its biggest shortcoming is that it is purely a fund-raising mechanism; the authority to spend the money is left with the governments of the member countries. This renders the EFSF useless in responding to a crisis; it has to await instructions from the member countries.

 

The seeds of the next crisis have already been sown by the way the authorities responded to the last crisis. They accepted the principle that countries receiving assistance should not have to pay punitive interest rates and they set up the EFSF as a fund-raising mechanism for this purpose. Had this principle been accepted in the first place, the Greek crisis would not have grown so severe.

These two deficiencies—no concessional rates for Italy or Spain and no preparation for a possible default and defection from the eurozone by Greece—have cast a heavy shadow of doubt both on the government bonds of other deficit countries and on the banking system of the eurozone, which is loaded with those bonds.

In any case the current intervention has to be limited in scope because the capacity of the EFSF to extend help is virtually exhausted by the rescue operations already in progress in Greece, Portugal, and Ireland.

In these circumstances an orderly default and temporary withdrawal from the eurozone may be preferable to a drawn-out agony. But no preparations have been made. A disorderly default could precipitate a meltdown similar to the one that followed the bankruptcy of Lehman Brothers, but this time one of the authorities that would be needed to contain it is missing.

It appears that the authorities have reached the end of the road with their policy of “kicking the can down the road.” Even if a catastrophe can be avoided, one thing is certain: the pressure to reduce deficits will push the eurozone into prolonged recession. This will have incalculable political consequences. The euro crisis could endanger the political cohesion of the European Union.

To resolve a crisis in which the impossible becomes possible it is necessary to think about the unthinkable. To start with, it is imperative to prepare for the possibility of default and defection from the eurozone in the case of Greece, Portugal, and perhaps Ireland. To prevent a financial meltdown, four sets of measures would have to be taken. First, bank deposits have to be protected. If a euro deposited in a Greek bank would be lost to the depositor, a euro deposited in an Italian bank would then be worth less than one in a German or Dutch bank and there would be a run on the banks of other deficit countries. Second, some banks in the defaulting countries have to be kept functioning in order to keep the economy from breaking down. Third, the European banking system would have to be recapitalized and put under European, as distinct from national, supervision. Fourth, the government bonds of the other deficit countries would have to be protected from contagion. The last two requirements would apply even if no country defaults.

You can read the full article here:
http://www.nybooks.com/articles/archives/2011/oct/13/does-euro-have-future/

Parag Parikh's view on the US downgrade by S&P

We tend to make decisions based on the currently, readily available
information vividly displayed. Open any newspaper or flip through a business
channel, or go to a party, there is only one talk of the US being downgraded
by the S&P. Why? Because of the high fiscal deficit and the high amount of
debt. Is this really new? Did not the world know about it? So why the
reaction? Well it is because of the availability bias. Today the downgrading
is the centre of attraction. 

Go back a couple of months in the memory lane.
The 2G scam, the Anna Hazare fast, the CWC games scandal. When they were the
centre of attraction the newspapers, the TV channels concentrated only on
those news. Although none of the matters have still been sorted out, how
much reporting does one see? Over the next week the euphoria on the down
grade will die down.

As the fear dies down and the reality dawns, things will improve. When this will happen, no one knows. It can be tomorrow, a week or a month or a year from now. You make the choice.

One another bias investors are prone to is the Representative Bias. The 2009 crisis still haunts investors. The way the stocks lost values is still very vivid in the minds of investors. One should not consider the recent downgrade and the fall as a representative of the 2008/2009. This is very different. We are not in a situation like that.

Lastly coming back to the downgrade by S&P. If they were so good in their judgments what happened in 2008/2009? Were they able to assess the quality of derivative mortgage backed securities which led to the downfall of so many financial institutions and banks? 

We are living in a society where insanity and irrationality works. The best way to survive is to follow a process and be disciplined to keep to that. The process: Buy good sustainable businesses available at attractive valuations and run by good management. The discipline: Think long term and not be swayed away by market swings.

Read the full post here: https://www.ppfas.net/blog/2011/08/08/sp-downgrade-caution-or-an-opportunity/

2008 vs 2011 - Which is a greater crash?

Fundamentally, we are not even close to the problems that were there in 2008. Credit markets froze then. Now, nothing of the sort is happening. S&P is basically getting back at the political top brass in the US. These were the people who lambasted them for not providing enough warning before the housing crisis and S&P, Moody's and Fitch got the wrong end of the stick back then. Now is their time to hit back. Revenge, as Dan Ariely argues in his latest book, is a very powerful motivation.

Funds and Institutions will probably not stop buying US bonds because a "A" was replaced by a "+" in somebody's report!! More because there is no credible alternative. Euro is in worse state, and Japanese Yen is not even in the running anymore. In this turmoil, Gold & Silver might shoot up along with the clamour for a gold-backed currency.

If we keep our heads above water now and can invest, 12 months down the line, we'll be happier for it.

My only caveat is that there should be no more adverse developments. Then the time horizon may need to be stretch from a year to more.

The Lost Art of Selling Stocks - Excerpts from Sanjoy Bhattacharya's column in Forbes

I am a great admirer of Sanjoy Bhattacharya, Prtner in Fortuna Capital. I enjoy his talks and columns that he writes for Forbes. This month he has tackled a great topic that merits repeating and internalizing. Here are some of the important thoughts from his article.

"I had managed to acquire any investment wisdom considering my labour of love for the past 25 years. ... it struck me that selling smart is probably the single most important element of investment success over the long-haul. In fact, I would dare to go one step further and suggest that accepting losses promptly is the key to investment nirvana."

"more often than not, one is too early to the party and the wait can be fairly embarrassing. In addition, the problem with a truly long timeframe is that in a fair number of cases the dynamics of the business begin to shift gradually which counter-intuitively has a disproportionate impact on price"

Private equity investors looking to buy a business typically have a holding period between three and five years. While too short a horizon typically leads to over-trading and disastrous results, it is vital to establish a finite exit point in order to have a realistic understanding of ‘intrinsic value’ and judge what management can realistically achieve. So, buy-and-hold is a sensible approach provided the fundamentals remain in good shape and in line with what can be reasonably expected but ‘forever’ might stretch both intellect and judgment to the brink.

While remaining disciplined in terms of the process of stock-picking, the seasoned value investor waits patiently for Mr. Market to provide opportunity. Typically, there are just four reasons to sell:

• A clear deterioration in either earning power or ‘asset’ value.
• Market price exceeds ‘fair’ value by a meaningful margin.
• The primary assumptions, or expected catalysts, identified prior to making the investment are unlikely to materialise or are proven to be flawed.
• An opportunity likely to yield superior returns (with a high degree of certainty) as compared to the least attractive current holdings is on offer.

Two genuinely useful primers I would recommend are The Zurich Axioms by Max Gunther and It’s When you sell that Counts by Donald Cassidy.

“Dead money” does insidious damage to the sensible portfolio, not by falling precipitously and then getting stuck in a narrow range, but far more by preventing redeployment of the same capital in distinctly superior opportunities.

Two simple rules come to mind. First, what works for me personally, after years of coping with unremitting losses is to sell out completely whenever a new investment shrinks by more than 15 percent. Not only does this deal with my dumber prejudices and blind spots in a ruthlessly efficient manner, more importantly it frees capital. With ‘dead money’ it is probably best to sell one-third, maybe even half the holding rather than the entire position simply because such stocks occasionally experience incredibly short, sharp rebounds. That is probably the moment to get rid of the rest! One final comment: When you are carrying out a portfolio review, resist the temptation to sell the stocks with the best profits. Instead, relentlessly focus on selling the companies which meet the BBBB test — bent, broken or beyond belief!

The other really serious affliction is refusing to sell because of the taxes that need to be paid. In a sense, this amounts to putting the cart before the horse. The idea behind sensible investing is to earn profits, not avoid taxes.

 Read the full article here: http://business.in.com/column/column/the-art-of-selling-stocks/27282/1