Making sense of sentiment
Suresh Krishnamurthy/Business Line/ 4th December, 2005
Staying rational does not require you to be a skilled investor. Some investment gurus have indicated that a simple buy-and-hold policy could be as effective as any complicated procedure. Investors who keep things simple could make as much money as the most skilled fund manager.
IN the last 60 days, stock prices have been on a roller-coaster ride. In the first couple of weeks of October, indices were down 10 per cent and were still looking down the barrel. A sub-7000 close for the Sensex did not appear all that unrealistic then.
Now, in December, after stock prices staged a remarkable recovery in November, the Finance Minister is yet again seen suggesting that valuations are within reasonable limits, and the ten thousand mark appears within reach.
Except for the unnatural predilection of the umpire (read Finance Minister) to keep forecasting that the star batsman (Sensex) would continue to score for investors, stock price movements only fill you with a sense of deja vu.
For instance, in October 1999, it looked as if the sky was about to fall as stock prices plummeted. It turned out to be a different story, as technology stocks broke through several barriers to post astronomical gains since November that year.
It is not clear if a repeat of the bull market of 1999, or the bear market of 1995-96, as some might suggest, is on the cards.
What is, however, clear is that investors increasingly have to brace for wild swings in sentiment.
The stock market is full of normal, not rational, people, as even the investment textbooks now concede. They do change their views at short notice.
Such changed views may be pregnant with implications. They may also be contrarian indicators, as they turned out to be in the past two months.
As normal investors, most of us are significantly influenced by these swings, that often induce sleepless nights.
As difficult as it may seem, investors have no option but to constantly stay as rational as possible under the circumstances.
Undue volatility: In September, the research report of an Indian brokerage identified excessive volatility as a prime risk even as it continued to stay positive about prospects. This brokerage was spot on.
Fluctuations in daily returns have continued to be as high as they were in the early days of the 2003 bull market.
For instance, the difference between high and low values for Nifty, as a proportion of closing value, was about 1.98 per cent in October and November.
In other words, intra-day swings of nearly 150 points in the Sensex are now par for the course. The proportion was identical between April 2003 and January 2004, representing intra-day swings of about 100 points then.
Stock prices appreciated 100 per cent or more in 2003. Analysts do not, however, expect returns of more than 12 per cent per annum now.
Given the low expected returns, the extent of volatility in stock prices appears abnormal.
This volatility may be suggestive of large price movements in the short term but is inconsistent with expected returns.
Staying rational: For an investor to remain completely rational in the backdrop of such extreme provocation is ruled out. It is a utopian ideal. Investors, however, have an obligation to themselves to stay as rational as possible.
In the context of building wealth, that would require investors to stick to their investment objectives and asset allocation plans.
Monthly stock price returns should not be the trigger for a change in strategy. If you decide at the beginning of the year to invest only so much in equities, stick to the plan. Enhancing the proportion now may not be rational.
Again, wealth is not built in a couple of months. If you are going to stay invested for over five years, then you can at the most earn 15 per cent per annum.
It is not possible to generate returns of 10 per cent every month. At best, you can do that only on a small part of your total capital. And not every investor can.
It would be better to swallow the impulse to actively churn your portfolio. Conviction, too, is necessary.
As Rakesh Jhunjhunwala has often indicated why he makes more money than others, you will need to hold through the ups and downs of the stock market. In today's volatile market, lack of conviction could hurt investors.
Staying rational also does not require you to be a skilled investor.
Some investment gurus have indicated that a simple policy of buy and hold could be as effective as any complicated procedure.
Investors who keep things simple could make as much money as the most skilled fund manager.
Keep investing in equities since they can, at most times, beat debt and inflation. Taking tips from market sentiment could, however, colour your perception of equities.
After a brief but thrilling roller-coaster ride, it would in the end make you wonder if equities are such an attractive asset class after all.
