Gloom and Doom

This was written to subscribers recently

It’s an understatement to say that things are getting scarier by the day in the stock market

We are seeing companies drop 20% or so in a matter of days (or sometimes in a day itself). I started reducing our positions in late 2017 as I became concerned with the valuations. However, I had no clue (and neither did anyone) that things would start falling apart in 2019. As a result, in hindsight we should have gone higher into cash. Please note the word hindsight which keeps coming up.

In the last two years we have exited the weaker positions where I was concerned about the business or management. We re-deployed some of that capital back into other positions, resulting in the same level of cash at the portfolio level. We will continue with this process in the future.

It reminds me of the famous bullet dodging scene in the movie ‘matrix’ – The hero -Neo manages to dodge multiple bullets from an agent, but one still gets him. In our case we have been able to dodge some, but got hit by a few inspite of our best efforts.

This dynamic now seems to be changing for the worse. There will be no dodging now.

Risks are rising

The drop we are seeing in the market seems to be pointing to something deeper. We are seeing a liquidity squeeze from multiple factors such as the NBFC crisis, high NPA in the system and possible global issues such as capital flight to the US dollar. There could be other issues too and your guess is as good as mine. In the end the reason does not matter.

The troubling part is that we are yet to see a major market meltdown in the US and other foreign market. I usually don’t talk much about macro issues but keep an eye on them. I will not go into various issues such negative bond yields across the board, inverting yield curves and other mumbo jumbo but say that the odds of a global recession are increasing. Combine this with trade issues and high debt levels, and we have a higher risk of a meltdown.

The above is not a given, but if it happens, we will feel the repercussions in India too.It could get worse if the system gets a macro shock.

I am not writing all of this to alarm you further. I don’t see an end of world scenario or anything of that sort. However, we need to understand the context of what is happening around us. It is easy to talk of a long-term view, but we may have to go through a lot of pain in the interim

Let’s look at the case of one of our holding. The company has dropped by 20% for no apparent reason. As we have done in the past lets invert the problem and look at reasons for the sale

< Company details and analysis has been deleted for this post >

A debt default or any other fraud will cause a steep drop in the stock price. However, it does not mean that a drop in the stock price is only due to management fraud or default.

A logical fallacy

I get emails from subscribers asking me for a reason after every such drop. If we continue to have market drops, we would see sudden drops in our stocks too. These drops could be due to various reasons – business, debt issues, margin calls, or fear induced selling.

One cannot find the reason for every case, nor can one generalize it to corporate governance or some other issue. We try our best to filter out unethical management before starting a position. However, it does not mean that we will avoid all of them. When we realize that we have made a mistake in terms of the business, management or under-estimated the risk, we will reduce the position or exit as we have done in the past.

I can assure you I am always alert to what is happening to our companies and their stock price. In most of the cases, I choose not to react by choice.

In the coming months, we could have more drops with some extreme ones too. Unless there is a fundamental issue with the business or management, I plan to bear these quotational losses. I have gone through such times in 2000 and 2008 and can tell you it is very painful to watch your portfolio get decimated. The only way forward is to have a sense of long-term optimism even when things around us are falling apart.

I have not invested the cash we hold till now. I want to wait patiently till we get some good bargains, which happens only when the news keeps getting worse. I hope you will have the courage and faith to invest at that time.