Market Calls I Got Right - and Wrong - In 2008

To say the least, 2008 was a very satisfying year. While I also got some calls wrong and overall lost money, it wasn't much. And if I were to do a sleight of hand and calculate returns in rupees and not dollars (rupee is my currency of consumption these days), I would have almost ended flat on the year because of rupee depreciation vis-a-vis dollar.

Here is what I got wrong:

a) Municipal bond funds: I had chosen some better credit quality close ended municipal bond funds. I am still keen to buy the underlying assets of some of these funds, like the pre refunded bonds. What I missed was that these funds are like any other structured product that employs leverage. And when mark-to-market losses hit, such structured products are forced to delever, irrespective of underlying credit quality. Actually I didn't miss it - I advised almost all my friends not to invest in FMP's in India for these precise reasons. But I myself didn't exit these funds. Hope is not a good strategy.

b) The second half rally in April-May-June: I got the timing of this wrong post Bear Stearns. I thought the "hope" rally would occur in May and June, and so invested at the end of April. Actually the rally occurred from the day Bear Stearns collapsed to the end of April.

c) ProShares UltraShort Financials (SKF), ProShares UltraShort Real Estate (SRS): It is only in the last month or so that I really understood the nature of these ultrashort ETFs. It was indeed very perplexing to me that while the underlying sectors have been cut in half over the past year, these ETF's are flat over the year. Now I know better - it is because they compound daily returns:

Suppose I start with 100 in SKF. Underlying benchmark goes down by 10% on day 1. Benchmark would be at 90. SKF will go to 120 (2x daily return).

On day 2, if benchmark goes up by 10%, then the benchmark would be at 99. However, SKF would be at 96. So even though benchmark has fallen from my initial purchase price, I would end up losing money.

The joys of structured products!! It is very important to make sure that I get exposure to what I really want to get exposure to.

d) I also got several stocks wrong - like Aban etc (Bombay). In almost all cases, I sold the stocks when they were down 20%-30% and went on to go down another 50%. So it wasn't an unqualified disaster.

The most important lesson of the year: Selling right is more important than buying, at least in the environment that exist(ed/s). Just because something is down 80% doesn't mean it can't go down another 80%. Almost everyone - media, newspaper, books, fund managers - is focused on the buying decision. Nobody talks about the selling decision. "Experts" in media write that - "Well the market is already down 50%, so it can't fall much more. So you should buy". Even more funny is, "See everybody is down 50%. We told you its impossible to time the market. Our advice is correct. So remain invested in index funds." Some people have lost their life savings following this.

I have realized that there is one very important difference in economics and physics. Faced with facts that don't match theory, physicists try to come up with alternative theories. Economists, on the other hand, try to change facts so that it matches their theory. So, today, economists on the left are arguing that defective regulation caused all the troubles. A year from now, I am sure conservative economists will come back and argue that government meddling post the Lehman (LEHMQ.PK) crises is what has caused the recession to be as long as it is going to turn out to be.

And it is not just economists. Almost all fund managers that I meet have one particular lens through which they want to view everything in the world. All stocks in the world need to fit their theory of how stocks should behave. And if they don't, it is just a short term disruption that will be corrected duly in the course of time. "In the long run, everyone is dead", as Keynes said. It is very bizarre to say the least.

Of all the things I got right this year, the best one will remain the one on Jan 22, 2008. I got the Fed rate cut right down to the minute - and it was a "between the meetings" rate cut. Another one would be the assertion that all Indian real estate stocks are going down by 90% in April 2008 - what this meant was that some of them will go below cash.

There is a difference between a stock and a business. Stocks neither reflect business performance in the upcycle, nor do they reflect them in the down cycle. It is only over long periods of time that one will observe correlations between surviving successful companies and their stock prices. But stocks will regularly deviate from their so called "fundamental" values.

Fundamentals, incidentally, is my nomination for the most abused word of our generation. "Fundamentally, this stock is sound, or the market is pricing the stock not on fundamentals but on irrational fears". These statements assume the price of a particular stock is not one of the factors that effects the business of the company. As events of last year show rather powerfully, the price of a stock is actually one of the most important factors that effects the business, and in turn the stock price. The operating and financing decisions can be kept separate in the excel sheet world of DCF models - in reality the financing decision impacts the operating decision.

"Stabilizing an Unstable Economy" by Minsky should be made compulsory reading in all economics classes. It is a gem of a book. Different economics theories are true at different points in time in this world. At this point in time and in this cycle, it is Minsky's theory that is correct.

Comments

[Muzie:]

"Selling right is more important than buying, at least in the environment that exist(ed/s). Just because something is down 80% doesn't mean it can't go down another 80%. Almost everyone - media, newspaper, books, fund managers - is focused on the buying decision. Nobody talks about the selling decision."

I have given some though to this, and frankly, focusing mainly on the buying decision makes sense.

Only when you are a market participant considering a buy are you in full control. Only at that time can you make an assessment of what that investment is worth in your view, add some margin of safety, and commit (or not) to exchange cash for your investment.

Everything that happens after reflects what others think of the investment, but doesn't necessarily tell you anything about if your initial buy was foolish or not.

A company is available for sale at a stock price X on a certain day. You deem this undervalued and buy the stock. The company consequently increases earnings by 50%. Yet, strong forces from the market crash deflate all stocks and your stock is still quoted 25% lower than your buy price as a result. Now, tell me, was your investment decision a good one or not?

Some would argue that you lost money, it was a bad call, and move on. Well, what if the market goes up and down 25% everyday, are you wrong one day and right the next? What kind of charade would that be?

There is truth that selling is just as important as buying, but when taken to the limit one can see that using day-to-day price quotes as a measure of success in investments is of limited use - unless, of course, one sees stocks as random pieces of paper completely untied to their respective companies. In that case I could understand why someone with no knowledge of the underlying companies would get heavily influenced by whatever other people are screaming on the markets everyday.

2008 Dec 27 03:34 PM

[Fred Voetsch:]

"Yet, strong forces from the market crash deflate all stocks and your stock is still quoted 25% lower than your buy price as a result. Now, tell me, was your investment decision a good one or not?"

The decision was NOT good if you should have known the market as a whole was overvalued. IMO, everyone investing in the market should first of all understand where we are in long-term and short-term history. If we are well in to a period of excess and a generational correction is due then you should know and you should blame no one else for thinking it will be different this time.

We are in a secular bear market. It may go up a bit. This is a called a sucker's rally and if you're astute you can profit from them but the market as a whole has years and thousands of Dow points to go before we have all been taught a lesson, so conserve your capital and be ready when some real investing opportunities arise.

--Fred Voetsch

2008 Dec 27 04:13 PM

[Glen Bradford:]

This is absolutely how I feel. Everyone is "Buy-Buy-Buy." The true champions understand when it's time to sell and what to sell. You shouldn't buy everything. I'm working on this. I missed the boat the last few months.


On Dec 27 03:34 PM Muzie wrote:

> "Selling right is more important than buying, at least in the environment
> that exist(ed/s). Just because something is down 80% doesn't mean
> it can't go down another 80%. Almost everyone - media, newspaper,
> books, fund managers - is focused on the buying decision. Nobody
> talks about the selling decision."
>
> I have given some though to this, and frankly, focusing mainly on
> the buying decision makes sense.
>
> Only when you are a market participant considering a buy are you
> in full control. Only at that time can you make an assessment of
> what that investment is worth in your view, add some margin of safety,
> and commit (or not) to exchange cash for your investment.
>
> Everything that happens after reflects what others think of the investment,
> but doesn't necessarily tell you anything about if your initial buy
> was foolish or not.
>
> A company is available for sale at a stock price X on a certain day.
> You deem this undervalued and buy the stock. The company consequently
> increases earnings by 50%. Yet, strong forces from the market crash
> deflate all stocks and your stock is still quoted 25% lower than
> your buy price as a result. Now, tell me, was your investment decision
> a good one or not?
>
> Some would argue that you lost money, it was a bad call, and move
> on. Well, what if the market goes up and down 25% everyday, are you
> wrong one day and right the next? What kind of charade would that
> be?
>
> There is truth that selling is just as important as buying, but when
> taken to the limit one can see that using day-to-day price quotes
> as a measure of success in investments is of limited use - unless,
> of course, one sees stocks as random pieces of paper completely untied
> to their respective companies. In that case I could understand why
> someone with no knowledge of the underlying companies would get heavily
> influenced by whatever other people are screaming on the markets
> everyday.

2008 Dec 27 08:03 PM

[Anthony Alfidi:]

The selling decision is easy with Warren Buffett's rule: "Never sell." The only time a stock sale makes sense is when a company's business model is completely broken. Mr. Buffett knew this when he sold Fannie and Freddie years ago when their balance sheets exhibited stress.

2008 Dec 28 12:05 AM

[long_on_oil:]

Stocks are pieces of paper and that is all they are. If a company goes bankrupt have you ever known a common stock holder that made a cent. Have you ever purchased a stock that eventually went private at a price below what you paid for it? If you purchase Berkshire at $4000 a share and it is worth $5,000 a share based on intrinsic value, but Buffet wants to take it private at $3750, where do you stand now? The lawyers will make a fortune but you will give up your shares at $3750. Share prices are set by the big boys and the little guys like us just hope to buy and sell at the right points.
The only way you are guaranteed any kind of return on your investment at all is to buy stocks that pay dividends. The dividend places a bottom on the stock and you are protected to a point. Even dividends get cut so that does not guarantee you will make a gain.
Companies with a long history of paying and increasing dividends are by far the best way to go for the average buy and hold investor. At least you are getting a known return on your investment. Any good site has a screener program which helps you find these stocks.
These last 6 months have taught us that fundamentals have been thrown out the window. We all know stocks that are currently selling at 2 to 5 times next years earnings. With interest rates at 4% stocks have historically sold as high as 25X earnings (based on growth).
Where are all the investors that sold off as this market tanked and when are they going to get back in the market, that is the question.

2008 Dec 28 09:03 AM

[auto44:]

There are no guarantees. Otherwise a nice job of commenting. Good Luck.....


On Dec 28 09:03 AM long_on_oil wrote:

> Stocks are pieces of paper and that is all they are. If a company
> goes bankrupt have you ever known a common stock holder that made
> a cent. Have you ever purchased a stock that eventually went private
> at a price below what you paid for it? If you purchase Berkshire
> at $4000 a share and it is worth $5,000 a share based on intrinsic
> value, but Buffet wants to take it private at $3750, where do you
> stand now? The lawyers will make a fortune but you will give up your
> shares at $3750. Share prices are set by the big boys and the little
> guys like us just hope to buy and sell at the right points.
> The only way you are guaranteed any kind of return on your investment
> at all is to buy stocks that pay dividends. The dividend places a
> bottom on the stock and you are protected to a point. Even dividends
> get cut so that does not guarantee you will make a gain.
> Companies with a long history of paying and increasing dividends
> are by far the best way to go for the average buy and hold investor.
> At least you are getting a known return on your investment. Any good
> site has a screener program which helps you find these stocks. <br/>These
> last 6 months have taught us that fundamentals have been thrown out
> the window. We all know stocks that are currently selling at 2 to
> 5 times next years earnings. With interest rates at 4% stocks have
> historically sold as high as 25X earnings (based on growth).
> Where are all the investors that sold off as this market tanked and
> when are they going to get back in the market, that is the question.

2008 Dec 28 09:49 AM

[notsosmart:]

since its all ponzi its all luck.good or bad.the insiders(scammers,scou... ceo's,self serving boards,loophole lawyers, & outright crooks)will fleece the sheeples all the time.just check on the 101k's of the average employee who cant really control the investment or fee structure.since we cant make much anymore we have become a country of small print,phony rated paper,monopoly money,& so called bailouts of the rich.

2008 Dec 28 11:34 AM

[Amsterdamjimmy:]

Buying and selling, it all doesnt make much difference as long as you have the basic fundamentals wrong. The trend is your friend is the only system that is up across the board by 75% plus for the year, and all other systems are and always will be flawed

2008 Dec 28 12:10 PM

[Fish Gone Bad:]

I learned a while ago that I needed to able to outlive my mistakes. I do not buy on margin. If I buy a stock in a company that I like and it goes down, I will not have to suffer the insult of a margin call.

There is a time to own, and a time to not own most things. It is very important to have a plan BEFORE you make a stock purchase. This takes a lot of the emotion out of the transaction.

Clark Jenkins
FishGoneBad.com

2008 Dec 28 05:36 PM

[Muzie:]

I understand your point - yet if the market is overvalued now (and it may very well be) the argument that the market was overvalued could have been made at anytime during the past 10 to 20 years. The only thing that has changed, in my humble opinion, is, well, that it is now very much in vogue that say you have just said.

I can't really respond to the rest of your comment as it appears heavily based on a subjective opinion that indicates that you believe you single-handedly know what millions of market participants (and millions of current non-participants) will do in the near-term future.

On Dec 27 04:13 PM freddyv wrote:

> "Yet, strong forces from the market crash deflate all stocks and
> your stock is still quoted 25% lower than your buy price as a result.
> Now, tell me, was your investment decision a good one or not?"

>
>
> The decision was NOT good if you should have known the market as
> a whole was overvalued. IMO, everyone investing in the market should
> first of all understand where we are in long-term and short-term
> history. If we are well in to a period of excess and a generational
> correction is due then you should know and you should blame no one
> else for thinking it will be different this time.
>
> We are in a secular bear market. It may go up a bit. This is a called
> a sucker's rally and if you're astute you can profit from them but
> the market as a whole has years and thousands of Dow points to go
> before we have all been taught a lesson, so conserve your capital
> and be ready when some real investing opportunities arise.
>
> --Fred Voetsch

2008 Dec 28 09:38 PM

[Muzie:]

Sir, I must say you very first statement contradicts your statement. If stocks were just pieces of paper, free to go up and down irrespective of the company, then indeed the bankruptcy of the company tied to the stock would have no effect on the "piece of paper" as you put it.

The very fact that the paper is worthless when the company is worthless implies the proxy relationship is alive and well.

> Have you ever purchased a stock that eventually went private
> at a price below what you paid for it? If you purchase Berkshire
> at $4000 a share and it is worth $5,000 a share based on intrinsic
> value, but Buffet wants to take it private at $3750, where do you
> stand now?

No, I never have, though I can't see what the price "I" paid for a stock has to do with the value of a company when it goes private. Though I have never heard of a company going private at a price below the CURRENT price of the stock, and in fact most companies going private will offer a significant premium on the current stock price. But you do make a good point: if you are the only one who "knows" the correct intrinsic value of a stock, then you may never profit from it as that information may never propagate to future buyers. It is unlikely that only one person would know about material information about a stock, and in fact once those buyers have committed themselves, it is usually very much in their interest to propagate what they knew so that new buyers may now see what wasn't widely known before (thus causing the price to rise).

There are no guarantees in markets - and I suspect in fact some dividend & bond buyers will sadly discover that bonds don't actually "guarantee" the stream of returns in the end.

> Where are all the investors that sold off as this market tanked and
> when are they going to get back in the market, that is the question.

That is a good question. As the value of the US dollar has risen, perhaps some have simply gone fully in cash? If these have truly given up on stocks, then they will not come back. If they are mostly "big boys" as you say (I think reality is a bit more in shades of grey than you imply), then it's these guys job to make a return no matter what, which to me implies it is in their own interest to come back sooner or later. Nobody wants to be the first to dip its toes back in, but being the last to come back is just as horrible for these managers.

On Dec 28 09:03 AM long_on_oil wrote:

> Stocks are pieces of paper and that is all they are. If a company
> goes bankrupt have you ever known a common stock holder that made
> a cent. Have you ever purchased a stock that eventually went private
> at a price below what you paid for it? If you purchase Berkshire
> at $4000 a share and it is worth $5,000 a share based on intrinsic
> value, but Buffet wants to take it private at $3750, where do you
> stand now? The lawyers will make a fortune but you will give up
> your shares at $3750. Share prices are set by the big boys and
> the little guys like us just hope to buy and sell at the right points.
>
> The only way you are guaranteed any kind of return on your investment
> at all is to buy stocks that pay dividends. The dividend places
> a bottom on the stock and you are protected to a point. Even dividends
> get cut so that does not guarantee you will make a gain.
> Companies with a long history of paying and increasing dividends
> are by far the best way to go for the average buy and hold investor.
> At least you are getting a known return on your investment. Any
> good site has a screener program which helps you find these stocks.
>
> These last 6 months have taught us that fundamentals have been thrown
> out the window. We all know stocks that are currently selling at
> 2 to 5 times next years earnings. With interest rates at 4% stocks
> have historically sold as high as 25X earnings (based on growth).
>
> Where are all the investors that sold off as this market tanked and
> when are they going to get back in the market, that is the question.

2008 Dec 28 09:55 PM

[psusense:]

I just want to add that one of the decisions I took (in October) was to wait for the markets to stabilize before I invest in Satyam. Yes, the same SAY which has got into multiple scandals since then! I am happy that I decided to wait till mid January.
One thing with the inverse ETF's I just use trending to get in and get out. And being trigger happy as long as you are on a profit side, does not hurt if you get Stopped out.

Jan 14 11:36 AM