Saturday, July 26, 2008

Now, learn stock portfolio selection from a tall ex-cricketer

During his playing days, former England & Sussex skipper Tony Greig literally towered over his opposition. His medium pace and offspin bowling and aggressive batting earned him the 'best England all-rounder' title till Ian Botham took over his mantle.

But he is best known for his controversial comments - used to intimidate and provoke the opposition. Many may remember his "I'll make them grovel" statement about the West Indies team that really stirred up a hornet's nest.

The comment I remember best is about which players to choose if he was the captain of a World XI. In typical Greig-like fashion he said that he would prefer to have a Geoff Boycott in his team over a Gary Sobers.

Now anyone who knows anything about cricket knows that Gary Sobers is the greatest all-rounder in the history of the game. Boycott is best known for his long, strokeless stints at the crease that frustrated opposition bowlers.

Greig's logic was simple - Sobers could, and often did, win a match single-handed with his flashy stroke play. But he was equally likely to score a zero. Boycott however could be relied upon to grind out scores of 30s and 40s in game after game.

That brings us to the biggest lesson in stock selection. Stock market success is all about staying power over the long haul. So you need stocks in your portfolio that have performed well - but may not be spectacularly - year after year after year, through bull and bear markets. Not only in terms of capital appreciation (often through attractive rights and bonus offers) but also regular income through steady or increasing dividends.

The Boycotts of the stock market are Hind Lever, ITC, Colgate, Reliance, Tata Steel, Tata Motors, Mahindra and Mahindra, Sesa Goa (you get the gist - this list is not meant to be exhaustive). The Rico Autos, Prajay Engineers, IVRCLs, Gujarat NRE Cokes shine for a year or two and then fade away.

Does it mean that your portfolio should only contain 'boring' stalwarts? Not really. But the high-fliers of the day should form only a small part. The formula that works for me is 8 to 10 stalwarts that form 90% of my 'core' stock portfolio. (And the best time to build such a 'core' portfolio is when the stock market is in a bear grip - like now!)

The balance 10% of my portfolio is made up of 6 to 8 mid-caps and small-caps with a potential to hit the big time. I'm mentally prepared to lose all the money allocated to this 10% 'speculative' part of my portfolio. You have to choose the percentage allocation that suits your risk profile. But a word of advice - don't let the 'speculative' part exceed 25% of your portfolio. If it does - and that is likely to happen near a market top - reallocate by booking partial profits.

If you prefer to invest in mutual funds - and most investors should, unless they have the time and interest to pursue the solid amount of research required to maintain a good stock portfolio - then the Boycott's are HDFC Equity, DSPML Equity, HSBC Equity, Magnum Contra, HDFC Prudence, Magnum Tax Gain (once again this list is not meant to be exhaustive). The 'speculative' portfolio can contain the ICICI Pru Infrastructures, Reliance Visions, DSPML T.I.G.E.R.s.

Saturday, July 19, 2008

How you can stay ahead by being interested in interest

After a couple of posts with strong technical overtones, it is time to clear the air that I am also interested in fundamentals.

Interest rates are a 'leading' indicator. That bit of profundity means that interest rates usually change direction before the stock market does. Some times this can happen several months ahead of time and some times it happens shortly before.

Back in 2002-03 (if you can remember that far back!) when the stock market was in the doldrums, the returns from debt mutual funds were so good - upwards of 15% - that a certain foreign bank's mutual fund division didn't even bother to have an equity fund in their portfolio!

Then the interest rates started falling and by the time they woke up to the fact that equities had started picking up, they were way behind in performance. They finally came out with some equity funds - one of which performed pretty well - but the bank's mutual funds division had to be sold off.

The situation had drastically changed by 2007 when interest rates started moving up again. Conservative Indian investors started moving money back into bank fixed deposits and inflation hadn't reared its ugly head. However, that was the first warning sign that the stock markets were going to be in trouble.

Why? Because most 'punters' (the gamblers who play with derivatives) bet with borrowed money - many a times loaned by their brokers. As interest rates move up, their cost of doing business goes up and makes the margin of profit minimal.

The higher interest rates also have a cascading effect on the economy - particularly in interest-rate sensitive sectors like banks, automobiles, real estate. The cost of doing business goes up for all of them. Less people take out loans at higher interest rates, so they hold back on their vehicle and apartment purchases.

To top it all, the huge run up in oil prices pushed inflation up - causing the Reserve Bank to raise interest rates even further to curb inflation! Then the FIIs started to depart. Talk about a 'perfect storm'!

So when will the nightmare end? A necessary - but not necessarily sufficient - condition is when interest rates start moving down again. That will be the first sign that the market may start to turn back up. It doesn't look like that is going to happen in a hurry - so be prepared for a long drawn out bear market - but keep your eyes and ears glued to the RBI pronouncements.

Just a positive note amongst all the gloom and doom. I tried to practice what I preach by going out and making small purchases in a leading Balanced fund and one of the top diversified equity funds on Thursday morning (the day after the market had made a 15 month low).

Does that mean that I think the market has touched bottom? Not really. No one knows that. But any time that the Sensex closes below 13000 provides opportunities to make small purchases.

Sunday, July 13, 2008

Why you need to follow the latest trends to become a better investor

There is an old market cliché: The trend is your friend. So how does one identify stock market trends?

The simple concept of a moving average gives a clear visual image of what the stock market has been doing and what it is likely to do next. A moving average is an average of the index level (or share price) over a specific number of days, updated daily by replacing the oldest day’s level with the most recent day’s level.

So for a 20 day (short term) moving average, the 21st day’s level replaces the 1st day’s level in the average; the 22nd day’s level replaces the 2nd day’s level, and so on. Likewise for a 50 day (medium term) or a 200 day (long term) moving average. An exponential moving average (EMA) provides more weightage to the recent prices/levels.

Why not a 13 day moving average or a 100 day moving average? No reason. You are free to choose which averages you wish to follow. Through trial and error, I found that the 20 EMA / 50 EMA / 200 EMA combination works best for me. Of the three, the 200 EMA is the most important average because it confirms transition from a bull to a bear market (and vice versa).

Now, do a little exercise to understand the power of moving averages. Open a new tab (assuming that you are familiar with tabbed browsing) or a new window on your browser.

Go to the Yahoo! Finance site ( which allows you to draw charts for the Sensex, Nifty and most shares listed on the two exchanges. Click on ‘BSE Sensex’ below the thumbnail chart. On the next page, under ‘Charts’ on the left panel, click on ‘Technical Analysis’. Now you’ll get to see the full 1 year chart of the Sensex. Click respectively on 200, 50 and 20 next to ‘EMA’. The three averages will get superimposed on the Sensex chart.

During Aug ’07 to Jan ’08 the last leg of the 5 year bull run played out. All three averages – 20 EMA / 50 EMA / 200 EMA moved up in tandem with the short term average on top and the long term average at the bottom. The last bull market correction happened in Aug ’07. The 20 EMA took support on the 50 EMA while the Sensex took support on the 200 EMA.

The wide gap of more than 2000 points between the 50 EMA and 200 EMA in Nov & Dec ’07 when the Sensex crossed 20000 was the first warning sign of a forthcoming correction. The 20 EMA dipped below the 50 EMA in Jan ’08 warning of trouble ahead. Both the Sensex and the 20 EMA went below the 200 EMA in Mar ’08 confirming that the market was changing trend from bull to bear.

After the bear market rally in Apr - May ’08 from 15000 to 18000 levels, the Sensex briefly nosed above the 200 EMA. All three averages bunched together - which is a sign of change. What followed thereafter was a confirmed bear market with all three averages moving down in unison – this time with the short term average at the bottom and the long term average on top.

Monday, July 7, 2008

What you can learn about contrarian investing from a great tennis player

While watching the epic Wimbledon final between Nadal and Federer on TV late Sunday night, I was disenchanted by the number of viewer polls popping up about “The King of Wimbledon” and “The Greatest tennis player”. None of these polls mentioned the name of arguably the best player ever – Rod Laver.

Sampras, McEnroe, Federer haven’t won at Roland Garros. Borg never won the US Open. Lendl and Rosewall never won Wimbledon. A handful of players have won all four majors in their career. Only two have won grand slams – all four majors in the same year – Budge and Laver. Only Laver has won the Grand Slam twice – once in 1962 in the amateur era and once in 1969 in the Open era. The defence rests.

So what does Laver have to do with investments? In his book, “The Education of a tennis player” Laver writes about his attitude at Wimbledon – a tournament frequently interrupted by rain and blustery winds. He used to put on his whitest and starched pair of shorts and shirt, was well-groomed and used to jump up and down with enthusiasm – as if the cold and rain was just the kind of weather he enjoyed. Far from it. It was specifically meant to demoralize the opponent, who was already feeling miserable in the inclement weather!

Contrarian investing is not about selling at the market top and buying at the bottom, nor is it about buying realty stocks when every one is dumping them. It is about developing a mindset that prevents you from getting swayed by what is happening in the market on a daily basis. It is about making an asset allocation plan and sticking to it. It is about ignoring all the buy calls given by so-called experts.

Most important of all, contrarian investing is about making an investment plan based on your knowledge and risk tolerance, and having the self-discipline to stay with the plan through the ups and downs of the market. But all this is common sense, isn’t it? You will be amazed how uncommon it is amongst the bulk of the investors!

In future posts, I will discuss about stock selection and making an asset allocation plan.