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Liquidity crash

By Rohit Chauhan
In Market analysis
May 12, 2022
3 Min read
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This was posted recently to subscribers of our advisory. Hope you find it useful

We are seeing what I would like to call liquidity crash in markets across the globe

Let me explain

In the last few months, I have been tweeting about inflation going up and prepared this presentation, which I did not post. I laid out my thoughts in the ppt which I created in Dec 2021 and posted a summary on twitter. Judging from the response, most people did not bother about it 😊

As inflation has risen, the Fed and other central banks have raised interest rates. This caused a slowdown in the markets in the last few months

The nifty and other indices have been flat, and several stocks are down in this period.

I think this was the first stage and we have moved into the next phase – that of tightening liquidity. The US fed and central banks have announced a withdrawal of bond buying and other liquidity measures they introduced during the Covid crisis

These measures led to all kinds of asset inflation as liquidity surged across the globe. As this liquidity is withdrawn, we are seeing sudden crashes in asset prices

In the last few months, various tech and SaaS companies have been obliterated. A lot of these company are down 50-90% and the selling hasn’t stopped yet. This is now spreading to other asset classes

We are seeing some early signs in the Indian markets, especially in the small/mid cap space. In the last few days, I am seeing sudden large drops, often for no fundamental or company level reason. This is likely to intensify in the coming weeks and months.

How are we positioned?

This is not new and occurs every few years. What is different this time, is that the Fed and other central banks will not be there to inject liquidity and save the markets. At best, they will continue to deflate the bubble slowly to ensure that markets and economies function properly

We have always been cautious and careful. For example

  • We hold 18%+ cash in the model portfolio
  • I have consciously kept the position sizes small especially if the company is in the small cap space due to the liquidity risk (the failure in Shemaroo is still fresh in my mind)
  • Our larger positions are in companies which are profitable, growing and with reasonable prospects and valuations

The coming weeks and months are going to be painful. I have always stressed on asset allocation to all of you and hope you have managed your equity allocations keeping that in mind. Our risk tolerance will be tested in the coming month

The key is to keep the equity allocation at level where a drop in the portfolio will not cause you to sell in panic. We will be tested on that count

As I have repeated ad-nauseum – Survival is key. There is no point making large gain, if we lose all of it and are forced out of the game. That is already happening to a lot of people

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Progress is never linear

By Rohit Chauhan
In General thoughts
April 19, 2022
2 Min read
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Let me share two graphs, which appear quite similar

Are they from the same data but drawn differently? Both graphs show periods of growth followed by consolidation or pullback

Let me zoom out and show the source of this data

The first graph is that of our model portfolio and second is of Vinati organics. One is a portfolio of stocks and another is a portfolio of products. Our portfolio has delivered 24% CAGR in the last 10 years and Vinati organics delivered 40% CAGR over the same period.

There is a deeper lesson in the above charts

Progress is never linear. It happens in fits and starts with periods of stagnation and backtracking.

Short-term thinking and extrapolation

It is easy to enter the portfolio (or a stock) at point A and just extrapolate that trend or at point B and do the same. The problem with this mindset is that the individuals expect progress to be linear and steady (purple line) whereas reality is the brown line of our portfolio

This is a problem no one can solve for us. I have seen this all my life, especially with investing. A lot of investors want immediate gratification and jump in at point A, only to be disappointed.

The right mindset is to zoom out and look at the long term trajectory. Does the mindset and approach of the advisor make sense and will it work over the long run. Is yes, then you must give it time to play out

What drives this behavior ?

I think the problem is our own expectations and lack of patience. We want immediate and consistent results. That’s the point of tweet below

The world is not kind to give something for free. If you want zero volatility – go for a fixed deposit. If you want high returns, the price you pay is the volatility of the returns.

Somehow everyone gets this in other facets of life – everything of value has a price. Patience and persistence is the key to success – in stock markets and a lot of other endeavors

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Déjà vu again

By Rohit Chauhan
In General thoughts, Market analysis
February 27, 2022
4 Min read
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The following was posted to all the subscribers. Hope you find it useful

Market drops have become a once in two year events

2016 – demonetization (note here)

2018 – ILFS crisis (note here)

2020 – Covid Crisis (note here)

2022 – Drop in US markets and now Russia Ukraine war

There is no regularity to these events and does not mean we will get these drops in even years. Such drops have occurred in the past and will occur in the future too.

You have to study the market history to know that there is always something to worry about and scare the markets

Bottoms instead of top down

I have never planned the portfolio based on some specific forecast or event. In the last 11 years of our advisory, we have seen all kinds of micro and macro events occur. At that time, the event appeared to be a big deal and then eventually everyone adapted to the new situation

What I have changed in the recent past (as I noted in the annual letter) is my response to company level events. If a company is not doing well or the management is lacking in execution, we would rather exit than hope things will work out

Doing so ensures that we clear the portfolio of its deadwood and have positions with higher level of conviction. That’s the reason we have 25% cash level in the portfolio, not because my crystal ball forecasted a downturn in 2022

What does the crystal ball say now?

My crystal ball is as murky as it always has been. The same is true for others, even if they claim otherwise

However, a few long term trends which impact investors the most, seem to standout. Inflation and by proxy interest rates appear to have bottomed and could rise in the future. This will exert a downward pressure on valuations.

Commodity prices and supply chains will continue to get disrupted due to this conflict and other geopolitical events

All of this means a lot more volatility in businesses and stock prices

How to invest with higher volatility

In my mind higher volatility means that managements of companies will have to be flexible and adapt faster to change. For us as investors, this means that the operating environment for our companies could change suddenly leading to a break in our thesis

When that happens, we may have to sell and move on. Holding onto an outdated thesis and hoping it works out is a recipe for disaster

We have been doing that for the last 6 months and will continue to do so. I am not counting on luck to bail me out.

The second change is portfolio diversification across companies and sectors. I have tried to spread out our investments across companies and sectors to ensure that a hit in one does not derail the portfolio. The same holds true for your overall portfolio outside of equities. I would recommend being diversified across asset classes with allocation adjusted to your personal situation

A plan of action

A lot of you have asked if you should add to positions which have dropped below the buy price. The simple answer is Yes. The only time when this happens is when there is chaos and crisis in the world. Such prices come only during times of trouble

It does not mean that if you start adding today, you will not see lower prices. No one can predict how low the markets can go and when they will turn around.

This is the price of investing in equities and no matter what system you follow, there will always be losses from time to time. you can use a stop loss but then on the flip side if the market suddenly turns, you will lose the upside.

The best option is to invest in a steady and measured way keeping in mind that your purchases could show a loss in the short to medium term. Invest only if you don’t need that money for the next 3-5 years and the amount is such that these losses will not cause you to lose sleep

We continue to look for new ideas and with the recent drop, a few are becoming attractive by the day.

As always, our money is invested the same as the model portfolio and we continue to eat our own cooking

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Playing games

By Rohit Chauhan
In General thoughts, Investment process
February 18, 2022
3 Min read
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I got introduced to poker in 2020 and have taken to this game. You can read the rules of the game here. The rules are quite simple. The richness comes from the lack of perfect information

As the community cards open on the board, one bets not only on one’s own cards but also based on the strength of the opponent’s hand. As the opponent’s hand is hidden from us, we are forced to make probabilistic decisions

As the card are dealt, one makes these decisions based on betting and other actions (called as tells) of the opponent. The beauty of the game is that one can see the result of the decisions quite quickly – in a matter of 5-10 min as the hand is played out. This allows for rapid learning

As you play the game, the parallels with investing/trading become clear. Investing has far more variables and is not the same as poker. That said, both involve decision making under uncertainty

I wanted to share some learnings from the game, as related to investing

  • Losing even when odds are in your favor: Decision making under uncertainty involves making probabilistic decision. Even when the odds are in your favor, the result can go against you. The probability of win could be 60% which is considered high in poker, yet 40% of the time the result will be against you (no surprise there). This happens often and inspite of all the rational thinking such events do upset me. Most other players in poker or investing are not even thinking of probabilities

The key is to focus on the process and not the outcome (easier said than done)

  • Keeping losses low: Odds will often not be in your favor and you will be tempted to make a bet. At such times, folding your hand against all your instincts is the right decision. Making such decisions is never easy as one is losing money – by folding in poker or selling a position in the portfolio. However, such decisions are the key to doing well in the long run.

What ‘feels’ good in the short term is not good for long term results and vice versa. That’s why investing is simple but not easy

  • Know yourself: Some players are aggressive risk taker. They will bluff often and make big bets when odds are slightly in their favor. Other players like me are more conservative. I am constantly calculating the odds and making bets accordingly. I am also focused on not going bust in a game (losing my entire stack). I invest in stocks in the same manner. The only difference in my poker game is that I will occasionally bet high when the odds are really good.

Successful players play to their natural bent of mind, but at the same time should try to do what is not comfortable for them. Combing the right amount of offense and defense is an art and a lifelong process in poker and investing

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