Tag Archives: contrarian

Dealing with Valuations

 

Podcast Transcript

When we find valuations at extremes, it usually is at the most difficult time. We struggle to decide how to deal with them. Mostly, amongst us, the risk averse find it convenient not to deal with them. We find it natural to do nothing. We avoid them. Our natural discomfort with difficult decisions stops us from approaching them. So, we simply stay away.

Alternately, if we are risk takers by nature, we may actually deal with them wrongly and end up hurting ourselves. Risk takers believe it is their will that brings outcomes. But that is completely dependent on the context. Most risk takers fail to acknowledge that when the going is good. We believe more in our risk taking that we ignore the context. But, the context is so important. And, how we deal with the context means everything to the outcome.

But the moment tends to overwhelm risks takers. We don’t want to be left out of a moment. So, we simply stay put in the game when we should have withdrawn to safety. We often fail to take a rational view of things.

Here, our understanding of risk and our acceptance of the limitations matter.

Firstly, risk taking is more of an art. It is a personality trait. It is an attitude. It is a way of life.

It rarely comes easily to anybody. So, in the world of investing, most of us seek the wrong kind of risks around the wrong hour. And, we then live through the excruciating pain of time. Seeking the right kind of risks at the right time requires a definitive personality.  It is the personality that causes one’s investing to be fashioned in a particular way.

So, when valuations rise to stratospheric levels, selling can happen only if we have the personality to do it. Or, if the decision is made by someone with that kind of personality for us. If everybody is into risk taking when it is the wrong hour, the situation will lead to an “All fall down”.

Strangely, we are in a market where indices are at all time high and most portfolios are down. The active risk takers are clearly badly down. This situation can lead us to an even more difficult place if we don’t deal smartly. A smart mind will not show excess in risk taking now. It may be a while before risk taking will work well again. An intelligent investor must seek the right risks, avoid the higher risks, and strive for return of capital.

Return on capital may anyway not be all that great in the coming months for risk seekers. Pragmatists would rather seek return of capital now. When valuations are not really in favour, one must deal with investments in a clinical, pragmatic, and decisive manner. The time to do it is now.

Be Defensive, Stay Contrarian

The genesis for the current meltdown in Indian markets must be understood well and remembered for a long time to come. Interestingly, the indices held steady during this period.  So, what caused this downslide?

Broadly, the markets showed overwhelming faith in smaller companies over the index bellwethers between 2015 and 2017. The poor performance of index bellwethers like tech and pharma during this period contributed to the heavy concentration of investor interest in midcaps and small caps.

The belief that small and mid-cap companies will be insulated from macroeconomic challenges grew on the investor psyche between 2015 and 2017. During this phase, investors gradually moved away from large caps and raised their exposure to midcaps, small caps, and even microcaps. The heavy concentration of fund flows clearly raised returns and valuations in this phase to all-time highs. Valuations spiked up leading to a premium in midcap valuations over even the indices.  This unusual trend persisted for months together. Investors knew this was unusual. But, nobody was ready to go into cash.

It is under these circumstances that valuations in midcaps cracked. With economic macros like exchange rate, oil prices, and inflation turning the markets may be on the cusp of a new trend. This is a good time for contrarian, defensive investing.