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Do not try to predict the unpredictable

Mistakes investors make in good times can be more of a problem than the ones they make in bad times.

, ET CONTRIBUTORS|
Sep 26, 2019, 09.26 AM IST
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It’s easy to conclude that because the root cause of the rally is a tax cut, then all companies that could be paying taxes are good to invest. That would be a big mistake
By the time you read this column, the tax cuts will be an old story and perhaps so will be the sharp reaction that the equity market had to it. I must say that all else apart, the Modi government’s ability to hold its cards close to its chest is remarkable. The conversion of the higher levels of the Union Government from a chronically leaky structure into a leak-proof one has added the continuous possibility of fresh excitement into the news.

And it’s certainly been an exciting few days for investors because investments that have long been looking ugly have suddenly bloomed. However, that should be no surprise at all, except to investors who had forgotten that equity markets turn around when least expected, regardless of government action. There’s nothing new in this — in the past two decades alone, there have been four or five occasions when similar upward surprises have hit the equity markets. In each case, investors who thought that they were smart enough to stay out, watch events carefully and then enter just as a good rally started were caught out. They lost out on the sweetest part of the gains.


One thing investors often do not think about is that both the heavily negative and positive days follow a strongly skewed distribution, what the nerds call pareto. From the beginning of the Sensex record till now, if you were out of the markets for just the ten worst days out of the total 9,200 or so trading days, your personal Sensex would have been at 103,000 points instead of about 39,000. That sounds amazing. What a great argument for market timing! However, there’s the flip side too, inevitably. If you were out of the markets for just the best ten days, then your personal Sensex would have been at 13,000 points. To compensate for the one, you have to be there in the other.

There’s no other way.

Most importantly, you cannot possibly anticipate these moves. That’s because it was exactly these 20 days that were the biggest surprises. That’s obvious because the biggest gains and the biggest losses, by definition, are the biggest surprises, Otherwise the change would have been spread over many days and they wouldn’t have been the biggest. The moral of the story is simple — don’t do this. Don’t run around in a frenzy trying to move in and out of the market by predicting the unpredictable. As an investor, the only sensible thing to do is to select stocks carefully by fundamental quality and value and then invest steadily and stay invested.

Which brings us to the second big issue that arises out of the markets’ sudden move. These are the kind of times during which investors always have a difficult time separating the good from the bad. It’s the rising tide that is lifting all boats. It’s easy to conclude that because the root cause of the rally is a tax cut, then all companies that could be paying taxes are good to invest. That would be a big mistake. Remember, while we investors lose money when the markets go down, we often sow the seeds of those losses during market rallies. All the dud stocks and sectors are looking so much better than last week and soon, promoters and brokers will start the earnest work of putting lipstick on pigs. Don’t fall for it.

One of the unsaid (or unrealised) truths of the past few years has been that India has lots and lots of incompetent businesspeople. Even when conditions are good, they’ll manage to run their companies badly. The point of investing is to identify and avoid these, something that’s as important in the good times as it is in the bad.
(Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com.)
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