Stock Market tips: Look before you leap

Nikunj Gandhi takes a stock of the situation when everybody around him is betting on which funds to invest and which shares to sell

Markets – primary, secondary, commodities and as a result the derivative – are caught in an exuberant frenzy both in the emerging as well as the OECD economies. You can find a plethora of explanations for this rollercoaster ride on tons of finance websites and I shall not try and analyse the various theories and reasons put forth by the gurus. However, there’s an interesting observation I happened to co-relate with an anecdote called as ‘The Cocktail Party Theory’ as a humorous approach to this stock picking exercise in this recent euphoria. The term was coined by Peter Lynch (Portfolio Manager for Fidelity Magellan fund, which is considered one of the best funds to have performed consistently under his leadership giving an average return of 29% annually) in one of his books One Up on Wall Street. Here is a replication of the theory, although not in verbatim.

He outlines this funny theory as a means of market forecasting. The parameters for this method involve hours of attending boring cocktail parties, standing in the living rooms with a glass of wine in hand and listening to hours of conversation from people about stock markets. Now, depending upon the prevailing market performance, he narrates how the conversation develops (in first person, as I recollect from the book).

Stage 1

This happens to be the stage of an upward market.

The markets have been down for a while now and nobody expects it to rise again. People aren’t talking about stocks and if they happen to ask me what I do for a living and I tell them I’m a fund manager, they politely nod and change the subject of conversation. The bloodbath experienced in the previous downfall in markets is still fresh in their minds and it’s too much to endure just talking about it. They would rather talk about the weather or crowd around the dentist and discuss their cavities and bad breath. So, at this stage, when people would rather talk to the dentist about gums than to a fund manager, it’s likely that the markets would go up.

Stage 2

At this stage the markets are up by approximately 15% than stage 1.

In stage 2, when I tell people about my profession, the new ones talk about it and suggest how risky the equity markets are and then they walk away to talk to the dentist sipping his umbrella cocktail, about their gum troubles. Hence, gum discussions are still the talk of townthan stock markets.

Stage 3

At this stage the markets are up by approximately 30% than stage 1.

At this stage I’m the bigshot in limelight and the dentist is ignored. Nobody gives two hoots about their gum troubles anymore and they enthusiastically gather around me once they know that I’m a hot-shot fund manager. I’m pestered constantly for tips and what shares to buy. Even the dentist seeks my advice. Everybody has put money in new issues or existing scrips and are talking about the phenomenal returns they expect.

Stage 4

At this stage the markets have hit the roof!

I’m still in the limelight, but for a different reason. People gather around me and tell me what stocks I should have in my fund portfolio. Everyone has a 100% sure shot winning tip from some operator or some insider or someone’s cousin who happens to know someone on the board of directors. Even the dentist has few tips for me. So, at this stage when everyone tells me what to buy and when I wish that I should have taken their advice, then it’s a sure sign that the markets have topped and a fall is inevitable.

Anyway, it’s a funny approach by Peter Lynch to predict the direction of the markets but in all seriousness, nowhere does he suggest that this is the approach we should take to pick stocks. The old school approach of picking fundamentally strong scrips still works and valuations, rather than timing the markets, are what matter the most.

If I were asked as to which stage are we approaching, I would say that we may have graduated from Stage 3 to Stage 4. I’m awfully surprised at the recommendations flying around. Everyone seems to have an ace up their sleeves these days. The general mood hogging around Facebook/Google/Yahoo discussion groups is that of a self-proclaimed superstar analyst. The common consensus seems to be that, this analyst (this includes the big broking firms as well) had suggested a stock some X months ago and today its market price has skyrocketed like hell and then he continues to bask in his own glory with the magic words “I said so” and then there are a bunch of hero-worshippers who give him a standing ovation.

However, they tend to overlook the very basic principle, that even a monkey can make money in a rising market. It happens to be a lost cause and like Warren Buffet says, “It’s only when the tide turns against you that you find who was swimming naked.”

Is this a bubble and are we headed for a crash? I’m no prophesist, but if history has ever taught us anything, then we should start believing in the fact that is true for any asset bubble; what goes up must come down!

I’m no Bear in this boom, but it’s not like ‘Infallibility’ is tattooed on the economy’s biceps. Hence, I would prefer to tread with caution. A reasonable target based investment in the equity scrips with valuations based on fundamentals and a foreseeable horizon should surely help in cashing in the profits. It’s exhilarating to watch the portfolio turn northbound, but it’s just a notional gain. The real profitsare reaped only upon making a sale!

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