Common Stocks – Common Mistakes

Money is a very strange thing–human beings make rational decisions while dealing with most aspects of life but make serious errors of judgment when it comes to dealing with money – be it saving, investing, borrowing or spending – and probably none are so glaring then when it comes to investment in equities. Completely rational investors take totally irrational decisions when part of crowd – their own individual rational minds come down many levels to the irrational level of the crowd. Many a times, individual rational intelligent persons commit simple mistakes while making investment decisions in common stocks. And market has its own method of finding and exploiting human weaknesses. I try to explain and explore the 10 most common mistakes which investors commit while investing in common stocks.     

Mistake 1: Trying to catch the top and bottom

This is one of the most common mistake while investing in equities which most of the investors commit i.e. trying to catch the top and the bottom little realizing that only fools can catch the top or the bottom. No Government, Central Bank, company management, fund manager, analyst or anybody knows what will be the exact top or bottom of any stock, then how does a common investor believe that he / she will be able to catch the top or bottom. Instead of that, determine the value and target price of any stock in which you intend to invest by whatever method you may follow – fundamental, technical or any other method- and then buy it within 5% to 10% range of your that “buy price”. You may pace out the purchase over a period of time keeping in mind the current performance of that company and / or the overall market conditions. But, once you determine the “correct price” for a stock to buy by whatever method you may follow and once that price approaches then don’t wait to “buy at the bottom” because you will probably never be able to do that. Remember that if you wait too long to buy, until every uncertainty is removed and every doubt is lifted at the bottom of a market cycle, you may keep waiting and waiting. The same rule will apply while selling also.

Mistake 2: It will come back

This is another common mistake which most of the investors commit while investing in equities – whether on the buying or selling side. If they see a certain price for a certain stock and they miss buying / selling at that price, then they keep waiting in anticipation that the same price will come back, irrespective of market or individual stock considerations. For example, somebody might have decided on whatever kind of analysis he / she might have done that Unitech is to be sold. Then he / she saw the price of Rs.530 in January 2008 but “missed” selling at that price and after that the stock started falling because of general market weakness and fundamental deterioration in the company. But, the investor who is influenced by this common mistake and waiting for the “price to come back” might still be waiting with the current price around Rs.26 and I don’t know whether the price of Rs.530 will ever come back! The lesson to be learned is that if the price of the stock has gone up / down for a change in the prospects of that company or sector, then there is no point being in illusion that the “price will come back”.

Mistake 3: Already fallen so much – cant fall further

This is one another serious mistake which many investors commit while investing in equities. A stock might have fallen “considerably” and hence they believe that now it cannot fall further. Nothing can be further from truth as this is one of the grave mistakes which results in multiplication of investor losses. Continuing with the Unitech example, the stock fell from Rs.530 in January 2008 to Rs.240 by March 2008, a  massive fall of 45% in just two months. Now, any investor who might have believed that it cant fall further because it has fallen 45% in 2 months and hence held on to it / purchased it was in for a rude shock as it fell to Rs.20 by December 2008, a massive 96% from the top and also a substantial fall of 92% from the March 2008 level of Rs.240. Unless the stock becomes attractive on a standalone basis on fundamental or technical or whatever analysis you may believe in, there is simply no logic in believing that “because it has already fallen so much and therefore it cant fall further”.

Mistake 4: Already risen so much – cant rise further

This is the corollary of mistake number 3 – many times investors believe that since the stock has risen so much, hence it cannot rise further. For example, Titan rose from around Rs.5 in July 2004 to Rs.42 by March 2006, stupendous jump of more than 8 times in less than 2 years. Anybody, thinking that the stock has risen so much and therefore cant rise further and sold it was for a rude surprise as the stock rose to Rs.237 by September 2011, not only swelling by 47 times from its July 2004 price of Rs.5 but even multiplying by around 5.5 times from its march 2006 level of Rs.42. Hence, unless the stock becomes expensive on valuation basis / future growth expectation basis or any other “price determination” parameter which you might be successfully applying, simply because the stock has risen so much does not warrant a sufficient reason to sell.

Mistake 5: Protect your profits or cut your losses

Many readers might not agree with me on this point. Unless you are a short term trader or investing on costly leveraged funds, there is no point in simply trying to “protect the profits” or “cut losses”. Unless the stock becomes costly on valuation basis or its fundamentals deteriorate on a long term basis or because of some other “price determination” parameter which you might be using, just because a stock on which you are making money corrects, it does not necessitate you to panic and sell out of it to “protect your profits”. Lets continue with the above example of Titan. After multiplying by about 8 times from Rs.5 in July 2004 to Rs.42 in March 2006, the stock corrected to Rs.21 by May 2006, almost halved from its peak of March 2006 in just two months. Any investor who might have panicked and sold the stock then would be in for a nasty surprise as the stock then went on to Rs.85 by December 2007 i.e. 4 times jump from the May 2006 low and beyond that as we now know it has touched Rs.237 by September 2011. The same principle would apply for cutting losses as you might be cutting your losses just before the stock is on the verge of embarking on its dream run. Lets continue with the Titan example above. Now, suppose you purchased the stock at Rs.42 in March 2006 and it halved to Rs.21 in the subsequent two months and you are nursing a massive 50% loss. On the fallacy of “cutting your losses” if you sell the stock at Rs.21 then you have sold it just before it was getting ready for its next dream run which would lead to many times price multiplication over the next few years. Hence, remember that after doing your analysis if you feel that the price is right for selling than only sell the stock and not on the misleading notion of protecting your profits because in fact by doing that you might be cutting any probability of serious wealth creation in the future. The same would apply to “cut your losses” fallacy also.

Mistake 6: Price Averaging

This is another grave mistake which investors do which takes them deeper and deeper down the loss lane. There is a wrong notion then averaging brings down the purchase cost and hence would be able to sell it at some marginal profit or atleast closer to cost price. Let us move back to the example of Unitech, suppose you invested in 1 share at Rs.530 in January 2008, then “averaged” by buying one more share at Rs.300 in February 2008 and further averaged by purchasing another one share at Rs.240 in March 2008 so that now your reduced “average cost” is Rs.357. But, what purpose has that served, today the stock is quoting around Rs.26, down by a phenomenal 93% from the reduced “averaged cost”. One caveat, that sometimes an investor might get an opportunity to ext in the averaged stock at close to the “average cost” but those opportunities are rare and only for a short period of time and therefore very difficult to capitalize at that point of time. And finally, if you would not otherwise want to buy a particular stock at a particular price then what is the logic for averaging it if you already own your stock. Remember, never throw good money after bad money. If you have made a mistake in selecting a wrong stock, humbly accept your mistake, sell it and book your loss and move ahead, - utilize the proceeds from sale to buy better investments with potential of price appreciation in future.

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Mistake 7: Stocks gone up so I am right or gone down so I am wrong – The Market Trap

Ego and lack of self confidence are both negative qualities of a human being and an investor. If you buy a stock and it goes up for no real reason but for market abnormalities then be smart enough to sell it and get out of it instead of pampering your ego that you are an astute investor or a great stock picker. Don’t forget that the market is a great deflator of all egos. The same can be true when you might have invested in a stock at a decent price after all your analysis and the stock falls for no deterioration in the company’s performance but for some uncontrollable market reasons – during that point of time there is no need to panic and loose self confidence and start believing that you are wrong. Remember that market can be wrong and is infact wrong most of the times, so try to take advantage of it abnormalities by using your knowledge, experience and judgment instead of getting swayed away by it and loosing your self confidence.    

Mistake 8: Efficient Market Theory

Don’t blindly believe in the efficient market theory – infact remember that market is inefficient for almost 95% of the time – its like a pendulum moving from over valuation to under valuation and then vice versa. Only like a pendulum’s movement from one side (over valuation) to the other side (under valuation) it is just by chance that it passes through the middle (fair valuation). And if the market was indeed always efficient it would simply be impossible for so many investment gurus and fund mangers to “claim that they can beat the market”. Having said that, over the long term the pendulum does move in the direction of what is right – if the country, economy, sector and the individual stock does perform well than over the longer term the pendulum does put its weight behind it, otherwise not.       

Mistake 9: Blindly follow the Guru

There is a saying that either you completely trust your judgment or the judgment of another person. And the another person in the market is the investment guru or fund managers etc. Kindly note, that you may trust any investment guru of your choice and some investor gurus will beat the market at certain points of time but all the investor gurus cannot in totality beat the whole market on a continuous basis because they only make up the market. Simply put, everybody cant beat everybody – for there to be a winner, there has to be a looser also. And kindly note, the buyer and seller are always on the opposite side of the trade and they both mysteriously believe that they are right – but one of them is infact wrong! So don’t trust any of the so called Investment gurus as face value (including myself although I don’t claim to be any investment guru but just a student of investing).

Mistake 10: Penny Stocks

This is another common mistake which most of the investors commit – buying into penny stocks thinking that the price is already “so low”, most probably in single digit, little realizing their own thinking folly. The amount of loss which can happen in common stock investing is reported in percentage terms and measured in rupee terms, whether it be a penny stock of Re.1 or a high priced stock of Rs.1000. Therefore, if a Re.1 stock falls to 10 paise or a Rs.1000 stock falls to Rs.100, the loss is 90% in both cases. And most importantly, if you invest say Rs.1000 in either of the above mentioned two stocks and both of them suppose become zero, then you loose your full investment of Rs.1000, irrespective of the initial price of the stock. So, remember the old saying “penny wise, pound foolish”, the stock price is just a quote in the market and on its own does not have any significance whatsoever, it has to be measured in conjunction with the company’s performance, earnings, book value, dividends etc – a high priced stock may actually be cheap on valuation basis while a low priced penny stock may actually be very costly if the underlying business does not support even that much of a price.  

Mistake 11: Fail to past the test of patience and character 

Market is a place which will test your patience and character. Many times you might have bought a stock for all the right reasons at the right price but the stock refuses to go up for a long period of time – just hang on to it because the day you get frustrated and sell it off, there are chances the stock will then start rising. Hence, patience and character are key virtues which will be repeatedly tested by the market.

To conclude, there are many simple and avoidable mistakes which investors commit while investing in common stocks and I have tried to explain some of the most common ones of them. Kindly note, that simple logical things work far better in the market place rather than complex algorithms, theorems, valuations principles, DCF etc. And there is no other place to test your virtues than the market – be it common sense, logical thinking, patience, perseverance, mental balance, emotional intelligence, performing under stress etc. All the qualities which make a successful human being will be tested by the market –it has its own method of finding and exploiting human weaknesses. Investing is not about beating the market or anybody else, its simply beating your own self, your own negative traits and once you are able to master your own self and become a complete human being, then only you would also become a successful investor. Avoid the common mistakes while investing in common stocks and embark on becoming a successful investor and a complete human being. All the very best.

Unfixed Returns from Fixed Income Funds

Have we ever taught how fixed are the returns from Fixed Income or Debt Mutual Funds. Fixed Income funds invest in fixed income securities. However, the irony is that the name is only fixed but the returns are certainly not fixed in any of the fixed income funds. To understand the risk of investing in fixed income funds we have to understand the risks of securities in which they invest. The common risks associated with fixed income securities are credit risks, interest rate risks, liquidity risks, basis risks, yield curve risks etc. Most of the risks are well understood by the investor community and even so if not understood then they don’t necessarily need to understand them because the fund manager will manage those risks on the investor’s behalf. However, the risk that most of the investors don’t understand and which they need to understand is the “interest rate risk” because that is the risk which the fund manager manages but the investor actually decides when and how to take. When investing in an equity fund, an investor has to first decide which level of the market to invest and then which fund category to invest like index, diversified, large / mid / small cap fund, sector specific fund etc. Similarly, while investing in a Debt Fund, an investor has to decide when to invest – in essence at what level of interest rate to invest and then which scheme to invest in – FMP, liquid fund, ultra short term, short term, income funds or gilt funds etc. The investor will be able to take an informed decision on which debt fund to invest and when in a more educated manner if he understands and appreciates the key risk affecting Debt funds i.e. interest rate risks. This article will briefly explain the highly difficult and mathematical measurement of interest rate risk in simple terms and then guide you in which category of debt fund to invest during each phase of the interest rate cycle.

A long term Government of India Security (GSec) may have zero credit risk (because the Government can literally “print notes” and pay back the loan), but it has one of the highest interest rate risks. Interest rate risk is directly related with the maturity of a security. Now, I will touch upon two very important contributors of interest rate risks in this note – duration and convexity.

Duration

I have seen many investors confuse duration with maturity. However, they both are distinctly different. Maturity is simply when the fixed income security will mature and pay back the principal. For example, the maturity of a 10-year paper will be 10 years at the time of issue. On the other hand, duration is the time within which the investor receives back all the cash flows related to the security i.e. interest and principal. For example, if there is a 10-year maturity paper paying yearly coupon at the interest rate of 8.0% p.a. issued at par (Rs.100) will have the following cash flows, 8 + 8 + 8 + 8 + 8 + 8 + 8 + 8 + 8 + 108 which will be paid at the end of every year for the next 10 years till it matures.  The Rs.8 is the interest at 8.0% p.a. on Rs.100 par value. Kindly note that at the end of the 10^th year the investor will receive Rs.108 i.e. Rs.100 of principal + Rs.8 of the 10^th year’s interest. This example clearly shows that although the maturity of the security is after 10-years, the investor receives cash flows frequently at regular intervals much before the final maturity of the security. That brings me to the concept of duration. The duration of a bond is defined as the “weighted average term to maturity of a security’s cash flows”. Since the cash flows on a security are received piecemeal before the actual maturity of the security, the duration of all coupon paying bonds will be less than its maturity. And as a Zero coupon bond does not pay any interest during its life, its duration = maturity.

There are different forms of duration. The basic one is the Macaulay or unadjusted duration. The one which we use for our calculation is the adjusted or Modified Duration. I would not go into the mathematical formulae of computing these but will explain the concepts which are necessary for understanding interest rate risks associated with fixed income securities.

Duration is useful primarily as a measure of the sensitivity of a bond's market price to interest rate (i.e. yield) movements. It is approximately equal to the percentage change in price for a given change in yield. For example, for small interest rate changes, the duration is the approximate percentage by which the value of the bond will fall for a 1% per annum increase in market interest rate. So a 10-year bond with a duration of 7 years would fall approximately 7% in value if the interest rate increased by 1% per annum. In other words, duration is the elasticity of the bond's price with respect to interest rates.

Convexity

Duration is a linear measure of how the price of a bond changes in response to interest rate changes. As interest rates change, the price does not change linearly, but rather is a convex function of interest rates. Convexity is a measure of the curvature of how the price of a bond changes as the interest rate changes. Convexity deals with the curvature of the price / yield relationship or chart. Specifically, duration can be formulated as the first derivative of the price function of the bond with respect to the interest rate in question, and the convexity as the second derivative.

Convexity also gives an idea of the spread of future cashflows. Just as the duration gives the discounted mean term, so convexity can be used to calculate the discounted standard deviation, say, of return.

Note that duration can be either negative or positive depending on the way the interest rates move but Convexity is always a positive feature of the bond. The exception to this rule is in the case of “callable bonds” where the convexity is a negative feature. By positive feature of convexity I mean that for a given change in interest rates and the modified duration of a bond, the change is price of the bond will be in favour of the investor. For example, because of the positive feature of convexity, when interest rates rise, the price of the bond will fall less than that indicated by the duration and when interest rates fall, the price of the bond will rise more than that indicated by the duration. This is because when we study the price / yield relationship of a coupon paying option free bond, the larger the increase in the YTM, the greater the magnitude of the error by which the modified duration will overestimate the bond’s price decline; the larger the decrease in the YTM, the greater the magnitude of the error by which the modified duration will underestimate the bond’s price rise.

Interest Rate risk and selection of different Debt Funds

Now, let us understand at what point within the interest rate cycle it is ideal to invest in which category of Debt Fund:

Ø       Fixed Maturity Plan: A Fixed Maturity Plan (FMP) is for a fixed period of time and hence locks in at the prevailing interest rate for that period of time and therefore does not have any interest rate risk. However, the FMP has a very high “opportunity loss risk” in the sense that if you lock in long term FMP just before the beginning of an interest rate hike cycle then you will loose the opportunity of earning higher yields. Therefore, investment in a FMP should ideally be done at the peak of the short term policy hike interest rate cycle. Currently, we are at that point of time and hence an ideal time for locking in long term funds into FMPs so as to lock in at high yields.

Ø       Liquid Funds: These are for parking surplus funds for meeting the liquidity needs and hence interest rate considerations are not to be taken in them.

Ø       Ultra Short Term Funds: If the liquidity need can be stretched to a couple of weeks, then the interest rate risk in the ultra short term will smoothen out and most probably give better returns then a liquid fund.

Ø       Short Term Funds: These should be considered when there has already been substantial hike in short term policy rates and importantly this should have resulted in the yield curve being inverted or flat.

Ø       Income Funds: These funds would become attractive when there has been substantial hike in short term policy rates and importantly the yield curve is steep or atleast upward sloping and the spread between GSecs and Corporate yields are high.

Ø       Gilt Funds: These funds would become ideal when there has been substantial hike in short term policy rates and importantly the yield curve is steep or atleast upward sloping and the spread between GSecs and Corporate yields are low.

Kindly note the difference between when to invest in short term, Income or Gilt Funds – all the three after substantial hike in short term policy rates but short term funds when the yield curve is inverted or flat, Income funds when the yield curve is steep/ upward sloping with high yield spreads as compared to GSecs while Gilt Funds when the yield curve is steep/ upwards sloping with low yield spread as compared Corporate bonds.

Conclusion

The decision of when and in which scheme of a Fixed Income Fund to invest is of paramount importance for enhancing returns from your Debt Allocation because the name is only fixed while the returns are certainly not fixed. If you follow these simple principles then you would be able to generate above average return from your Debt Allocation which will many a times even put your equity portfolio into envy!

Ten Investment Commandments & Outlook for the Year 2012

The New Year 2012 is very soon approaching and we will be busy making different wows in order to improve our health, social and family life. Now, let us also make 10 commandments to improve our financial health through the year 2012 for our entire future lives. And at the end of it there is a brief view and outlook on different asset classes for the year 2012.

Commandment 1: Thou shall make a proper Asset Allocation Plan

Asset Allocation is the primary premise for investments. Long term statistical analysis has shown than 90% of our returns are due to proper asset allocation, 9% through stock selection ad 1% through market timing. While allocating assets, remember to allocate only that much funds to equities which you don’t require for atleast the next 5-years and which you can emotionally see it going down by upto 50% in the short term and not panic on it.

Commandment 2: Thou shall do proper budgeting

Thou shall not invest what is left after spending but spend what is left after investing. Investing without a purpose is bad, but investing when you have high-interest debt is much worst.

Commandment 3: Thou shall take proper family protection

Thou will not confuse insurance with investments. Thou shall take proper insurance cover of atleast 10 times your annual after tax expenses (revenue and average of past 3-year capital expenditure). Thou shall also take proper medical insurance.

Commandment 4: Thou shall take proper Asset protection

Before starting to build fresh wealth, it is our duty to protect our existing assets. Assets like house, flat, or car can be insured against accident and natural perils. The event of earthquake or terrorist attack to our flat/ house seems to be remote but the impact of such things could change our financial stability upside down. So protect your house and other major assets with proper insurance.

Commandment 5: Thou shall buy your own house for self occupation

Thou shall look into buying your own house in the year 2012 with some bargain and discount from the developer while trying to time it in the middle of the interest rate reduction cycle (because you may not be able to get your house at a discounted price at the lowest interest rate).    

Commandment 6: Thou shall not over invest in speculative items

This would include speculative or penny stocks, junk bonds, non cash flow generating commodities like gold or silver and non-revenue generating posh real estate like beach houses. Investments in these can be done only when you have a clear view on the above asset class and expecting to gain from the price movement in it. But, you have to remember that they are speculative in nature and will not go up in perpetuity and hence you should not marry with those investments but sell it when the right time comes.

Commandment 7: Thou shall learn difference between good and bad debt

Learn to distinguish between good and bad debt. According to me, bad debt would be that debt which is used to create Gruesome / Bad Capital Expenditure – those assets like car, beach house which take away money from your pocket or a house which do not put any money in your pocket. On the other hand, Good Debt would be that which helps you in creating an Asset which then puts money in your pocket (income) as well as scope for future capital appreciation e.g. rental property which earns rent, shares which earn (tax free) dividends and both having potential for future capital appreciation. Never borrow to incur a revenue expenditure like foreign trip or gruesome / bad capital asset like a car, beach house because they will not only take away money from your pocket in the form of interest payments but also put you into recurring waste revenue expenditure in the form of maintenance of that gruesome / bad capital asset like petrol, repairs, property taxes etc.

Commandment 8: Thou shall make a proper retirement plan

If you want to enjoy the same life style which you are currently even after your retirement or have the joy of bequeathing your wealth to your children then start planning for it today. And be realistic about it – make an estimate of thou needs which will keep evolving with your age and time and also consider inflation in your computations.

Commandment 9: Thou shall remember these principles while investing in equities:

Ø      Bull and bear markets run for several years. Hence determine the primary trend of the market and don’t generally go against the primary trend

Ø      Market is supreme and above everybody - no Government, Central Bank, Industrialist or Operator can alter the primary trend of the market – they can only complicate the wave structure

Ø      Once a low is made – it gets and has to be tested once or twice – if it gets tested again and again it means that it was not the low and market is eventually going to break it

Ø      Right asset allocation and getting the macro view right are far more important and profitable rather than individual investment ideas

Ø      Never invest or trade more than you can reasonably afford to loose

Ø      Put stop loss at a logical, not convenient, place and always adhere to it

Ø      Cut losses and let profits run. Don’t let a profit get converted to loss

Ø      If you wait too long to buy, until every uncertainty is removed and every doubt is lifted at the bottom of a market cycle, you may keep waiting and waiting

Ø      Act on your own judgment or entirely on the judgment of another

Ø      Tips are for waiters and not investors

Ø      When in doubt, stay out and don’t get in when in doubt

Ø      Don’t overtrade

Ø      Don’t invest or trade based on hope

Ø      Learn to accept your mistakes in the market (otherwise market will make you accept it in a cruel way) and then analyze and learn from your mistakes

Ø      Wherever possible, trade liquid markets

Ø      Don’t believe everything which a corporate official says about his / her company’s stock

Ø      When opinions in the market are too unanimous – beware because markets are famous for doing the unexpected

Ø      Never be sentimental about an asset class or individual stock

Ø      Market is more of an art rather than science

Ø      Simple logical things work far better in the market place rather than complex algorithms, theorems, valuations principles, DCF etc

Ø      Buy the stocks of companies that have shown consistent growth in earnings and producing those goods / services which people cannot do without

Ø      Last but not the least - Never try to catch the top and the bottom because only fools can do it

Commandment 10: Thou shall not forget the above 9 commandments and keep reviewing, changing and refining it with time and your financial condition.

View on different Asset Classes:

Equities: The year 2011 was bad for equities with it loosing around 25% and valuations correcting from 18x P/E (15% premium to long term averages) to 13x (10% discount to long term averages). This correction synchronized with stubbornly high inflation, rising interest rates, policy holiday by the Government, various scams, depreciating rupee resulting to forex losses and uncertain global environment. What is the solution of all these problems and where the end lies, probably nobody knows. I just know one thing that we have to buy equities not at the best time but when we are moving from worst to bad times – probably the year 2012 will be that when we will move from worst to bad and with discount valuations invest in equities for the long term. And when shopping for stocks, during period of crisis, buy companies which are leaders in their businesses, have good management, currently facing P&L problems but with clean Balance Sheets. The Sensex is likely to bottom out in the range of 12800 to 14000; but the important point is that the roots of a new multi year bull market is likely to sowed in the year 2012 which is expected to take the Sensex to 35000 to 40000 by the year 2016 to 2017.

Fixed Income: Kindly note, that currently the inflation is high at close to 9.5% but the average for the past entire decade (2000-2010) was just 5% while the current interest rates are high at close to 10%. Therefore, if you have free surplus cash and don’t require for some years than take long term Bank FD and / or NCD of a reputed company and lock in at around 10% to 11% for the long term. On the other hand if you don’t have free surplus cash immediately but earn regular monthly income then lock into a long term (say 10 years) bank recurring deposit at around 9.5% and enjoy the high interest rates while inflation eventually does fall and at the same time build capital for your future.

Gold: As explained in one of my previous columns, Gold is a speculative financial asset with no real industrial use and whose value depends on the value of US Dollar, real interest rates in the US which in turn depend on nominal interest rates and inflation over there and then the value of Indian rupee against the US Dollar. Till the global world is in turmoil Gold is likely to rise over the next few years. However, nothing can just go up one way – over the past few weeks international gold prices has corrected by almost 16% while Indian Gold is steady because the Indian rupee has depreciated by almost 20% during the same period. It would not be out of the way to expect Gold to correct in the year 2012. Hence, look into buying Gold between Rs.2100 to 2200 per gm in the year 2012 and a price of Rs.5000 per gm cannot be ruled out over the next 3 to 4 years.

Real Estate: High interest rates have taken its toll on this sector with retail and commercial real estate prices and rentals crashing by 30% to 50%. Residential sector has been resilient because of the developers withholding price power due to easy credit available from banks who in turn are supporting them since they don’t want that to be classified as NPAs after the problems already faced by the airlines, metals, mining etc sectors. So, it’s a chicken and egg situation but residential sales have dipped by 20% to 40% in different pockets of say a city like Mumbai. So, look to buying your house in the year 2012 with some bargain and discount from the developer while trying to time it in the middle of the interest rate reduction cycle (because you may not be able to get your house at a discounted price at the lowest interest rate).   

Happy New Year 2012 with good health and sensible wealth creation!

The American Stock Market Super Cycle – 300 Years & Beyond

The current turbulent and volatility witnessed in all the asset classes including equities, bonds, oil gold, industrial metals, real estate etc and the synchronized global bear market which we are currently observing is leaving many investors totally agashed. There has been lots of panic and every investor, analyst, fund manager are debating whether this is a bull market correction or a bear market and if the answer is the latter, than whether a structural or a cyclical one. The developed markets are currently under lot of turmoil due to the debt default problems in the Europe and danger of the euro breakout while the US has its own problems of high debt, slowing growth and elevated unemployment levels. The problems of the developed world are well documented and there may not be any need to discuss them in detail over here. And as far as solutions for the same is concerned, then as of now their Governments and other regulatory authorities have not found it. Some market experts like Mr. Robert Prechter of Elliot Wave International is predicting the US Dow Jones Industrial Average (DJIA) would go to around 400 levels i.e. a crash of almost 97% from the current 12000 levels. While on the other hand Mr. Glen Neely who follows the Neo Wave believes that the US DJIA will touch 100000 (yes, there are 5 zeros after 1) not earlier by the year 2020 but latest by 2060. Such, is the difference in opinion between two renowned individuals following Elliott wave.

I am neither nor claim to be an expert like them. However, I do my own wave and market cycle analysis. I am making an attempt to predict the next 60-year large movement in US equities based on my study of human behavior, mass psychology, behavior finance, socioeconomics and the “madness of crowds” spanning back by around last 700 years including the minor financial revolution of the 1550s, troubles of Henry VIII, Francois I, the Fuggers, the Genose and eighteenth century “madness of crowds” like the South Sea Bubble, Tulip Bulb craze and the Mississippi bubbles and then combining all those with Elliot Wave, Neo Wave, market cycle studies, math cycle analysis, astronomical and planetary cycle analysis, Dow Theory, Fibonacci retracements, Earnings Yield Vs Bond Yields, cyclically adjusted P/E multiples, long term dividend yield and growth rates, inflation rates, interest rates etc have formed my own view on the long term market cycle in which US might currently be. I present in this article my personal views on the same.

Before proceeding further, kindly note that this study is a cycle analysis spanning over centuries of American civilization. This is not any short term prediction or projections. The cycles will run into several decades. We will call this the “Market Super Cycle”. Since, over the long term human civilization grows and man’s progress is dynamic and logarithmetic, the start to finish of the market super cycle would be trending upwards. However, during human civilization there has been periods of depression, severe recession, deflation, wars and other natural and human catastrophic events, the cycles are certainly not straight forward uptrending, even when compared at the super cycle level or sub-cycle level. What I mean by this is that we all know that stock markets don’t go up or down in a linear manner – but in an erratic manner giving bulk of the returns over a short period of time while not giving any return or infact giving negative return over most of the other time. The same is true with the long term “market super cycle”. During the “trending advance” of many decades there will be couple or more decades within that which will be the “corrective phase”. This correction will be both price and time wise. There are chances that a whole generation of investors will not actually know that stock market goes up also or there are bull markets also! And for them it would not had been wise to invest in the stock markets. There have been periods wherein there is depression all over or other periods of very high inflation or worst stagflation and these periods will be repeated. All these have happened and have possibility of happening in the future. So, where we are currently and what are the past cycles telling us.

I have data for the US markets since 1789 which is shown by Exhibit 1.

Exhibit I: US Stock Market Index 1789 to 1900

Source: Foundation for the study of Cycles

Now, Exhibit II graphically depicts the US DJIA since its inception at 41 in 1896.

Exhibit II: US Dow Jones Industrial Average 1896 to 2011

  Source: Dow Jones & Co.

Both these exhibits I and II, pictorially depict the US stock markets over the past 222 years i.e. from 1789 to 2011. One thing is clearly visible in the past 222 years of US stock market history and that is that over the past more than two centuries, the stock markets have trended higher. Now, within them there have been periods running into decades where they have lost upto even 90% of its value in nominal terms. There have been periods wherein the markets have lost significant value in real terms. Having said this, one thing is clearly brought out that history is dynamic and loarithmetic, not static or linear. Looking back at the 222 year chart of the US stock market we notice that sometimes advances occur in spurts followed by consolidation phases that last for long periods of time. Then again, the reverse happens. This reveals the market’s behavior. The relatively consistent advance on a log scale for the last 220-plus years demonstrates the logarithmic nature of economic progress. The market super cycle which we will use will help us forecast on a logarithmetic basis. We will have to deal with the complex reasoning of crowd psychology and chaos theory. The patterns observed over the past 222 years might be repetitive but with some variations. These repetitive patterns can then be combined to create larger patterns of appearance or design similar to the smaller structures.  

Now, let us classify the “market super cycles” which have occurred during the past 222 years. Kindly note, that these are “market super cycles” of the highest degree and hence have been captured on the highest scale. Within the “market super cycle” there would be smaller degree market cycles and sub-cycles running along side with it. Each smaller degree cycle might be running in the same direction (trend) or opposite direction (corrective) of the next higher degree cycle. The purpose of this study is not to capture the small degree cycles or sub-cycles but only the larger “market super cycle”.

Now, how do we define “market super cycle”. I have derived the “market super cycle” by studying the price behavior of the US stock market for the past 222 years spanning across more than 2 centuries. Now, if we study the past 700 years of human history and evolution of money, banking and finance then we realize that the problems which the world is facing then we see the evolution of banking which began around the time 1390 after the “loan shark” era was over, the “French invasion” in 1494 when the rogue bankers were caught, the “price revolution” in Europe from the 1540 to 1640, setting up of the Amsterdam Exchange Bank in 1609 and Bank of England in 1694.

Again, if we study the past 700 years of human history and evolution of money, banking and finance then we realize that the problems which the world is facing today regarding the European debt crisis is not just about today but has been there in history over the past several centuries and the earliest count of that was in the sixteenth and seventieth centuries when various European Governments defaulted on their debt in the years 1557, 1560, 1575, 1596, 1607, 1627, 1647, 1652 and 1662. Further, if we study the past 500 years history of the evolution of debt and bonds, then there used to be cycles in bond prices also. For example, in 1814 during the time of Napoleon and Nathan Rothschild, the latter purchased perpetual European Bonds at 55 Pounds in the year 1815 and sold it at 85 pounds in 1817. If we see the history of the stock markets beyond the past 400 years, the United Dutch Chartered East India Company was formed in the year 1602. Despite lot of difficulties which the company faced, the stock price rose from 100 in the year 1602 to 786 by the year 1733, this inspite of the fact that from 1652 until the glorious revolution of 1688 the company was being challenged by bellicose British competition. Such, sustained capital appreciation combined with regular dividends and stable prices marked the performance of this stock. As early as 1650, total dividend payments were already 8 times the original investment, return CAGR of 27%! The ascent of the stock was gradual, spread over more than a century and though its descent was more rapid, it still took more than 60 years to fall back down to 120 in the year 1794. The rise and fall of the stock closely tracked the rise and fall of the Dutch empire. The lesson we learn from all this is that the rise and fall of the entire stock market of a country which has happened steadily over certain centuries cant just collapse in 1 or 2 or even 10 years – it may take some decades for it to finally fall and go into oblivion, if ever it has to happen.

There have also been lots of bubbles over the past several centuries including the Tulip bulb in Netherlands, South Sea Bubble, Mississippi scheme, Florida land bubble etc but those were bubbles or some kid of fraudulent schemes and hence cannot in any way be compared to the US stock market.

Market Super Cycle

Now, let us re-look at Exhibits I and II. There have clearly been 3 market super cycles over the past 222 years – the third one is currently going on which might end somewhere in between the years 2060 to 2075. The first market super cycle began at 2.7 in the year 1789 (actually it might have begun much lower around 20 to 40 years back but because of lack of data we would assume it to begun from the year 1789). This up trending wave of the market super cycle lasted till 1835 where it ended at 23. Then, the corrective wave of the market super cycle commenced which took it to 8 by the year 1860. Kindly refer to Exhibit III which shows the Trending and the Corrective phase of the market super cycle I and the returns during each of the periods. Kindly note, how in the Market Super Cycle I, the returns if held over the entire cycle (trending and corrective) was just 1.54% CAGR over 71 years while if the stocks were just sold before the start of the corrective phase it would have been 4.77% over 46 years. Similar results are obtained for market Super Cycle II with slightly higher returns. Currently, we are in market Super Cycle III which I believe, based on all the studies which I have done and mentioned before in this report, that it will end around 28000 which is be beyond the year 2070 – the trending cycle might end somewhere between 2038 to 2050 at close to 75000 levels on the US DJIA while the corrective phase in all probability is likely to end around 28000 levels on the US DJIA beyond the year 2070. This conclusion has also taken into account the “Math Cycle Analysis” and the “Astronomical & Planetary Analysis” into account which I present after the conclusion. Those two would be a different kind of research work to read for the investors.   

Exhibit III: US Market Super Cycles - 1789 to 2070

Market Super Cycle	Start Date	End Date	Star date Index Level	End Date Index Level	Number of Years	Return CAGR (%)
Market Super Cycle I	1789	1860	2.7	8	71	1.54%
Trending Phase	1789	1835	2.7	23	46	4.77%
Corrective Phase	1835	1860	23	8	25	-4.14%
Market Super Cycle II	1860	1949	8	150	89	3.35%
Trending Phase	1860	1929	8	381	69	5.76%
Corrective Phase	1929	1949	381	150	20	-4.55%
Market Super Cycle III	1949	2070 & Beyond	150	28000	121	4.42%
Trending Phase	1949	2038 to 2050	150	75000	89 to 101	7.23% to 6.35%
Corrective Phase	2038 to 2050	2070 & Beyond	75000	28000	20 to 32	-4.81% to -3.03%

  

Math Cycle Analysis

There are different math cycles like the 9.1 year cycle, 40.5 year cycle, Kondratieff wave of 56 years. The first step for any mathematician researching in any time series data is to try the spectrum analysis. It looks this way (we use the period scale in years as an X axis, the Y shows the strength of some particular cycle). To calculate this periodogram, the Fourier transform of the auto covariance function of the oscillator has been done. To be sure, we have tried to calculate the spectrum with the oscillators based on different smoothing periods. The strongest cycle here is 9.1 years cycle. The peak on 9.1 year definitely points on the importance of this cycle to American economy. Another strong cycle is 40.5 years cycle. The forecast up to 2023 year has been obtained by the Math Cycle Analysis.

Exhibit IV: Math Cycles

Summarizing these composites all together, we can get a long term forecast based on “Math Cycle Analysis” as shown by Exhibit V. The chart shows that the US markets will make some kind of high in the year 2012 and remain volatile for many years beyond it and finally make a low around the year 2020. The US markets are then likely to rally and make significant highs around the year 2023. This forecast chart also implies that the US market might make new highs only around the 2023!

 Exhibit V: Long Term projection Based on Math Cycles

The above long term forecasts of the US DJIA based on different planetary movements including the Jupiter 11.9 year cycle, Saturn 29.4 year cycle and the Saturn–Neptune 35.9 year cycle shows that the US markets will make some kind of top in the year 2010. The markets will correct up to the year 2015, then rally until the year 2018 and subsequently make a bottom around the year 2021. The US markets are then likely to rally and make significant highs around the year 2023. This forecast chart also implies that the US market might make new highs only around the year 2023!

Astronomical and Planetary Cycles

There are also different astronomical cycles based on the position of the planets in the solar system. For example, certain astronomical cycles which are useful are the Jupiter 11.9 year cycle, Saturn 29.4 year cycle and the Saturn–Neptune 35.9 year cycle.

In comparison to fixed cycles, the astronomical/ astrological cycles have irregular structure. Because the planets move not evenly and sometimes might be even retrograde (if being observed from the Earth), these astro cycles give additional dimension to our research which is impossible to get using the spectrum analysis only. The basic technique used to catch the planetary cycles is the Composite Expert module. The result obtained by this module looks like the one shown in Exhibit VI.

 Exhibit VI: Jupiter Geo Longitude Composite – 1792 to 1972  

In brief, the composite is a special kind of a diagram where we can see the change of some analyzed parameter (like DJIA, or price, or relative price oscillator) in respect to some astro event (like position of some planet in Zodiac or angle between any two planets). On Exhibit VI, the upper diagram shows how the analyzed index changes when Jupiter comes through the Zodiac. Looking at this diagram, we can tell that when Jupiter ingresses in Taurus, the DJIA is high and is starting a downtrend movement; when it reaches 15 degrees of Leo, this index is low and starts up trend.

The stock market usually leads the economy by one year. Bill Meridian's study of US economic production over the same time period shows that the economy bottoms when Jupiter is in Virgo. Thus, the finding that the stock market bottoms in Leo makes sense. We understand very well that the composite gives us the picture "in average", because there are a lot of other factors (and non astronomical as well) that hit the stock market. My modest purpose is only to demonstrate how astronomical factors also move the economy.

It is very difficult to specify what astronomical cycles are important and what are not. This problem is not the math problem only, it arises of the fact that analyzing long term periods we have no enough data to produce the mathematically (statistically) correct research. So, in any case, conclusions will be hypothetical, but providing enough evidence to accept it as a working theory. To select the playing planetary pairs, we have compared the two composites created on two different independent intervals- 1789-1900 and 1900-2004. After that, we have created composites for each of these two intervals and compared them. If these two composite give approximately the similar composite diagrams, we would have to accept this composite model as a working one. Kindly look at Exhibit VII.

 Exhibit VII: Composite Jupiter Position Geo 1789 to 1900 & 1900 to 2011

The reader will observe two composite diagrams, the upper is created on 1789-1900 data, the lower composite is calculated using the data 1900-2011 year. Though they are not identical, there are similarities there- tops and bottoms are almost the same (for example, Jupiter in Taurus - downward trend; Jupiter around 15 degrees of Leo - upward trend starts for DJIA). I have marked some turning points by red arrows. To understand better what is going on we can consider the composite diagram as a memory of stock market regarding to the position of the planets above. When any planet comes through some point on Zodiac, the stock market somehow "remembers" it. While time is going on, new "memory" of the event is added to the previous one, making this cycle stronger. Then something totally new occurs (like slow moving planets ingress another Zodiac sign), and the memory of the past starts to fade; the cycle is weak and ceases to exist.

Summarizing these composites all together, we can get a long term forecast based on planetary cycles as depicted by Exhibit VIII. The long term forecasts of the US DJIA based on different planetary movements including the Jupiter 11.9 year cycle, Saturn 29.4 year cycle and the Saturn – Neptune 35.9 year cycle shows that the US markets will make some kind of top in the year 2010. The markets will correct until the year 2015, then rally to the year 2018 and subsequently make a bottom around the year 2021. The US markets are then likely to rally and make significant highs approximately in the year 2024. This forecast chart also implies that the US market might make new highs only around the 2024!

 Exhibit VIII: Astronomical & Planetary Cycles - Long Term Forecasts of US DJIA till 2025

Conclusion

After extensively studying all the aspects mentioned in this report, I conclude that the US stock markets are currently in the market Super Cycle III of the Grand Market Super Cycle which started latest in the year 1789 (from where we have data) and which is likely to make a top at around 75000 levels on the US DJIA between the years 2038 to 2050 after which the “corrective phase” within the “Market Super Cycle III” is likely to commence having a downside target of close to 28000 which is probable to be achieved not before the year 2070.