There are two kinds of investors, one who look at assets and the other who look for assets. When you look at an asset, the chances are that you are already looking late. The conventional belief that one who looks first is a loner, the one who looks next is a speculator and the only looks last is a loser. So our best chances of catching a big move place us among speculators or losers. There are other problems linked with this strategy of looking at assets. First is the time. Looking at assets is more time consuming. You can look at the Indian Sensex, its 30 stock components and maybe the DOW. |
The "looking at" strategy can never allow you to cover the total global equity market, leave aside other asset classes like bonds, currencies and commodities at the same time.
Second is the X factor. In a world full of hot money where money flows from one asset class to another, from one region to the other, holding on to one section of a regional asset is a strategy exposed to risk and volatility.
No wonder we behave like a chaotic herd of deer not knowing where to look and where to run when that small part of the asset under watch suddenly spurts. The X factor, the unforeseen variable disturbs the otherwise predictable markets. Third are the biases.
The high focus at the asset rather than the universe creates biases, geographical bias e.g. "I am an Indian who understands Indian equity". Asset biases like "I am trading gold for five years that is what I understand". Overestimation of skill..."I am a sector specialist"...You can actually illustrate Daniel Kahneman's entire list of Behavioral finance flaws when you examine the "looking at asset" cases.
Hence, either the Nobel Prize winning Kahneman's endowment theory has some merit or all the investment strategies focused on looking at assets are wrong. Endowment theory says that we fall in love with the assets that we look at, or own, overestimation of skills is a reality just like loss aversion.
A majority of us are prone to irrationality and poor economic decision making, so probably the popular research models or strategies that are not globally scalable or implementable also suffer from the endowment effect failure.
This is why if we claim to just understand one part of a global asset, we are talking more about comfort here than understanding.
And if we indeed think we are oil sector experts who understand oil sector stocks but not the oil prices, or we understand gold but we do not know much about dollar (inverted against gold), or we look at Dow more than Indian rupee for understanding Sensex then we indeed are overestimating not only our skills but also the efficiency of the forecasting instruments we use.
We are loss averse, as we stick to India without daring to trade on Brazil, Russia or China, which behaved similarly over the last eight years. How can you explain this that too highly correlated assets behave the same, but we are comfortable on one but not the other? Ownership creates bias.
The next 15 years are for an upside on global volatility. This uptrend should thrash all such biases, geographical, asset based, and overestimation of skill. Markets do not respect investment psychology vices. What we will be left with is uncertainty and lack of belief.
Something like what a fund manager candidly admitted to me that "I have been in the market for more than a decade and I have come to the conclusion that I don't understand the market anymore."
Few investors in the world come in the other category of "looking for assets" like a few global macro funds looking for assets. And just because they are few makes them loners, the investors from the first leg of the trend.
Looking at the total picture and playing between markets and assets is called Intermarket analysis, coined by John Murphy. The subject encompasses everything including commodities, bonds, currencies, equity and is focused on looking for assets.
The subjects talks about asset leadership and outperformance. How bonds lead stocks, how commodity prices trend in the same direction as interest rates, and how a falling dollar is bullish for commodities and vice versa.
Chief Global Strategist Sam Stovall, S&P adds to the subject with his sector rotation work. The sector rotation aspect first coined in 1995 defines an economic cycle and when and how a sector outperforms the rest.
Energy outperforms in a late expansion stage of the economic cycle and generally marks the top of the market leading to an early contraction in the market. Indian sectoral comparisons can illustrate where the money is going to flow next. If we look at underperformance over the last 12 months, CNXIT started underperforming the Sensex from June 2007.
This was followed by Capital Goods sector, which started its relative underperformance to the market in November 2007. Then it was the Banking slowdown, which happened starting January 2008.
The only bull we were left with was the BSE Oil, which also cracked compared to the Sensex from April 2008. What does this mean? This means that asset performance is cyclical and now Indian markets are short of bulls and whatever bounces we are left with should not last more than a quarter or two.
After this leg up happens, a section market will cry in calamity. While the other will look for assets to move into. Sectorally speaking pharma and FMCG are two sectors, which underperformed Sensex starting September 2003 and December 2006, respectively.
HUL (Hindustan Unilever) is still below its 2000 low, while the Indian market has grown eight times from 2001 lows. And for the last two years Ranbaxy and Cipla did not make more noise than oil. These are the two early contraction economic stage sectors that should deliver.
Masses may go easy on credit and business may aim to reduce energy costs, but staples (inferior goods) deliver in tough times and health remains defensive. Well it is indeed tricky to see the money flowing from one sector to another, but atleast it keeps you out from biases and uncertainties regarding the X factor.
Intermarket analysis and search for assets does not end here, the subject can be extended to intermarket cyclicality. We have mentioned about a few intermarket pairs over the last many months e.g. rubber and Sensex, how rubber leads markets to strength and vice versa.
Gold vs uranium, how this pair knew about oil at $40 where it was headed. It was here we mentioned about simplifying BRICS, when we illustrated Brazil and Russia outperformance compared to China and India.
Brazil is already at a new historical high and Russia is retesting historical highs. Simple intermarket ratios could tell us why the BRICS are polarised.
Intermarket pairs can be formed between water and oil, renewable vs non-renewable energy assets, green vs non-green sectors, gold vs oil, soya vs shanghai, copper vs gold, health care vs FMCG and even stocks of the same sector like Reliance vs ONGC.
Reliance is a sector leader. And when it starts underperforming another sector peer like ONGC, we get our first economic cycle peak signal. The last time this ratio peaked was in September 2000 few months after the full fledged bear was in.
Though the respective ratio has peaked, we don't have a turn yet. So expectations for a last leg up could be realistic.
We don't live in a confined world, we never did. It is a pity if our research models confine us and fail to look at markets in totality. And like Barton Briggs, former chief global strategist for Morgan Stanley exhorts the rich in his book Wealth, War and Wisdom, "Brace up for calamity, study history and listen to equity markets".
Briggs who left Morgan Stanley and manages Traxis Partners, a hedge fund is still addressing to the section of the market that looks for assets and not otherwise.
The author is CEO, Orpheus Capitals, a global alternative research firm.
