A famous quote by Warren Buffet goes: “Be greedy when others are fearful, be fearful when others are greedy.” Ever wondered who is the “others”? Why are such maxims pinned on millions of softboards all over the world and still very few find it possible to follow?
Humans by nature are not wired for markets. Whenever something happens contrary to expectations, we are quick to judge, label, categorize, conclude etc. We want explanations, we want closure, we sleep well only with clarity, however fleeting. But stock markets are not amenable to all of this. At any point in time, multiple outcomes are possible, and any outcome can be attributed to multiple causes and/or their interplay. Economics of yore assumes that human beings are rational and logical but off late the Nobel Prize has been awarded to scientists who study human behaviour, and the Prize has been awarded for challenging this very notion. Humans are not rational and logical; we are now told they are emotional and psychological. Humans are deterministic, markets need us to think probabilistic. Humans want conclusions, markets require us to be open minded. Humans want to pronounce winners and losers; markets expect us to learn the game for nuances. Humans want to reach the destination; markets are a journey. Humans seek comfort in categorizing the world in blacks and whites, goods and bads, rights and wrongs but the world is a spectrum of greys.
The acclaimed American philosopher, F. Scott Fitzgerald said: “The test of a first-rate intelligence is the ability to hold two opposing ideas in mind at the same time, and still retain ability to function.”
In March 2020, when covid-19 struck, markets declined 35-40% and some stocks declined 60-70%. The market reaction suggests companies could be worthless, investing in them was futile and humans were the next dinosaur. Quick to draw conclusions; but equally quick to unwind and conclude the opposite. By November 2020, markets crossed previous highs and by October 2021, Nifty 50 made an all-time high ~18,500. The conclusion in March 2020: Humans are the next dinosaurs. The conclusion in October 2021: Humans are invincible. My learning was: “Be open to probabilities but be prepared for eventualities.”
In our profession, it’s very common to be asked, “Is market at the top or bottom, will it go up or down?” People expect perfect answers, but the job of markets is to make a monkey out of people who give perfect answers. Stock markets are a sine wave and there is a crest followed by trough, followed by crest, so on and so forth. But unlike electric currents, in the stock market sine wave, the centre line is inclined roughly 45 degrees up. If we look vis-a-vis the long-range past, markets today are close to the top. If we look at the long-range future, markets are close to the bottom. Humans want definitive guidance, but what matters is context and perspective.
A key tenet of financial planning is asset allocation. Yet, how many investors strictly follow asset allocation? Even if they start right, somewhere in the journey they get waylaid by a hot new product, changes in taxation or the latest market “call”. But strategic asset allocation rests upon probabilistic thinking; it is precisely about not taking a “call” on anything.
There is a perennial debate whether we should pick value or growth, defensive or cyclical, large mid or small cap stocks. However, the broad market as represented by the BSE 500 index, consists of all styles, all sectors and large mid and small cap stocks. Winners rotate as different components of the market do well in response to macroeconomic changes. The answer is to have a diversified portfolio that has all factors of the market but with better stock picking and balanced portfolio construction. Aim to be consistently correct rather than being occasionally brilliant.
I recently read Alchemy by Rory Sutherland, renowned author and vice-chairman of Ogilvy Group and I quote “The opposite of a good idea can also be a good idea”. It means there are no good or bad ideas, there are only choices. Thinking in black and white might give a few nights of sleep and make you feel smart temporarily, but to thrive we should learn to relax in grey.
Aashish P. Somaiyaa is the chief executive of WhiteOak Capital Asset Management Ltd.