What if the stock market remains in a down trend for another year?

The Sensex and Nifty indices had touched their peaks one year back. Since then, both indices have been in down trends – neither falling a lot, nor rising much during counter-trend rallies. A gradual drift downwards that has all but sapped the bullish energy of small investors.

Several rounds of interest rate hikes by the RBI have failed to restrain rising inflation, but has started affecting economic growth. The high interest rates have led to postponing or cancelling of capital expenditure by companies, which in turn has affected the order books of capital goods makers, and engineering and construction companies.

The RBI had indicated the possibility of pausing the rate hikes if inflation begins to moderate. If the situation doesn’t improve within the next month or so, the RBI may be forced to hike the interest rate again.

Even if there is a pause in the rate hike, the already high rates are unlikely to be reduced immediately. Market sentiments do not turn bullish when interest rates are high and the GDP growth is slipping. It is quite possible that the Sensex and the Nifty may continue to trend downwards for another year.

However unlikely or pessimistic the above may sound, the path to success in stock market investing is to assess the surrounding environment at all times, and have strategies and plans in place. So, what can small investors do to prepare for another year of down trend in the stock indices?

The most important – and I can’t emphasise this more – is to have a financial plan, and based on it, an asset allocation plan. The queries I receive from small investors are mostly of these two types: “This stock is going up in a bear market – should I buy now or wait” or, “That stock has fallen a lot – should I wait longer or buy now”.

Hardly anyone asks me: “How do I make a financial plan” or, “How do I work out an asset allocation plan”. Without a plan, random buying and selling of stocks will lead to an unwieldy portfolio and very little returns.

Once plans are in place, a portfolio to suit the plans and the risk tolerance level of an individual can be built. A stock market in a down trend is the best time to build portfolios, because many good stocks are available at bargain prices.

What if you are one of those enlightened investors who already has plans and a well thought-out portfolio in place? Allow your portfolio to grow and prosper. How do you do that in a down trend? Mostly by not being overly aggressive. Within an overall down trend, individual stocks may perform better or worse. Use opportunities to book part profits or add to fundamentally strong stocks that have been beaten down.

Needless to say, whether to buy, sell or hold should be determined not by market fluctuations or gut feel, but by your asset allocation plan. When you book part profits, try to control the impulse of buying some thing right away. The high interest regime has its benefits in the form of higher bank fixed deposit rates and good returns from debt funds. Invest in them – as per your asset allocation plan.

Use the stock dividends that you receive at this time of the year to reinvest in your portfolio companies. Dividend reinvestment is like adding fertiliser to your plants. It helps them to grow better and faster.

Continue with your regular savings and systematic investment plans. There is a tendency of many small investors to stop investing when the markets are down. If you haven’t developed the skills to time the market (very few investors do), stick to your regular investments. Again, follow your asset allocation plan in a disciplined manner.

That is all there is to it. No magic formula will produce phenomenal returns in a down trending market. Just a boring, disciplined approach to planning, saving and investing for building wealth over the long term.

Why long-term investors should look at the big picture

With the Sensex and Nifty indices stuck within trading ranges for more than a month, small investors are in a quandary. What to do next? Two days of sharp bounce from a bottom, and the urge to jump in and buy is almost uncontrollable. Three days of correction from a resistance level, and every one is worried about a 2008-like crash.

Getting worried and disturbed about short-term index gyrations only increases your blood pressure and clouds your decision making. Times like these are true tests of your investment mettle. In life, unplanned action is some times better than planned inaction. But, for building wealth through successful investing in the stock market, you should practice the discipline of planned inaction.

The inaction refers only to buying and selling of stocks. Reading annual reports, books and preparing buy/sell lists are part of the daily ritual of  long-term investors. What then is the big picture referred to in the headline? I’m not an economist, but here is my take on what is happening around us.

Thanks to the Internet and FIIs, our stock market is fully integrated with global markets. All the nonsense about decoupling because of our strong domestic market is just that – nonsense. So, keep an eye on what is happening in global markets. To keep readers updated, I regularly post about stock indices in the US, Europe and Asia. If you are not reading those posts, ask yourself: Why not?

Europe is in quite a mess due to a unified currency that is not helping profligate nations - like Greece, Italy, Spain, Portugal - that are deep in debt and have very little capabilities (or even intentions) of repaying that debt. They neither can print their own currencies, nor can they devalue their currencies. The only options are that a financially stronger economy like Germany, and perhaps the IMF, will bail them out to stop them from defaulting. But that is postponing the problem – not solving it.

Many Indian companies – particularly IT services companies – switched their export focus from the USA to Europe post the dot.com crash in 2001. Some have built up significant businesses in Europe, including acquisition of European companies. The economic mess in the Eurozone is going to affect their bottom lines for the next few years.

China is a wild card. For years, they have been far ahead of India in building world-class infrastructure and an export-led high-growth economy. But with global economies slowing down, China is desperately trying to re-focus on their domestic market. There is strong suspicion about their reported growth figures, and that is reflected in their sliding stock market. If they start cutting back on their commodity purchases, which has been sustaining the global commodities market and shipping businesses, a big crash in global stock markets may follow.

The USA is not on the verge of collapse – like they were three years back. The situation is grim, but not hopeless. There will be a lot of pain before their economy eventually turns around. But thanks to two rounds of quantitative easing, and significant belt-tightening, US corporations are sitting on a lot of cash. They haven’t curtailed spending on existing IT services, and there are signs that they may be spending more on new services. The strengthening dollar will add to the bottom lines of IT services and export companies.

Our over-dependence on oil imports will further add to our balance of payments problem. The government had introduced several populist measures to help the rural poor. Subsidies on diesel, kerosene, fertilisers have added to the fiscal deficit. Rampant corruption and scams, as well as high inflation are keeping FIIs away. Their inflows partly help in reducing the deficit.

However, our GDP continues to grow. Not at 8-9% but more like 6-7%, which is much better than almost every one else except China. That pretty much rules out a 2008-like crash in the Indian stock market. But it could take a while before we see new highs on the Sensex and Nifty.

The sensible approach will be to cut out the daily noise emanating from the business TV channels, and concentrate on companies that have capable and trustworthy managements, and have records of several years of good performances through bull and bear cycles. If they produce goods or services that find buyers regardless of the state of the economy, so much the better. Companies that sell toothpaste, cigarettes, soaps and detergents, biscuits, life-saving drugs, drugs for chronic diseases, tractors, power tillers, tea and coffee will continue to do well.

Just remember that the stocks that don’t fall much during a down trend, don’t rise much during the subsequent up trend. The ones that fall more, tend to rise more. Of course, this ‘rule’ works only for well-managed companies.

Should investors keep a beady eye on the BDI (Baltic Dry Index)?

What makes successful investing in the stock market (or mutual funds) such a challenge (or, intellectually stimulating – depending on your mental makeup) is the wide variety of factors and indicators that you need to keep track of. The Baltic Dry Index (BDI) is one such indicator that many investors may not have a clue about.

What is the BDI, and why should investors keep a watchful eye on it? This is how wikipedia.com describes it:

The Baltic Dry Index (BDI) is a number issued daily by the London-based Baltic Exchange. … the index tracks worldwide international shipping prices of various dry bulk cargoes.

The index provides "an assessment of the price of moving the major raw materials by sea. Taking in 26 shipping routes measured on a timecharter and voyage basis, the index covers Handymax, Panamax, and Capesize dry bulk carriers carrying a range of commodities including coal, iron ore, and grain."

In plain English, the BDI gives an indication of international rates for transporting raw materials by sea in cargo ships of different sizes – based on supply and demand of commodities.

Why should stock or funds investors be interested in the current state of the BDI? Most economic indicators, like consumer spending, unemployment figures, housing starts are lagging indicators. That means, we get to assess the implications after the events have already occurred.

However, the BDI is a leading economic indicator because increasing demand for raw materials (which leads to higher shipping rates) is a signal of greater economic activity. That in turn, leads to growth and higher stock prices. Likewise, a fall in the BDI indicates declining demand for raw materials, leading to reducing economic growth and a likely slide in stock prices.

Unlike stock and commodity exchanges, where speculation is an important part of the overall activity and may camouflage the actual supply-demand equation, the BDI is free of any speculation since the index is based on shipping rates on various representative routes submitted by international shipbrokers who have actual cargo to transport.

Supply and demand of raw materials is not the only reason for changes in the BDI. Availability of cargo carriers, heavy traffic on certain routes, bad weather, price of oil can all contribute to higher shipping rates. Like all indicators, the BDI can’t be used in isolation.

Over the past year, the BDI has fluctuated between a high of about 2750 in Oct ‘10 and a low of about 1050 in Feb ‘11. It rose sharply from 1270 in Aug ‘11 to its current level of 1890. Is it indicating that the global economy may not be in the doldrums that many economists are suggesting?

How to choose stocks for trading

Regular readers of this blog need not feel let down by the subject of today’s post. I am a firm proponent of generating wealth through long-term investment by carefully choosing stocks, using both fundamental and technical analysis.

Though I occasionally indulge in longer-term trading in cyclical and FMCG stocks, intra-day or short-term trading remains a strict no-no. The odds for success are too low and the scales are heavily tipped towards the professional traders.

So, why write a post about how to choose stocks for trading? Last week, I had written a post explaining why good investment stocks may not be good trading stocks – and vice versa. The chart patterns of Titan and Reliance were used for comparison. The concluding statement in the post was: “Whether you are a trader, or investor, or both – it improves your chances of making big money if you do your homework in selecting stocks.”

I have already written a series of three posts on how to pick stocks for investment. If you haven’t read those posts, I would strongly recommend that you do so. But because of my antipathy towards trading, I had refrained from writing about choosing stocks for trading.

Why then the sudden change of heart? Let me explain. I have been working on this theory about suicides: If any one is hell-bent on committing it, it should be my duty to guide that person towards the least painful method.

If some one is planning to commit financial suicide (which I reckon a few readers may already have attempted), then it is also my duty to guide them towards the process that may be less painful.

Enough preamble. Now let us get down to brass tacks. Though any stock can be chosen for trading – regardless of its fundamentals – it helps to have a plan and some background knowledge.

High value stalwart stocks typically do not fall too much during down trends, neither do they rise much during up trends. That makes them good picks for stability in one’s long-term portfolio. Not so great for trading.

Penny stocks (i.e. those trading below Rs 10) tend to be irregularly and thinly traded most of the time. Only a few hundred shares being bought and sold can change the stock’s price by a significant amount. While that may appear attractive for trading, being able to buy or sell any decent quantity when you want to can pose a problem.

Mid-priced stocks – say those trading between Rs 30 – 80 – may be the best bets for trading success. Of course, such stocks should trade regularly and with decent volumes. Make a list of such stocks, and start studying their chart patterns. Short-list the ones that are most volatile (i.e. the ones that give big swings from high to low in short periods of time).

Even after going through the above exercise, you may have a short-list that is not so short. Checking the charts of more than 20 or 25 stocks on a regular basis can be a daunting task unless you are doing it full-time. Use the ‘Circle of Competence’ concept to drill down to about 20 stocks, and then spend a period of ‘paper trading’ to fine tune your short-list.

Drop the ones where your paper trades turn sour. Add a few more from the original short-list till you are comfortable with the final choice of the stocks you would like to trade.

Happy trading! (Don’t blame me if you get killed – you are the one attempting to commit financial suicide.)