Saturday, December 27, 2008

Looking Back at 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 was not a good strategy last year. 

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

c) SKF, 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. 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 of the selling decision. "Expertsin 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 between economics and physics. Faced with facts 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 Lehman 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 do not, 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 meeting" 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. Neither do stocks reflect business performance in the upcycle, nor do they reflect it 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. "Fundametally, this stock is sound, or 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 affects 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 affects the business, and in turn the stock price. The operating and financing  decisions can be made 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 of time in this world. At this point of time and in this cycle, it is Minsky's theory that is correct. 

1 comment:


2008 was some year alright.