Lessons from 20 years in the stock markets
Every year in September, I wish the markets a happy Teacher’s Day. To this day, that is the only teacher to whom I have paid fees more than once to learn the same lesson. Here are some of my favourite learnings from 20 years in the markets.
The test of a first-rate intelligence is the ability to hold two opposed ideas in the mind at the same time and still retain the ability to function.
—F. Scott Fitzgerald
I started out in the equity markets in June 1994. I could not have timed it better—it was the start of a long summer; in April 2003, the market was 23% lower than when I started out. Yes, the long term can be quite long in equities. But I learnt a valuable lesson—companies that allocate capital efficiently and earn a healthy return on capital are more likely to survive and create wealth over the long term. It also taught me a not so obvious lesson—individual stocks can be big winners even during trying circumstances for the aggregate market. Many companies created tremendous value during that period even as the market lost ground. So it is ok to be worried about the market and also be positive about a company. Respect this distinction.
Those who do not remember the past are condemned to repeat it.
In the mid 90s, I invested in a consumer company that we believed was embarking on a turnaround. A new chief executive officer (CEO) was in place, and he came with a solid reputation. As we walked out of a meeting, the old-timer chief financial officer said something to the effect “don’t know why you are so excited”. But we felt very excited in the belief that we were the first to recognize the imminent change. Two years down the road, we had lost money on the stock and the turnaround was nowhere in sight. If only I had read the previous annual reports, I would have known that the company had been battling the same set of challenges for nearly 10 years. The company had changed strategies and CEOs more than once and yet it had come up short each time. You will know more about the characteristics of the company by studying its past financial history than by meeting the management.
Correlation is not the same as causation.
—A phrase used in statistics
Much discussion in the market centres on correlation. Who does better during periods of falling interest rates? Does gold rise when the dollar is rising? These correlations are good to know, but this is not the same as causation. Anchoring investment strategy to events and correlations is not just wrong but can be dangerous. There is no better example of this than the behaviour of rates and markets in India in the late 90s leading up to 2003 and then during the bull market of 2003-2008. During the first period, rates fell dramatically even as stock markets did poorly and during 2003-2008, rates climbed and so did equities. Now please don’t jump to the conclusion that this is the correlation that works! These are just two data points—insufficient for any correlation, leave alone conclusion. Markets are driven by multiple variables and correlation is not the same as causation.
Emotional intelligence is not the opposite of intelligence, it is not the triumph of heart over head—it is the unique intersection of both.
Every stock market investor reads about Warren Buffet. But the difficulty in achieving the outcomes he has enjoyed lies not in copying his investment ideas but in living it. The challenge is not in identifying a good investment, but in committing to it in size and then staying the course even as the markets challenge you every day. A successful self-made investor told me that he has suffered 3 cuts of over 50% in his portfolio value over the past 20 years. He does not easily sell his stocks and some have turned to lemons, but the winners that he never sold have multiplied his net worth to what it is. Do you have the guts and conviction to stay the course?
If you can’t do something smart, do something right.
What exactly is a systematic investment plan (SIP)? It is a tool that ensures that you invest in good times and bad times. You can normally tell the fireman apart not just from his uniform but from that he is the one running towards the fire. SIP is an insurance policy against our instinct to flee from a fire. But an SIP does not create alpha or return by itself—it merely smoothes risk, and therefore it also smoothes returns. SIP is a dumb and yet effective solution to the problem of volatility. If you are not smart enough to trade the volatility perfectly, then SIP is a handy tool.