Saturday, 6 August 2011

Markets in Turmoil

Until very recently I had no interest in the stock market. A friend of mine who has read rather a lot of Warren Buffet than I think is good for his health kindled my interest in shares.

It is an academic interest only, as, at this stage, because of my special circumstances (I am skint) I do not have the capital to invest in stocks.

Which means that I am likely to miss out on the opportunity of buying shares and investment trusts at what I have heard some pundits describe as basement bargain price. 

With the global turmoil several billion pounds have been wiped out of stock market, as investors have been selling in a panic. This apparently is exactly the time when a clever investor with intestinal fortitude (and obviously access to cash) goes on a buying spree that would make a Saudi Princess visiting Harrods green with envy.

The theory, as far as my understanding goes (which admittedly is not very far), is like this: If you, say, buy shares of solid companies with good fundamentals, and a long and proven history of increasing their dividends every year, cheaply; and if you are in the game for the long run, then you are on to a winner. You have earned yourself steady income (in dividends); plus, since the companies whose shares who have bought are strong enough to withstand the vicissitudes of the markets (unless the unthinkable happens, as in case of the Royal Bank of Scotland during the last stock market meltdown), you can rest assured that the shares, in due course, will rise again. They might regain or even exceed their pre-slump prices; and then you are laughing, as your net worth has increased. Until the next slump hits you. Then you tell yourself the same thing; buy more shares again at bargain prices, and remain convinced that you are very clever and are becoming richer as a direct consequence of your cleverness.

The above is just one version of how you can strike it rich. There are several other variations of the theme I have come across. You might, for example, do the so called value investing. Dudes who do this buy shares of companies when they are cheap; wait patiently until the shares rise and then sell them at a higher price. They will then buy more shares of ‘distressed’ companies and repeat the cycle.

If you are following either of the above two strategies, you are going against the market sentiments. Thus, when you are buying shares when everyone else is trying to get out faster than a drug addict out of a crack-den following a police raid, you are essentially saying: all these millions are fools; they are panicking unnecessarily; I am altogether much cleverer, shrewder, and smarter than they are; and I am going to take advantage of this mass hysteria and buy shares even if that might seem contrary now. Similarly, when you buy shares of a company which is not valued highly by the market (because the market thinks it is a crap company), you are saying that the market has got it wrong and you have got it right. You are therefore going to buy shares of this company. In due course the market will realise its mistake and will accord the company its worth, the shares will rise and you will get richer.

As I said earlier, it takes, depending on how one looks at it, a confidence in oneself or an ability to delude oneself, to go against the sentiment of the majority.

The friend who got me interested in equities is an enthusiastic private investor. He is more into shares than Michael Douglas was into Catherine Zeta Jones. He is self taught and, by his own admission, has learnt hard lessons along the way. A few years ago he bought shares worth several thousand pounds of the Royal Bank of Scotland. We all know what happened to RBS shares. I guess he was not alone in losing a fortune on RBS. Many people bought RBS shares when it was considered one of the sexiest shares on the FTSE. My friends bought RBS shares when the price started plummeting. He began buying RBS shares when they, as he saw it, became available for basement-bargain price. Unfortunately for him the shares have stayed in the basement and are not likely to come to the ground floor any time soon. ‘I tried to catch a falling knife,’ he told me. I complimented him on his excellent use of metaphor; and he said that this was a common phrase used in the world of stock market when your calculations regarding the value of a company whose fortunes are sliding, which are against the market sentiments go wrong. (In other words the market turns out to be right and you turn out to be a fool).

So has my friend learnt any lessons? He says he has. He shall no longer attempt to catch a falling knife. 

The thing is how do you spot the figurative knife falling and get out of its way?

I asked my friend yesterday how his ‘large and diversified’ portfolio had fared in the most recent rout of the markets. ‘Thousands of pounds have been wiped out of my portfolio,’ he informed me cheerfully. ‘I lost almost 2000 pounds in a single day,’ he added with barely concealed excitement.

It wasn’t immediately clear to me why he was so cheerful when he had lost several thousand pounds. I would be mightily pissed off if that happened to me.

‘That’s where you are wrong,’ my friend said. ‘You have to conquer your emotions. You can’t let emotions rule you. That is when you start taking illogical decisions.'

‘You mean to say,’ I tried to clarify,’ the decimation of your portfolio was a logical and planned outcome of a carefully orchestrated manoeuvre?’

‘You are missing the point, mate,’ my friend said with the exaggerated patience of a primary school teacher who is trying to get a not very bright pupil to understand additions.

‘What is the point then?’

‘The point is: you must learn to take reverses in your stride. If you let emotions rule you, you will make silly errors.’

Reacting with insane cheerfulness when you have lost several thousand pounds within a few days did not seem like a response I’d be able to manage if I were in his position, but I decided to let it go.

‘Not a good time to get into stocks, then,’ I said.

Au contraire,’ my friend (who has an irritating habit of inserting French phrases unnecessarily in the hope that it will make him appear more sophisticated) said, ‘this is the perfect time to buy shares. There is a party going on. Why do you want to miss out on it?’

He then rattled out a list of shares which I ought to buy.  ‘Believe me,’ he said, ‘these shares have become really cheap; all are treading at the multiples of less than 10. It can’t get better than this.’

‘Unless,’ I pointed out, ‘the share price falls further next week. Then, in defiance of your dictate, things, using your logic, will get better.’

‘But they may not get better,’ he countered.

‘By that you mean the share prices will get better or fall further?’

‘If the share prices rise, and if you haven’t already bought the shares, then you will be missing out,’ my friend was unwilling to let go of the party analogy.

‘So what do you think is going to happen next week?’ I asked.

‘I haven’t a clue,’ my friend admitted. ‘But,’ he added, ‘you are in it for the long term; not for the short or even medium term.’

I refrained from pointing out that he was in the whole shebang for the long term and had just seen ‘several thousand pounds’ wiped out of his portfolio.

‘So this is your strategy? Keep on buying through the bear market when others are selling?’


‘Do you think,’ I asked, ‘it is possible that if you can keep your head when all others around you are losing theirs, maybe you have misread the situation?’

‘Not possible,’ my friend declared with the assurance of an Estate Agent who is trying to convince you that the crack in the sidewall of the house he is trying to get you to buy is nothing to worry about.

‘What if there is a nuclear war tomorrow?’ I asked.

‘Then my friend,’ my friend said, ‘it wouldn’t matter crockshit whether you have bought the shares or not. The Western civilization will end and we shall all die.’

‘Fair point.’

It seems to me that the trick of investing in shares is to figure out what for you is the right thing. Once you have convinced yourself that it is the right thing to do, the right thing to do is to keep on repeating 'the right thing' until it is no longer the right thing to do (because, usually, of forces totally beyond your control). Then you figure out the next right thing to do and keep on doingit till it is no longer the right thing to do. And the cycle continues.

PS: I started off writing this post with the intention of putting down my impressions of some of the money and personal investor blogs I have been reading, but got waylaid into writing something  different. More about the money blogs some other time.