Lessons from another time

I am going through my usual weekend research with respect to ideas generation and stock prospecting / analysis. I chanced upon this video, which has been a consolidation of the lessons this you-tuber learnt at 10 July 2017, when the market is continually going up. Surprisingly, as the market is now falling down a slippery slope at January 2019, the lessons that this you-tuber is espousing at boom markets, is equally relevant in bear markets from another perspective. I shall try to summarize them from my own individual perspective. Instead of setting new year resolutions of what to do this coming year, I shall concrete on what NOT to do in this market correction ahead.

Not To Do List
1) Do not get too affected when your emotional partner (Mr market) makes ridiculous demands

i) When you are dealing with someone that is emotional and throwing tantrums, if you don't have a controlled behavior and thinking, you will simply be gripped by the negative emotions at the heat of the moment and make irrational and bad decisions.

ii) As per The Intelligent investor, seek to take advantage of Mr Market and make yourself the Master, rather than a slave to the market. When discount season is near, and the odds are good, bet big to optimise risk adjusted returns.

iii) Nonetheless, as you are drawing down your cash position, Do not underestimate the volatility of the market and ignore the spillover effects the financial markets have over the real economy. Always have sufficient cash buffer to capitalize on further downside, as what have gone low can simply go lower.

2) Do not seek to fool yourself with unsound narratives, as you are the easiest person to fool 

i) Confirmation Bias - Dont actively try to seek assurance from Yes Men and people whom simply seek to reassure you of your beliefs (Echo Chamber) . Try to get qualified people, with opposing points of view to make sure you are not being delusional over your narratives for your own investments.

ii)  Endowment bias - Dont trick yourself to believe that what you hold is more valuable than it actually is. Keeps your eyes open when there is a change in the fundamentals, and there is a change in the thesis of the company.

iii) Loss aversion bias - When it is time to sell, it is time to sell. You can fall in love with the stock but the stock will not love you back.

iv) Do not overvalue information that seeks to reinforce your decision / thesis. Always have  objective information / financial ratios / numbers to justify the soundness of your decision rather than let your narrative / others opinion veer yourself off course.

v) Always question yourself, and identify what you don't know and what is actually unknowable. Equity risk premiums exist for the reason that equity investments are inherently risky and the price and value divergence (if any) can be sustained over long periods of time.

3) Do not assume the current trend will always continue

i) Recency Bias - Markets downturns don't last forever contrary to the popular opinion in today's climate. Do not seek to sell something at the worst possible time. What happened most recently does not mean it is more real or impact is larger. 

ii) Buy low and sell high is easy to understand but difficult to execute. Seek to identify mis-priced assets, then buy from pessimists and sell to optimists.

iii) Value investment at its core means you need to be early to the party before it has started, and calling it a day when it is overcrowded and people are getting ahead of themselves and making drunk / foolish decisions.

iv) Deploying second level thinking, the reasons why US Federal Reserve is increasing interest rate, is because they have larger informational advantage and is of the opinion that the US economy is overheating and expanding too fast. With strong bottom up performance of US companies, loosened tax laws as well as dividend payout / share buyback of the companies, there could be significant margin of safety supported by strong bottom up performance. 

Similarly, Equity funds such as Temesek holdings are increasing leverage and raising capital for their business operations (equity investment). They are acting as a market maker in this adverse financial climate, and issuing popular SSB to willing and able buyers in an increasing interest rate environment. Although I am averse to leverage, understand how institutional investors operate allows me to have a clearer big picture perspective.

4) Do not overestimate your abilities

i) Overconfidence bias - Always think in terms of an amateur, and make sure your decisions are rational instead of rationalizing yourself that you are the "smart money". Always try to evaluate new investments as though you are up taking new business operations and have sound rational criteria for additional acquisitions as well as averaging up / down

ii) Do not try to time the market, market booms and recessions.

One person's salesmanship becomes another person's certainty. Always make sure that the investment strategy is sound and you can execute. One is useless without the another.

Although there are other social influencers that are propagating the fact that the market is going to recover eventually and dabbing in different elaborate financing and investing options (Leverage, Long - short , Options, derivatives, credit card financing, gold speculation)  recognize that your risk appetite and your cash position may be dis similar and you may not sufficiently understand the downsides or be able to execute. Although I wish them the best in their experiments and endeavors, I will be staying out.

iii) For bottom up analysis,instead of predicting cash flow, find companies with predictable cash flows. Figure out what you know, what you don't know, and what is impossible to know.

One of the reasons why quantitative driven investors are so attracted to REITs, is because of its transparent business structure, and easy to assess cash flows. From a DCF analysis, a longer WALE can be used to gauge the stability of cash inflows to gauge the reliability of the outputs. Similarly, consumer staples like Coca Cola and McDonald may have unimpressive business models but strong, stable and sustainable cash flows.

Although I am still uncomfortable with the usage of DCF and making the subjective underlying inputs and assumptions, I will be exploring lessons from Aswoth Damodaran and use his models to try to value companies that I am interested in. Instead of sticking my neck out and assessing  companies with volatile cash flow and growth (Facebook, Snapchat, Uber), I will be sticking to the easy and understandable businesses

5) Avoid making your investment journey into Quest for Home Runs

i) Fun and excitement - Avoid buying cyclical and Turnarounds beyond your circle of competence.

Differentiate between speculative behavior and business operations. Always remind yourself that speculating is only fun if you are right. If you make 50% loss in an investment, you need to make 100% return in another equal sized position to compensate. Although I did not deploy a stop-loss as a portfolio management control for my positions (Unusable and guaranteed losses in highly volatile markets), I am well aware of this fact and the need to sit tight.

ii) Leave speculative tendencies to video gaming or casino trips, where I am mentally prepared to write off 100% of my capital.

iii) Do not let envy or knowledge of another's fantastic investment returns veer you off course. As a retail investor, there is no need to beat the market every quarter. Desperation and FOMO can convince many to make decisions that provide lousy risk-adjusted returns.

6) Do not get entrenched to Home Town Bias
This bias is the hardest to shake off. Investing in your circle of competence and those things you are familiar with, does not mean you will be selecting the best companies and investments. My recent overseas positions (sub-conscious decision) is an attempt to break out of the cocoon I was in.

The cost-benefit of this decision (political risk, FX risk, regulatory and market risk) will need further analysis and examination. If I am still uncomfortable with active selection of individual stocks, I will simply conduct DCA of a fundamental weighted / low cost index fund.

7) Do not speak haphazardly, and learn when to hold your tongue

Personally, this life advice is more applicable to areas way beyond investments. When working with others at a position of power above you, it is about making him and his opinions feel valued rather than correcting him and challenging his decisions. You should not win the battle to lose the war.

In real life, intellectual honesty is not often valued in organizations or people whom often feel insecure and seek to exert his opinion and influence over matters beyond their circle of competence. In the case of valuing wisdom over intelligence, positive influence can be more effective than intellectual honesty to survive and rank up. Yes men, Finance, sales and marketing personnel are often more valued than product, operations and technology personnel in most company structures. Nonetheless, in your private moments, never lose sight of the important ideals that seek to guide your life and career decisions.


Popular posts from this blog

Thoughts about Investing in China Market