A stock which typically rises in price when the economy expands and falls when it retracts. A stock which rises as the economy contracts and falls when it expands is said to be countercyclical.

“Hedging” or opening up a “hedge position” is the process of establishing an exposure to a particular risk in order to offset an existing but opposite exposure. The term originates from the game of roulette where the lines between betting squares are called hedges. A bet place on the “hedge” wins if the ball lands on one of the numbers either side of it but the payout is lower than for betting on the number itself. The phrase “hedging you bets” became common parlance in English and over time has become established finance terminology. (more…)

The smallest unit of price in which a security may be quoted. The value of a Tickvaries across asset class but a movement of 1 Tick is always the smallest price movement possible

It can sometimes appeear as if the universe of investment strategies is characterised by linear dimension and polar opposites. You’ either go long or you go short, you’re a day trade or a long term investor, you’re a risk taker or a risk avoider.  Some would add to this collection your either a value investor or a growth investor. Even the professionals seem keen to pigeon-hole themselves as one or the other. Scratch the surface however and you’ll find very similar principles at the heart of both. (more…)

A term used to describe a small upswing in the price of a stock which is on a rapid downward trajectory. The term originates from the slightly heartless theory that even a dead cat would bounce if thrown from a great height

A statistical measure of how much a stock price moves in relation to the overall market or benchmark index. A Beta of 1 means the stock historically moves in line with the index (10% rise in index = 10% rise in stock), a Beta less than 1 indicates the stock rises (or falls) less than the index and a Beta greater than 1 indicates the stock rises (or falls) more than the index. A negative Beta indicates the stock moves in the opposite direction to the index.

Companies which sell staple goods like food generally have low Betas while luxury goods companies typcially have high Betas. Negative Betas are rare but can be found in some gold, mining and oil companies. In a bull market high Beta stocks typically outperform the market and in a bear market low Beta stock lose value less quickly than the market while negative Beta stocks generate a positive return.

An investment strategy where the investor or fund manager attempts to match the returns of a specific index by replicating the make up of the index in their portfolio. This is the opposite of an active strategy in which the investor or fund manager attempts to outperform an index by identifying and investing in securities which are under priced

One of the underlying assumptions of technical analysis is that stock and index prices follow trends which are determined by the interplay between numerous forces which affect price. These can be broadly split into four categories; economic, monetary, technical and psychological. Depending on the direction of these forces, traders in a stock fall into one of two groups; bulls plan to buy now sell later and benefit from a price rise; bears plan to sell now buy back later and benefit from a price fall.

During a rising trend bulls dominate the market and during a downward trend the bears dominate. In a reversal period, where the trend is changing from an upward one to a downward one (or vice versa), there is a temporary balance between the two groups. These transitional periods are often characterized by price patterns which can be used to identify when a prevailing trend is reversing. 

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The mistake made by inexperienced investors who believe that buying a variety of stocks will automatically give them a diversified portfolio. A portfolio which contains a large number highly correlated stocks is said to be naively diversified because the overall risk is not significantly reduced by the fact the portfolio has many components

Efficient-market theory (or Efficient Market Hypothesis EMH) argues that in the long run it is impossible to “beat the market” because the current price of a stock always factors in all available information.

According to the theory, stocks always trade at fair value and it is impossible to buy undervalued stocks or sell stocks for inflated prices. Therefore it is impossible to outperform the market by stock picking or market timing; the only way to earn higher returns is to buy riskier investments. The theory gained prominence in the mid-1960s and in 1970 Eugene Fama refined it into three distinct forms: weak, semi-strong and strong. (more…)

The (MACD) Indicator is a technical analysis method first developed in the 1960s by Gerald Appel, a prominent author in investment and trading strategy. MACD stands for Moving Average Convergence-Divergence and is based on the comparison of fast and slow exponential moving average  prices. Proponents of MACD Indicator methodology argue it can be used to identify trend changes in stocks and indices.

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Its not really news when I say that we’re in a bear market (the widely accepted definition for western equity markets is a sustained 20% drop is much smaller than the 50% drop of the Nifty from our January high of 6357). But the question on everybody’s mind is - where are we in this bear market? The beginning, the middle, or at the end (the bottom)? Let’s have a look at the past three Indian bear markets and see if we can get some clues (data below sourced from Morgan Stanley Report, “India Strategy: How to Cope with a Bear Market”, published on 13 March 2008):

First: 2 April 1992 (top) - 26 April 1993 (bottom)

• Tipping point: Harshad Mehta
• Lasted for 56 weeks (just over a year)
• Sensex Peak at 4547
• Sensex Bottom at 2073
• Decline of 55%
• Time taken in days to cross previous high: 881 (2.5 years)
• 6 months return from the bottom: 34%

• Tipping point: Dot-com bubble bursts / Ketan Parekh scandal comes to the fore
• Lasted for 84 weeks (around 1 year 7 months)
• Sensex Peak at 6151
• Sensex Bottom at 2627
• Decline of 57%
• 12 months trailing PE at the Bull market peak: 33.9
• At the Bear market bottom: 13.6
• Decline of 60%
• Time taken in days to cross the previous high: 1425 (4 years)
• 6 months return from the bottom: 34%

• A bear market leads to an average decline of 51% of the index, and upto 60% decline in PE ratios
• If you managed to invest at the bottom, 6 months down the line you’d have made an average of 35% return (although spotting the bottom is near impossible - so this is rather misleading)
• It lasts anywhere between 1-2 years
• It takes anywhere between 2.5 to 5 years for the market to ‘recover fully’ to its previous peak - therefore the bear market is accompanied by a considerable ‘horizontal’ market
• The bull market peak is over 32x earnings (PE ratio), and tends to more than halve at the bottom.

The crash of the Indian Stock Market since January 2008 has been widely attributed to FIIs pulling their money out to meet liabilities and redemptions. According to this article, however, FIIs have only pulled out $12.7bn and still have another $53.7bn, or almost Rs. 270,000 Cr. left in the market. 

A lot of market experts are talking about the market being near the bottom (”Valuations just cannot get any cheaper! The Indian growth story is sound, even at 7%!”) Let’s be clear on this: these falling prices are not about fundamentals - its simply about lack of liquidity. FIIs are not exiting the market because they want to, but because they are being forced to - nobody wants to book such massive losses, and nobody would argue against the fact that as an emerging market India is looking pretty cheap.

The fact that there’s so much FII money still in the market - 80% - is quite scary (more…)

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If you’ve been watching the market, even if not very closely, you’ll agree with me that it’s been – at the risk of sounding facetious – surreal.

Monday felt like a train wreck – Paulson’s refusal to bailout Lehman over the weekend and its subsequent bankruptcy announcement, and Merrill’s overnight sale to Bank of America (BoA) had my head spinning. If the Monday wasn’t black enough with news of Lehman and Merrill, we quickly learned that AIG was going around with a begging bowl trying to raise capital in the tens of billions to escape bankruptcy. Monday closed with the Dow 500 points down – that’s almost 5% - in contrast to the less that 1% movements that we’re used to seeing for that index.

In a discussion with a friend we realised that two global and highly esteemed (although Lehman had a more patchy 160 year history than Merrill Lynch) had within days just *poof!* ceased to exist. While BoA will probably retain the Merrill brand, its unlikely that my kids will ever hear the word ‘Lehman’. Indeed Lehman Brothers will probably be relegated to a notch in Barclay’s timeline on their website’s ‘About Us’ page.

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Analysts blame the high interest rate environment on the poor results. Some 70% of car sales are financed, and high interest rates make it more expensive to take out loans to pay for their car purchases. The small car segment is thought to be more sensitive to interest rate fluctuations, as the middle class families that buy from this segment cannot afford to make outright purchases.

I largely agree with the rationale presented above. However, the high interest rate environment should have had an equally damaging effect on Hyundai’s sales as well. Even if you take into account that Hyundai’s August 2007 base of 16,000 cars was lower than Maruti’s base of 60,000 cars – you cannot explain away such a dramatic a dramatic difference in results.

The reason for Maruti’s poor performance goes beyond the interest rate environment. Since the Swift Maruti hasn’t had any new launches of note. Moreover, its marketing has been limited and unfocussed. Its strategy of driving sales through schemes in the rural and semi-urban segment – although intuitively appealing (tap into less served segments) – failed to provide results. The likely reason is that households in these regions, who have fewer financing options, are even more interest rate (more…)

Periods of high inflation often provide a much more difficult investment environment than periods of low inflation. Investors may therefore need to adopt a more active investment style if they are to maximise returns.

When inflation is high, as it is now, there are two basic principles which should be followed. Firstly, buy companies whose earnings growth will be able offset the inflationary effects on P/E ratios. Secondly, be prepared to rebalance your portfolio between inflationary and deflationary strategies, in response to changes in the economic environment.

The inflationary effect on P/E ratios is that they are generally downgraded in times of high inflation. As inflation rises, the inflationary component of earnings growth becomes a more significant proportion of the total. As the price of both inputs and sales increases, profits generally rise in nominal value without any improvement in productivity. So over time earnings growth, which is a key factor in determining stock price, becomes more and more a product of inflation rather than anything else.

Now you might think that all earnings growth would be a good thing. However, investors typically place less value on increased earnings (more…)

There has been a lot of chatter in the market about FIIs staying away from the Indian markets because they feel that the valuations in India are still relatively quite expensive. Index PE ratios, when looked at in comparison to historical levels are a good way to determine how cheaply/fairly/expensively the companies that make up the index are relative to their historical levels.

But first, an explanation of how an ‘Index’ is calculated: There several ways to create an ‘index’ but the method commonly used is the ‘free float market capitalisation methodology’ where very crudely Indices are calculated adding together the market capitalisation of each of the companies chosen for that index based on some sort of criteria, dividing that figure by the sum of the market capitalisation of those companies that met the same criteria in a base year and then (more…)

We haven’t heard much (except Bhave telling some investors that SEBI may allow it, read BS article here) about Real Estate Investment Trusts (REITs) since SEBI released the draft guidelines in December last year - but I think that its a very interesting concept and worth a revisit.

Real estate in India has experienced exceptional growth since 2004-05, with some cities even experiencing a more than 50% price rise on a compounded annual basis. While pundits and the common man alike are slightly nervous owing to double digit inflation, rising crude prices, and a stumbling equity market - leading to a cooling of real estate prices in tier 1 cities, residential and commercial real projects in tier 2 and tier 3 cities are holding firm. 8 months have already passed since the equity market crash of January this year, and while many are forecasting a further drop in the markets, others are talking more optimistically about us already having bottomed out, and the interest rate cycle having peaked. This bodes well for the real estate market, and as inflation and interest rates start coming off over the next 6 months (we hope) - this will lead to a resumption of the real estate bull run.

With this backdrop, Indian investors are slated to have access to real estate investment trusts (REITS) as the country is poised to embrace deregulation and further formalization of its booming real estate market.

The move is driven in part by the demand fuelled by domestic players looking to implement ambitious expansion plans. Reits have been introduced in most of Asia’s leading markets (Singapore, HK and Japan) in the last seven years and the introduction of Indian Reits will prevent the profitable Reit business going overseas. Moreover, as property prices in the the US and elsewhere crumble in light of the subprime mess, foreign investors seeking to allocate their capital to real estate will seek to put their funds elsewhere - e.g. developing economies such as India, where although there has been recent turmoil, fundamentals are strong, and this may be a good opportunity to get in at a bargain. Reits would certainly be a mechanism that simplifies investment (more…)

Given the recent news SEBI considering (but not doing anything yet) about revoking the P-note ban, I thought it might be a good idea to revisit the topic. Thank you to Akshay for passing on info that has helped me better write this post.

In India, only domestic investors, or ‘Foreign Institutional Investors’ (FIIs) - those foreign institutions that have registered with SEBI, are allow to invest into the equity markets directly. Participatory notes (P-notes) allow foreign investors, such as hedge funds, which are not registered with SEBI to invest easily in the Indian equity market.

Practically, the way that P-notes work is that a foreign investor - say a hedge fund - would deposit funds with an FII that is authorized to issue P-notes, who would use the funds to purchase shares as instructed by the hedge fund. The FII would then issue a P-note to the hedge fund, which is essentially a certificate that says that it is entitled to X shares of company ABC, and any capital gains or losses and dividend payments would be passed onto the hedge fund. In return for this service, the hedge fund would pay the FII a fee.

A crude example: If a hedge fund not registered with SEBI wants to buy one share of Hindustan Unilever Limited (HUL), their FII would pick up a share of HUL for Rs. 240 and write a contract that says that in return for a fee and the Rs. 240 paid by the hedge fund, when the hedge fund asks the broker to sell the share they will comply and pay back the hedge the Rs. 240 plus or minus the rise or fall of the share price and the dividends if there were any.

Because foreign investors bought P-notes from reputable FIIs (they knew that they wouldn’t go back on the agreement), and there was a healthy supply of P-notes going around, foreign institutions were able to trade these P-notes amongst themselves.

On October 16, 2007, N. Damodaran, the then SEBI chief issued a decision to curb foreign participation through P-notes as he felt that there was excess money being pumped into the Indian market unchecked leading to volatility - which is always bad thing, especially for the retail investor (more…)

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I believe that retail investors – that is those of us that invest in the stock market – have the odds stacked pretty heavily against us. The biggest one really being that we’re pitted against large institutions – people who have had far greater resources in terms of research and analysis, and indeed training in high finance.

Even if we did have all the resources, and the knowledge, we just wouldn’t have the time. The guys working for large investment banks, literally do this for a living, and many retail investors – well, don’t. We have day jobs – and most of us cannot watch the trading screen and read research papers all day.

Despite being aware of these facts, we continue to choose to invest directly. Why? Because of the allure of high returns, the thrill of picking the right stock, and the excitement of watching our stock move in the right direction. Moreover, we like being in control of our own finances.

One keeps hearing all sorts of anecdotal statistics from various studies – one revealed that over a decade, only 20% of asset managers managed to beat the S&P 500. One can react to this statistic in two ways: either the retail investor thinks to himself that if sophisticated financial analysts have such a poor record, they don’t stand a chance.

Alternatively, they might think to themselves that the belief that ‘investing is best left to professionals’ is false. I tend to agree more with this view. If anything, statistics such as these should only serve to further encourage retail investors to participate more actively in the market. If professionals have such a poor success rate, we might as well give it a shot ourselves (more…)

When the equity markets are faring poorly due to a bad economic environment. When trying to figure out whether a company’s stock is defensive or not - ask yourself one question - are its products neccessities or luxuries? Can consumers cut back spending on them just because economic conditions are poor and they’ve possibly seen a reduction in wages, or been laid off? Indeed, could the consumption of the goods created by such a company rise in uncertain times?

Sectors that have traditionally been thought of as defensive include Food, Tobacco, Utilities, and Oil. Makes sense - the amount that households can cut back on Food is limited, and indeed, Tobacco consumption tends to go up when times are bad. When input costs rise, these are the companies that can pass on the price rises to the consumer. Therefore, in times of economic uncertainty, equity investors’ money flows into these types of stocks, leading to an increases in their prices.

However, when times are good, the stocks that fall into the above sectors aren’t star performers - for the opposite reason as outlined above, there’s only so much you can eat - indeed margins in the stocks of defensive industries are often quite low.

Let’s look at two stocks that are considered defensive (more…)