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Stock Picking in Times of WAR: From Kargil to Korea - Private Briefing
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Stock Picking in Times of WAR: From Kargil to Korea
Sep 9, 2017

  • The surprising truth about stock prices in times of war
  • This bull market is a big fat lie
  • War Time Investing: What you should do with your money
  • Mark Faber in Mumbai: Your chance to meet him at the Taj
  • Stocks closed with big gains!
  • Equitymaster's Hall of Fame

WAR.

What does it even mean anymore?

In earlier times, war meant destruction...life, property, wealth...all decimated.

Today, for most of us, it's just another headline on the news.

But not so for the markets.

You see, in 1999 I was tracking the stock markets for Equitymaster.

To get in on the day's khabar I would call brokers.

All pretty straight-forward stuff... Until you factor in that there was a war on. The Kargil War.

Day in and day out, I would get khabar that the markets were nervous about what could happen in Kargil.

There was fear of escalation. And perhaps even nuclear war. You would think the markets were tanking, right?

But here's what was really happening...


Even though the talk was of fear... As soon as the war began, almost as if on cue, the stock markets took off.

And then levelled off as the war was coming to an end...but at a much higher level than pre-war.

Odd, right?

Why would this be happening?

For an answer, let's turn to one of our pet themes: Smart money.

Let me back up a moment and explain what I mean by 'smart money'.

Smart money is FII (foreign institutional investor) money.

FIIs, in general, have a global perspective. More sophisticated tools. Access to deeper research.

That's not to say they don't make bets that go horribly wrong... But collectively, FIIs are better placed to make informed decisions than local investors.

So, coming back to Kargil and the irrational exuberance, was it maybe FIIs who were driving up stock prices?

I checked the Equitymaster FII database. Here's what I found...


FII Flows During the Kargil War
Month Net FII Inv. (Rs m)
May-99 886
Jun-99 15,037
Jul-99 (1,220)
Aug-99 (7,404)

The data's mixed. But clearly FIIs were not the ones driving up stock prices.

That leaves the domestic investors.

Hmmm...

We are at war...

The smart money first comes in (probably due to commitments already made)...but then starts to leave.

The domestic money, oddly enough, keeps pouring in...even driving the markets higher.

So, who made the right call?

There are so many factors at play in the markets it's hard to tell. But there are lessons in this...

First, let's take a look at how a current conflict situation is playing out...

Enter North 'Nuclear' Korea...

A full-blown crisis is staring at the world.

There's a mad man with a nuke... With capability to strike deep into South Korea, Japan and even America.

How would the markets react to the North 'Nuclear' Korea situation?

Fear, as you know, is not great for stock prices.

But, as we already saw, the Kargil War experience showed otherwise.

To see how the North 'Nuclear' Korea incident is playing out...let's look at what stock prices have done since the issue hit the headlines...


Point to point, the markets have again risen quite sharply.

That's another snub from the market to those who fear war.

And once again, when we look at the smart money vs domestic money...we find something odd.

Take a look...

FII Flows During the North Korea Crisis
Month Net FII Inv. (Rs m)
Apr-17 27,433
May-17 77,114
Jun-17 23,449
Jul-17 63,192
Aug-17 (127,697)

The smart money, as you can see, had been pouring in...but in August, as the chance of confrontation increased, it rushed back out. Make sense...

But domestic investors...

DII Flows During the North Korea Crisis
Month Net DII Inv. (Rs m)
Apr-17 112,443
May-17 99,777
Jun-17 91,061
Jul-17 117,999
Aug-17 179,411

WOW.

Domestic investors are cascading money into stocks...even as the smart money is slowing to a drizzle!

What does this mean for investors?

The Big Risk and Bigger Rewards of War Time Investing

Here's what legendry investor Philip Fisher said about investing in times of war...

  • Through the entire twentieth century, with a single exception, every time major war has broken out anywhere in the world or whenever American forces have become involved in any fighting whatever, the American stock market has always plunged sharply downward.

    Nevertheless, at the conclusion of all actual fighting most stocks were selling at levels vastly higher than prevailed before there was any thought of war at all.

    Furthermore, at least ten times in the last twenty-two years, news has come of other international crises which gave threat of major war. In every instance, stocks dipped sharply on the fear of war and rebounded sharply as the war scare subsided.

The war scare always goes away...and stocks always rise when that happens.

The aam investor may not know Philip Fisher. And he has no idea the risk he is taking...

But if and when the chance of war fades, the aam investor will be counting his riches.

Before we talk more on war time investing and what it means for you, here's a quick update on India's much talked about big growth numbers...

The Huge Bull Market Looks a Lot Like a Big Fat Lie

This chart is just the tip of the iceberg...


If India had not changed its GDP series, our growth rate would be even lower.

Demonetisation played its part, of course, (you can read Vivek Kaul's definitive piece on demonetisation here) but growth has been slowing down for some time.

GST also proved disruptive for businesses.

Richa Agarwal, editor of Hidden Treasure, tells me that most small businesses are just getting by.

They do not like the disruption caused by GST, and they certainly did not like demonetisation.

While some have added a little capacity, many are repaying debts and keeping a lid on costs. Hiring has not picked up.

The overall business environment in the country is a downer. They seem to be worried about the high levels of taxes and the many regulatory requirements.

One thing is clear...there's no economic boom in India.

It might be around the corner... But right now? At this very moment?

Not even close.

And Vivek Kaul has the numbers to prove it.

Readers of Vivek Kaul's Letter will be aware that Vivek has created the Indian Economic Thermometer (IET). With the IET you get a good idea of what is really happening in the economy.

Here's how Vivek explains the IET...

  • This thermometer is made up of 24 economic indicators. These are real numbers which tell us the real state of the Indian economy.

    The way this works is very simple. We look at how an economic indicator has performed over a given period of three months in comparison to the same period in the previous year.

    Like in this edition of the Letter, we look at the performance of the indicators for the period between April and June 2017, and compare it to the same period in 2016. We look at whether the indicator is doing better in 2017 than in 2016 () or it is doing worse than in 2016 (). It's a very simple system which tells us whether the economic activity has picked up or gone down this year in comparison to the last year.

Vivek considered 23 out of the 24 indicators (leaving out bank deposits due to the impact of demonetisation). Here's what he found...

  • 15 out the 23 economic indicators that we have used in this Letter, have lost steam during April to June 2017, in comparison to the same period in 2016 How were things in the previous quarter i.e. January to March 2017? 13 out the 23 economic indicators that we have used in this Letter, have lost steam this year, in comparison to the previous year. Hence, the situation has clearly worsened between March and June 2017.

In fact, I would recommend you read the entire note here. Vivek's explained this issue very well. You will enjoy it.

Markets Go Up!

Growth Goes Down...?

Some things are inexplicable.

But they happen.

Like stock markets continuing to do well, even when the 'numbers' that drive stock prices remain terrible.

I guess you could say that future expectations that drive stock prices. So, what are our future expectations? How does the long-term look?

In the long-term only one thing drives stock prices...earnings. But so far earnings haven't recovered. In fact, the market is betting that earnings will recover...in FY19.

But what if they don't?

What if the growth slowdown lasts longer than the market expects?

And don't forget...the market is expensive right now: The Sensex PE is 23.7 compared to its historical average of around 18.

You see this chart. Here's what a recent 5 Minute WrapUp issue said about it...

The Dark Truth of the Rising Stock Market
*Based on a common sample of 802 companies from the BSE Large, Mid, and Small-Cap Indices

  • The chart pegs the amount of profits the underlying business earns per rupee of price you pay for the stock.

    So for every Rs 100 you paid for the average stock in 2009, you became owner of Rs 8.7 of profits the underlying business earned.

    You got Rs 6.5 of profits for that same amount in 2012-2013.

    That figure is now down to only Rs 3.3.

    It's quite simple actually. The amount of profit in the business represented by one share is finite. As the share price goes up, that profit relative to your buying price becomes smaller. You get less and less bang for your buck.

Not a great picture at all if you ask us.

So, where does that leave us?

My Solution to the War Time Investing Dilemma

Investing in times of war is tricky.

You want to be out of the market well before the fear of war hits.

And you want to be back in, when the fear is at its peak...yet actual war is unlikely.

In essence, one has to time entry and exit perfectly.

Sounds doable, right?

Wrong. Equitymaster readers know our views on timing.

It's impossible to time the markets to perfection.

And that's only one of our problems.

The other, like we just discussed, is 'business fundamentals'. They are not that great.

For 'value investors', that's a big red flag.

In such a scenario, what does one do?

This is where the simple tenets of creating long term wealth will serve you well.

Here they are...the Simple Tenets of Creating Long Term Wealth:

  • Hold cash. Upto 12 - 24 months of expenses so that you never have to sell stocks in a panic.
  • Hold 5% to 10% of assets in gold. Like Bill Bonner says, stocks are for good times, and gold for bad times.
  • Hold stocks with a 5 to 10 year horizon. Broadly allocated along the lines we suggest...most in solid bluechip stocks, some in midcaps and the least in small and micro caps.

This is just a generalized allocation which could work for anyone. To plan something that is suited to your exact needs and circumstances talk to your investment advisor.

But if you takeaway one thing from this letter, it is this: Don't get carried away.

Remember, smart money is rushing out.

Domestic aka innocent money is rushing in.

If things go south, you could get hurt.

Plan for success, but as they say, be prepared for failure.

Speaking of Smart Money...here's some incredible news.

Mark Faber is Coming to Mumbai!

One of the most successful investors of our times - the man who called the 2007 crisis - is coming to Mumbai!

To talk to you.

In private.

To tell you...

...Why he believes it's a mistake NOT to be invested in India.

...Why he believes there are excesses in some parts of the markets.

...Where he sees Indian stocks long term.

...Where he sees an opportunity right now.

I've known Dr Faber since 22 September 2003, when I interviewed him Equitymaster. You can read it here...

Since then, I have been in touch with Marc intermittently...doing interviews, a webinar, even simply asking for his opinion...

If you know Dr Faber, you will know how precise he can be when calling the market tops and bottoms.

In fact, it would not be an exaggeration to call Dr Faber one of the most successful investors of our times.

And that's why, when he speaks, we listen. ...And we certainly would NEVER miss the chance to listen to him in person.

And that's exactly what is about to happen...

Your Chance to Meet Marc Faber...

Dr. Marc Faber has agreed to deliver the Keynote Address at the Equitymaster Conference 2018.

Yes, this is big.

Bigger still when you consider that you also get to hear from our founder, Ajit Dayal.

And that's not all.

We also have on board...

Vivek Kaul, Editor, The Vivek Kaul Letter
Tanushree Banerjee, Editor, StockSelect, ValuePro, The India Letter
Rahul Shah, Editor, Microcap Millionaires, Profit Velocity
Richa Agarwal, Editor, Hidden Treasure, Phase One Alert

And...this year, we are going to be talking a lot about real estate.

Yes, Ashwin Ramesh (CEO, Primary Real Estate), is going to be at the conference to talk about the asset class that was probably worst hit by demonetisation.

This is going to be our biggest conference yet.

With...

...The best ever line-up of speakers.

...Interactive sessions.

...And, above all, contrarian ideas from across asset classes.

If you are an investor or have any interest in understanding where the Indian economy, and the stock markets are headed, you cannot miss this.

The conference will be hosted at The Taj Mahal Hotel, Mumbai (just off the historic Gateway of India).

Unlike in previous years when we crammed the conference into one short day, the 2018 edition is going to be a two-day affair.

That gives us time to bring in brilliant speakers like Dr Faber and spend more time answering your questions.

Here are the dates... 10 - 11 February 2018.

Now, I might be jumping the gun here a little bit because invitations have not officially gone out...

But I just couldn't wait to tell you.

And since I have gone ahead and blabbed to you...

I'm sure Trupti will be willing to make an exception and accept reservations for Private Briefing readers only.

So get in touch with Trupti and lock down your seat here.

You know, our mission at the Private Briefing is to share our view on the big picture that is developing in India...and the stock market movements at large. But we also promised to serve as your window into what's happening within Equitymaster...

What the Equitymaster Research Team Is Up To...

Richa closed two Hidden Treasure positions recently - Vinati Organics and Sintex industries.

The gains?

145% and 56% respectively in just a year and nine months.

Rahul Shah closed a position (Maharashtra Seamless) with a gain on 110% recently in Microcap Millionaires.

Tanushree recommended a large stable Pharma stock in ValuePro that Warren Buffett himself may have considered.

You can also get the research team's views on the latest IPOs here. It is, after all, IPO season.

Equitymaster's Hall of Fame

The Biggest Money Multipliers We've Recommended
Stock Date of Recommendation Returns till date* Publication
Page Industries 15 Jan 2009 4,321% Hidden Treasure
L&T 5 Nov 2002 3,309% StockSelect
e-Clerx Services 14 Mar 2009 2,928% Hidden Treasure
Titan Company 21 Jul 2003 1,082% StockSelect
Balkrishna Industries 15 Oct 2009 1,058% Hidden Treasure
Infosys Ltd 19 Aug 2002 938% StockSelect
TCS 7 Feb 2009 863% StockSelect
NIIT Tech 15 Oct 2008 553% Hidden Treasure
Titagarh Wagons 20 Mar 2014 545% Microcap Millionaires
City Union Bank 15 Jan 2010 489% Hidden Treasure
Sun Pharma 3 Oct 2009 432% StockSelect
Avanti Feeds ** 18 Feb 2015 398% The India Letter
Canfin Homes 16 Jan 2010 330% Hidden Treasure
Rallis 4 Jan 2010 228% ValuePro
HDFC Bank 2 Jan 2012 179% ValuePro
HIL Ltd 20 Feb 2014 170% Microcap Millionaires
* Returns calculated up to January 2017. Past performance does not guarantee future results.
** Returns up to 30 June 2017.


Warm regards,
Rahul Goel
CEO, Equitymaster


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