Guided Investing

Bet the House or Paranoid

Category : Investing · by Mar 16th, 2020

This note is about the panic like situation observed in financial markets in last couple of weeks. The movements seen in equity market last week was unprecedented. The range of price movements that usually take few months, happened over few days. But one should not be hugely surprised. It is this ever-changing nature of markets that keeps us on our toes.

Unviable businesses close down regularly due to operational and/or financial reasons. But normal, running entities being asked to shut by the Govt is un-chartered territory. With multiple state Governments (temporarily) shutting down schools, malls, theatres and few other activities, businesses in those sectors will be directly affected. Travel, airlines, hotels & resorts and entertainment sector are affected the most. As an entire section of business has been asked to shut down, it would imprudent to assume that other businesses will remain unaffected. From daily wage earner, to an office worker to a businessman, all will be affected. Only the magnitude of impact will different. We don’t know the full impact of it yet.

To understand better, we can consider second order effect. For example, the owners of malls and theatres might not resort to job cuts immediately but if the shutdown lingers on, then wage cut is possible. In such case, demand contraction for consumer goods can be the first victim. Similarly, with real possibility of weak businesses shutting down and uncertainty in job market, individual purchase decisions will be deferred. With businesses operating at reduced capacity and slowdown in credit offtake, banking and NBFC sector will be affected. Many viable businesses until a month ago can suddenly become non-performing if the interest payments are not honoured. Sectors that are already under stress and over-leveraged companies might see recovery cycle getting stretched. With restrictions and fear on non-essential travel, leisure and real estate might get affected. The point being, second order effects are very real but difficult to quantify.

Investing is one field that draws from many knowledge streams. Psychology is one of them. People’s decisions are affected by their psychological makeup and also influenced by the current environment. Investing decisions are no different. People make overly optimistic decisions in positive environment. Likewise, they tend to have overly pessimistic views in a negative environment. If everybody were to take rational decisions, then there would be no investing opportunities in the world! Amongst the large range of human emotions, one is Paranoia. To put it very simply, it is a feeling of extreme fear that one would go to any lengths to avoid repeat of “bad experience”. A recent and common example could be the extreme security measures at US airports after 9/11. As with most things extreme, the unintended collateral damage was the inconvenience caused to genuine travellers.

So why are we talking about Paranoia? Because history has shown that paranoids survive. Mind you, we are talking about surviving not thriving. One can be wrong multiple times about a catastrophic event and still survive if it does not materialize. But being wrong about it just once and the event happening could mean The End. The equivalent of catastrophe in financial markets could be deep portfolio drawdowns. For example, after portfolio drawdown of 75%, it needs to grow 4X just to break-even. With drawdown of 90%, it needs to go 10X just to breakeven. The recovery can be very painful and slow. The equivalent of collateral damage of paranoid is that one sacrifices growth. The paranoid might put all money in safe haven securities. This portfolio will grow at debt rate in case of a non-event while everybody else will be growing at equity growth rates.

Over the years, world has seen two world wars, hundreds of big and small wars and numerous natural calamities. People have endured great personal pain and suffering. Yet they have managed to come on top. Human will-power to succeed supersedes all hurdles. But an important point to remember is – history is written by the survivors. When somebody bets against a trend, they can re-write history if they win. If they fail, they will be probably be forgotten in the annals of history. A case in point would be George Soros, who made a hugely aggressive $10 Billion (yes big B) bet against the Bank of England. He literally Bet the House and, in the process, made profit of $1 Billion. Had he lost the money, people might make an example of him and say – don’t be aggressive in the face of danger. The key learning here is – there is a time to bet and there is a time to fold. Know when is when. In order to bet big, one has to survive the storm. One day at a time. Don’t try be a hero where none is required. Survive now to thrive later.

As with most things in investing and finance, there is no one universal advice. Every person will have their individual temperament and needs. Identify those and create a roadmap for that. A healthy balance between aggressive and paranoia is generally a good thing. The important point is – knowing when to be what. As Charlie Munger says, a man with only a hammer sees nails everywhere. Don’t be that man. Have multiple skill sets and identify the phases of market. If all this sounds too complicated, take the services of an Investment Advisor!

There is no point fretting over things you cannot control. Ignore market noise, FM announcements, Trump tweets and other such non-issues. These will have no bearing on your portfolio performance. However, your emotional well-being and your actions will definitely have an impact on the portfolio. These you can control. So, focus on these. Another thing you control is Asset Allocation. Pay attention to it. Make sure it is aligned with your goals. As legendary economist Keynes said – “markets can remain irrational a lot longer than you and I can remain solvent”. What can we do – try and maintain sanity in a seemingly irrational market. Stay calm and stick to the plan. The current market is not what one might have planned for. So, tweak the plan to suit your current and future needs. Most important thing is to keep a level head. After all, this is not end of the world. Let me end with the old words of wisdom – this too shall pass.


(1) Comment

4 years ago · Reply

very nice article!!

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