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

There are some stocks which have a high risk reward equation for investors, but the equation does not work for the investment manager

Let me explain –  There are some stocks a fund manager can buy and even if he loses money, his investors will not be upset. Think of HDFC bank or Reliance industries

And then there are stocks which if you lose money, you will be questioned (to put it mildly). There have been such positions in our portfolio in the past. The prime example was Shemaroo. I still have some of those emails with me as a reminder

We try to ignore the noise and act as rationally as possible. That said, I am human and experience the same emotions. We are far tolerant of such positions in our own portfolio compared to what we recommend for all of you. Neuland labs was not entirely in that bucket, but had elements to it when we re-initiated the position

To begin with, we lost money on it in our first try. We were cautious in restarting the position and did not want to impact the portfolio if it failed again.

High returns are not free

There are some positions which have worked very well in our personal portfolio, but we will not add to the model portfolio. These are small cap, turnaround companies which have a higher risk reward ratio. Also if things go wrong, exit is not easy.

There is no free lunch in the stock market. We are not going to find a 20% compounder with 25% ROC valued at 10 times earnings. There was a time when such stocks were available and I was lucky to invest in some, but those days are long gone

We some time buy these higher risk/reward, ugly looking stocks for our personal account, but the downside for the model portfolio is too high.

We are thinking of how we can develop a different product for such stocks for investors who are tolerant of much higher risk. We will keep you posted as we get ready for the launch

Disclaimer

• This report is published by RC Capital Management – SEBI Registered Investment Advisor (INA000004088).
• This report is for educational purposes only and should not be construed as an Investment Advice.
• RC Capital Management may have recommended the above stocks to our clients in the past. However, this is not a recommendation to buy / hold / sell the stock at the time of publishing this report.
• The securities quoted are for illustration purpose only and are not recommendatory
• RC Capital Management may hold position in any of the companies mentioned in the report at the time of publishing the same. Its partners may hold a position in this company in their individual capacity at the time of publishing.
• Neither RC Capital Management nor its partners have received any compensation from any company mentioned in this report for the preparation of this report.
• There is no conflict of interest for RC Capital Management / it’s partners due to publishing this report