The Market Could Fall 30%...Avoid This Mistake

Seth Klarman is the founder of the Boston-based hedge fund Baupost Group, with around US $10 billion in assets under management. He has a reputation for being media shy.

His book, Margin of Safety, retails on Amazon for an eye-popping Rs 1.4 lakh!

Of course, part of the reason is that it's out of print. But the book contains some amazing insights. It's chock-a-block with wisdom. Even Warren Buffett is rumored to have a copy.

Now, Klarman does not talk to the media too often. But whenever he does or writes to his clients, we don't miss it.

The hedge fund mogul isn't happy with the goings on in the world of investing. He is most worried about the difference between real risk and perceived risk.

He believes, perceived risk is low but the real risk is high.

What does that mean?

In the aftermath of the 9/11 attacks in the US, air traffic went down and road traffic went up. More people preferred to travel by car than by plane.

You might say, that's understandable. But was it the right thing to do?

Emotionally, yes. After all, who would want to fly after seeing those horrific images?

However, bring in the rational mind and it's clear that those who opted for road travel made a huge mistake.

Why?

Even after the attacks, air travel had a much better safety record than road travel.

It's estimated that an additional 1,595 Americans died in car accidents in the year after the attacks. Those people mistook perceived risk for actual risk.

This game between real risk and our perception of it, plays out in the stock market all the time.

And investors who are smart enough to know the difference end up as big winners in the long-term.

Just after the 2008 financial crisis, stock markets crashed. The perception of risk was very high. Few people wanted anything to do with stocks.

But the real risk was low.

Why?

Stocks were available cheap.

They were beaten down to insanely low levels. That made them less risky for a long-term investor.

During those days, most investors were understandably mentally scarred. But those who overcame the false perception of risk make tons of money.

The markets are correcting again.

If the correction lasts for a while, investors could start recalling the events of 2008. They would want to avoid getting scarred again.

But if they give in to fear, they will commit the huge mistake of dumping stocks in a falling market and even worse, exiting the markets completely.

Don't be that investor.

I believe, the market could fall by 30% from the recent peak. But don't let fear guide your stock selection during this time.

Instead, I recommend you focus on safe stocks to ride out this storm. There isn't much real risk in them.

Chart of the Day

A good example of real risk v/s perceived risk is Infosys during the time of Vishal Sikka.

When he joined the company as CEO, the stock price went up. The initial up move was justified. But the stock kept rising.

The market believed, Sikka and his initiatives would turn things around. The perceived risk was low.

But the market ignored the real risk. Trouble was brewing and when the market realised it, the stock fell.

The stock hasn't fully recovered yet even though the dust has settled down.

The important question now is whether the market's perception of risk in the stock today is correct or wrong.

Infosys Stock Price When Sikka Was CEO

Regards,

Tanushree Banerjee (Research Analyst)
Editor, The 5 Minute WrapUp

Editor's note: There will be no issue of The 5 Minute WrapUp on 30^th March 2018 on account of Good Friday.

PS: Sensex 100,000 will have lots of winning stocks. Some may already be in your portfolio. Some may be on your watchlist. And this service will help you figure out the rest. Read on to find out more...