Liar loans

Do you know that during the boom before the sub-prime crisis, in there US there was a category of loans that was known as “liar loans”?

Apparently, this was a brilliant innovation (!) to give away loans to people who may not have supporting financial strength. These borrowers could take loans by simply stating that they had enough income and/or assets to qualify for the loans. No documents were checked.

As we have written elsewhere, “… seeds of disasters are sown in boom times …”

Well, if this sounds familiar to the current situation in India, remember Bishop Desmond Tutu’s words, “What we learn from history is that we don’t learn from history”.

#RidingTheRollerCoaster – 89

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How much land does a man need?

Greed knows no end. The Great Russian writer Leo Tolstoy wrote a short story titled “How much land does a man need?” This story is a wonderful account of what greed can do.

If you haven’t read this story, I strongly recommend it.

Greed is a basic emotion. It can lead to ruins as the story suggests. One must be ambitious, but avoid greed.

In the financial markets, we have seen many falling prey to the greed and losing capital.

#RidingTheRollerCoaster – 88

Ben Graham’s classic books

I believe it was the experience of the boom and bust of that period, which Benjamin Graham brought out in his 1934 classic “Security Analysis” and the subsequent book “The Intelligent Investor”. Warren Buffett described the latter as the best book on investing ever written.

#RidingTheRollerCoaster – 87

 

Folly of forecasting

It is not fair or meaningful to predict which companies will do well after looking at which companies did well! Those are not predictions, just history.” – Gary Smith writes in his book “Standard Deviations – Flawed assumptions, tortured data and other ways to lie with statistics”

So often, we are tempted to look backwards and fit the data into some theory without worrying about the hindsight bias or the survivorship bias. We also extrapolate the past into the future. It is important to test back the hypothesis with forward looking data.

I have come across the Wipro example so many times. Someone who invested a small sum of money in Wipro stock in 1979 would be sitting on a treasure. However, explaining this story today is very easy – finding the next Wipro is not. In fact, identifying Wipro in 1979 was impossible.

There is a full chapter “On Forecasting and Expertise” in the book “Riding The Roller Coaster – Lessons from financial market cycles we repeatedly forget”.

#RidingTheRollerCoaster – 86

It is human to expect order

“We yearn to make an uncertain world more certain, to gain control over things we do not control, to predict the unpredictable.” – Gary Smith writes in his book “Standard Deviations – Flawed assumptions, tortured data and other ways to lie with statistics

It is human nature to expect order where chaos prevails. Order is always more comforting than chaos.

#RidingTheRollerCoaster – 85

 

Perspective on the recent market crash

“Sensex falls by 807 points” – this was a major news item in many leading dailies – general purpose or the pink papers. It looks threatening. Losing more than 800 points in a day is scary. Sensex lost 807 points on 11th February 2016.

It has happened only the 13th time since 1980. In other words, this was 12th largest single day drop (measured in points) in Sensex (on 10th Oct, 2008 Sensex lost 800.5 points, which was the 13th largest Sensex fall – the lowest among the 800+ point falls).

In other words, we have witnessed 800+ points falls 13 times in 36 years, which is roughly once in a three-years event. Once in 3-years does not look as threatening as 12th largest fall. See the beauty of the language. The same event presented differently, looks less threatening – emotions at play.

However, if we dig deeper into the history, it was only in May 2006 that we saw the first ever 800+ points fall in Sensex. And then, it has happened 12 more times since. So now we can say that in the last 10 years, this has happened 12 times. Oh God, the markets have become so volatile of late! See, the same thing looks scarier now.

Having said that, it was only on 8th April, 1990 that Sensex closed above 800 points. Hence, there was no way it would have dropped by 800 points in the first decade of its existence.

However, a “points-drop” should not bother an investor. It is the percentage drop that matters and not the points drop.

So how big was the Sensex fall on 11th February 2016 in terms of percentage of the previous day? It was -3.40%.

Once again, we looked into the historical data. Such a fall has happened 188 times in the history of Sensex (I have data since 2nd January 1980. So, if something happened before that, I have no idea). This makes it roughly a little over 5 times a year.Something happening more than 5 times a year may be considered as normal. Mumbaikars expect to lose one day a year due to heavy rains and water-logging. People travelling to (or within) North India expect delayed flights / trains due to heavy fog at least for a few days every winter. Such events happen. One need not and cannot plan to avoid such events.

The first time (as per the data available), Sensex lost more than 3.4% on 6th June 1980. Incidentally, the drop was 5.76 points and Sensex closed the day at 122.55 points.

See the wonder: it is often not the event, it is how it is presented that evokes the emotions.

807 points loss looks threatening. 3.4% makes it look acceptable.

It is important for investors to develop the ability to put things in a proper perspective, else the environment has the ability to test our resolve, often without substance.

Rise and falls are natural to the markets. So long as people can transact based on their opinions, the prices would remain volatile.

To be a better investor, you need a balanced mind. If you still need help, consult someone who has one.

Enjoy the roller coaster ride. Happy investing

#RidingTheRollerCoaster – 84

Imagination

Humans are believed to be the only animals with the power to imagine. We can imagine situations that are not there yet, or events that have yet to take place. This ability has probably been one of the major factors behind all development.

So when we are feared, we imagine the possibility of an event with unacceptable or bad outcome. And imagination of profit leads to an emotion known as greed.

#RidingTheRollerCoaster – 83