We wrote the following to our subscribers

When and at what level will the market bottom?

what should be the cash level in the portfolio to ride out the bear market?

These are wrong questions to ask. Let me explain –

I wrote about preparing for a downturn in my prior note. We have developed a process based on the study of the past bear markets and our failures. The key point is that we ignored some risks in the past which hurt us when the market cycle turned.

We have identified the following risks and managed them as they intensified towards the second half of 2024

1. Valuation risk: We exited/trimmed several positions in tranches as stocks went from under-valued to fairly and then overvalued. We did not exit these positions in one shot as we wanted to take advantage of the momentum
2. Position size risk: There are positions we want to hold through the cycle. However, this poses the risk of opportunity loss if the size is too large. We trimmed some of these positions so that we can hold the balance with less stress
3. Sector concentration: we reduced positions if they were based on the same theme and sector. When a sector goes out of favor, it can impact the stock for a long time
4. Poor performance: In some cases, the performance of the company was weakening and we exited as the risk reward was no longer attractive

One additional element this time was to review the indices and breadth to gauge the market cycle. As the cycle weakened in Q4, we actively reduced our risk.

In summary, we were focused on managing risk and not predicting what will happen to the market.

Half the battle

We are now at 45%+ cash level which is the highest ever and it is NOT burning a hole in our pocket. This cash level is an outcome of the process

It is easy to feel smug at this point. However, this is only half the battle. Equally important is to re-enter the market and not get locked into a bearish outlook.

We will not depend on market forecast or expert views for it. We have looked at this phase of the market too in the past cycles and have a process of initiating or raising our positions. Some of you have asked how long will it take?

We don’t know. That can only be known if you can predict the market (We can’t)

Graded entry and exit

We had a gradual exit out of several positions to reduce the aggregate risk as the market weakened.  We will re-enter in a gradual manner too driven by our buy process

The buy process for a stock will be based on its fundamentals and risk reward equation. It does not require for us to forecast when and at what level the market will bottom. Fixating on the market level is a waste of time. We are focused on refining and executing our process of finding and entering new positions

This time around, the cash level will also be a result of executing this process

I started my career in Marketing and switched to IT (consulting). The pay was 2X and the stress was half of that. I had also come to the realization that I did not enjoy sales/marketing. Reading and learning was the thing I loved, and IT provided a great opportunity for that. Investing was the other area where I could the same and earn at the same time

I joined one of the Large IT services companies and was deployed on an ERP project. I had no clue about the technology. I tackled the problem the same way I had handled it as an investor

I went online, downloaded the implementation guides, manuals, notes – whatever I could find and started reading them. At first, they made no sense. However, by the third reading (cover to cover), I started getting a hang of it

The next step was to get into the software and practice. I became good at it within a year.

On the next project, I had some juniors working with me who were in the same place, I was a year back. To my surprise, when I asked them to read all the material, cover to cover, they balked at it. Till the end of the project, they kept reaching out to me for help and just coasted along

Most people avoid lifelong learning

At the end of this episode and a few years later, I realized a couple of things

• These colleagues did reasonably well in other companies and moved into managerial roles. It just showed that learning was not key in moving up the ladder and most companies did not care for it.
• There is a perverse system where a lot of IT service companies do not reward for deep expertise. As a result, they end up with a layer of management who have outdated technology skills. It is not their loss though as they tend to fire such resources when they get bloated
• Curiosity and drive to learn is not as common as I thought. Most of the people I know would rather coast along without pushing themselves

Why people avoid learning

Initially I was puzzled why people avoided learning when it was fun, and you were better off in the end

I realized that the process of learning makes you feel stupid. I recently went through this phase when I was learning technical analysis and poker a few years back. Even now, I get the same feeling on a regular basis. This is not a question of intelligence. No one likes to feel dumb and as a result people avoid learning new things

This will be a major hurdle in the future for a lot of people as new AI based technologies go mainstream. I have gone down that rabbit hole in the last 2 years and can see massive changes on the horizon.

Unfortunately, a lot of people will complain and find reasons to avoid the discomfort of learning. I am lucky that I am comfortable with feeling lost and stupid most of the time. I have 25 years of practice in it

A recent post to our subscribers on the current market situation. Hope you find it useful

We have experienced 13 drops of more than 10% in the last 14 years of our advisory. A few have been more than 20% and the one in 2020 was 30%+

If you have been in the equity market for a long time, this is not a surprise. Even a cursory study of market history, shows the same. Yet, a lot of people get shocked by such drops.

The recent drop is being explained with a new set of reasons whereas just a few months back, India was being touted as a miracle economy. If you really need a reason, how about this? – The markets fell as it often has in the past and will do so from time to time in the future

A study of the past

I recently did a talk about past cycles of manias and booms & busts. You can watch the recording here. Some of the key lessons are

• Manias and crashes are driven by human nature. They will always be there as long as people are trading in the markets
• There is a plausible, kernel of truth which gets stretched to excess
• No one can predict when/where a bubble will start and when it will end
• Media always acts as a cheer leader of Bubbles (Story/Attention Bias)

As part of this study, we also reviewed the past 25 years of the Indian market. We have incorporated the learnings in a new process, where we review the market on a monthly basis to gauge its trend, breadth and sectors which are doing well and ones that are slowing down

As a result of this review and rising valuations, we started exiting some positions and are now at 25% cash levels

Did I foresee that the market would drop? No amount of market analysis can help you forecast the future. What we did realize was that some companies in our portfolio were stretched and so we started pulling back. We also exited positions where the performance was poor and the stock was weakening

In a nutshell, we raised our cash level as the risk reward ratio in our portfolio dropped

So what about the cash?

The next set of questions, we invariably get after every drop, is when we plan to invest the cash. For starters, we are not swing traders who are trying to catch the swing low to make a 20% gain on the next bounce

Our focus is to buy stocks with a 2-3 yr window and a 10% drop is not enough. Several stocks have dropped from a PE of 100 to 70. That is not cheap

We are constantly searching for new ideas and that process continues independent of the market condition. A bear market turns up more ideas for consideration, but we are not in a hurry. We have slept well and made reasonable returns inspite of holding high cash from time to time. We will continue in the same manner