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Tuesday, October 14, 2008

Timing is everything for investors

In the unforgiving, yet fascinating world of equities, Warren Buffet is the epitome of success. From high-flying fund managers to Ivy league management students, from the Ferrari-driving Wall Street broker to the pan-chewing punter on Dalal Street, most will vouch that in the world of investments, their idol is none other than the Oracle of Omaha. More reams of paper must have been dedicated to his abilities and wisdom than probably all other successful investors put together.

Even his random statements have become a part of financial folklore and investors blindly pick up stocks which he buys, the sole reason and justification being, “Warren Buffet is buying it.” Although questioning the investment acumen of the world’s most successful investor will be crazy, there definitely seems to be a case for scrutinising some of his most glorified statements — particularly in times such as these, where forget stocks, entire indices are collapsing 10% a day. In 1988, in a letter to Berkshire Hathaway shareholders, Mr Buffet wrote, “Our favourite holding period is forever.”

Not even trying to analyse the context in which the statement was made, the cliché-hungry financial media in general and investment advisors in particular lapped up the statement, with both hands. What they actually did was further strengthen two of the biggest misconceptions prevalent in the world of equities — a simple ‘buy and hold’ strategy will give great returns in the long run and trying to time the market is a futile exercise. In reality, nothing can be further from the truth. Firstly, there have been numerous decade-long spells, where equities have given negative returns.

For example, if you had bought Nasdaq stocks about a decade ago, you would now be sitting with very hefty losses, notwithstanding whether those stocks were blue-chips like Microsoft or Yahoo or some, now extinct, dot-com hotties, and that too, despite the fact that you held on to them for a full decade!

The Nasdaq bubble was not a one-off thing. It happened during the Great Depression, with Japanese stocks in the 1990s and closer home, even with a large number of Sensex constituents of the 1990s, who are today languishing way off the highs seen during their heydays. Remember Mukand Iron? In fact, between 1992 and ’03, the Sensex persistently gave negative returns.

And if you thought this happens only when an investor is caught in a bubble, there are numerous examples to the contrary, when investors have lost money even though they have managed to enter at absolute lows. Their only fault is that they did not sell out, when prices went up, but decided to hold on forever.

For example, the Dow Jones Industrial Average started rallying after hitting a multi-year low around 530 in 1962.

Over the next decade, it went on to hit multiple highs around 1,000 in 1966, 1968 and 1972, but then crashed all the way back to the 500s in 1974.

So, an investor who had managed to get in even at the absolute bottom in 1962, would have actually lost money after 12 years, if he had just held on instead of booking profits, when they were there.

The story was the same during the Great Depression, when the Dow rose six-fold from just 64 in 1921 to about 380 in 1929. But then the big crack emerged and by the time it found its bottom in 1932 — at around 41 — it had given up all the gains of the eight-year bull run and some more.

Needless to say, this is happening all over again as the Dow Jones Industrial Average has given up all the gains of the five-year bull run that started in ’03.

In fact, investing can be compared to growing a mango tree. You have to pluck the mangoes when they are there, instead of just letting them rot.

A few decades before Buffet advocated investing for the long run, an equally brilliant, if not better, John Maynard Keynes had famously said, “In the long run, we are all dead.”

And taking the risk of inviting the ire of all Buffet fans, Keynes makes more sense than Buffet.

As for the second big misconception, it’s a fact that very few people can time the market, but then, making money in the market is a very difficult job and every Tom, Dick, Harry and Ram doesn’t succeed in it.

Of course, it’s next to impossible to catch the absolute top and the bottom, but even if you can catch the trend and skim a reasonable amount between the top and the bottom, you have achieved your objective. Isn’t it?

At the same time, Buffet once said, “I realised technical analysis didn’t work when I turned the charts upside down and didn’t get a different answer.”

Although it’s difficult to believe that he really meant what he said, if your faith in ‘buy and hold’ is waning and you are ready to time the market, let’s take a look at the following technical charts to understand what exactly they’re trying to tell us...

This Nifty chart was being carried with the Derivatives Diary column of ET Investor’s Guide for the past few weeks. As written last week, the pillar (the trendline from the lows made on May 17, ’04, when the Nifty had crashed because of the NDA’s rout in the general elections) on which the five-year bull run was built was busted in the first week of October ’08. What followed next was worse than the worst nightmare of an equity investor. In order to find the support levels from hereon, let’s take the help of Fiobonacci numbers, which are giving some mind-blowing conclusions.

If we deduct the top of 6357.10 made on January 8, ’08 from the bottom of 1292.20 made on the May 17, ’04, we get 5064.9. A 38.2% fibonacci retracement of the entire bull move gives us about 4420. This was roughly the level that came to our rescue, when intermediate bottoms were made on January 22 and March 18. This support held on for a while, but then gave way and the Nifty fell like a stone to form the next intermediate bottom on July 16 at the 50% retracement of the entire bull move, which roughly gives us levels of 3820. This coincided with the trendline and if the bull run was to survive, this bottom needed to hold on.

However, once that was gone, the next support is the 61.8% fibonacci retracement of the entire bull move, which gives us a figure of 3227. While this was breached on Friday, it is still holding up on a closing basis. So, if this is not broken today, expect a sharp bounce till 3800, which will then decide if we have just had a massive bull market correction, or the bull run has indeed become history and we go on to test the June ’06 lows of about 2600.

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