Do you have patience and is your war chest ready?
John Hussman is a veteran investor, fund manager who has seen many cycles. He became famous for his successful calls and maneuvering of the dotcom bubble of 2000 and housing bubble of 2007. Just three days before the dotcom bubble peaked on March 10, 2000, he published a note warning that ‘valuations will begin to matter with a vengeance’ and warned of potential 65 to 83 per cent decline in technology stocks (Nasdaq 100 fell 83 per cent from its peak during the 20002002 bear market).
As investors, we must assess asset allocation and risk exposures, and manage our portfolio in line with prevailing market circumstances — valuation, fundamental outlook, market sentiment — as well as according to personal circumstances — age until retirement, financial goals, risk tolerance, job security. Diligently doing this assessment is crucial in managing risks and manoeuvring market cycles.
In rightsizing our investment exposure in dealing with these constraints, John Hussman recommends beginning with the acceptance that whatever you do, there will be regret and ‘If you begin by accepting that there will be regret of one form or another, you won’t feel paralysed, and you’ll consider more possibilities than you might otherwise.’
All investors, including the most successful ones, experience regret. Warren Buffett himself has said he was ‘too dumb’ in not buying Amazon early. So, rest assured, whether you turn out being an average investor or a successful investor, you will have regrets. You have to bear in mind that not one person can know for sure where the markets are headed in the next 12 years.
If you understand this and approach investing, regrets will not weigh you down or impact your decisionmaking, it is more probable that you will end up as a successful investor rather than average. The only regret you must avoid is the regret of not following a disciplined process and falling prey to entrenched biases. That is entirely in your hands.
AQR is a pioneer in quant investing and one of the largest in the space today, with over a 20yeartrack record. Having set up shop during dotcom bubble phase, Cliff Asness has experience in perils of trying to predict limits of market excesses on either side of the spectrum. He advises following this rule of thumb: of doubling the worst case scenarios you’ve seen. He suggests this more as a guideline.
Stress test is the new game in town with recent weeks’ news dominated by MF stress test for small and midcap funds. Individual investors can do their own stress tests to determine the strengths and risks in their portfolio. Let’s say you entered the markets during the Covid19 bear market; post that the worst correction you might have seen would have been the 19 per cent correction in Nifty in mid2022, from its peak levels in October 2021. Can you withstand a correction twice that — let’s say in the region of 3040 per cent or even 50 per cent? Can you also deal with a longer recovery timeline?
Analysing on these lines can prepare you for worstcase scenarios and respond in a positive way, when such corrections play out.
Like in the case of MF stress test, if the worst case scenarios you forsee on applying this rule of thumb are alarming, it does not mean you will have to immediately unwind your investments. You only need to resize your portfolio to reduce the risk. Or you may choose to maintain your portfolio as it is, but be cognizant of risk and be open to the outcomes.
In 1987, the Dow Jones had crashed 22.6 per cent in one single day on October 19. But the rebound was quick too. Hence, Buffett could not buy bargains as he would have preferred, but rather than lamenting on the missed opportunity he was certain that markets will offer opportunities again in the future.
This has a lot of relevance in current times, especially for investors who may have missed some of the best parts of the current bull market. Should you get in now or should you wait for corrections?
Market history indicates deep corrections are endemic every few years. It’s just that one must have the patience to wait for it, however long it takes. In this case it means waiting for deep corrections, not the typical 24 per cent correction these days which results in a humorous clamour for ‘buy the dips’. Investors must have the patience to wait for real dips — corrections that are painful like it played out in mid2022, especially in the technology stocks.
The second important thing is to have the war chest ready to invest when the opportunity presents. Similar to the ‘do not bet against India’ theme today, Buffett many times has said ‘never bet against America’. In believing in that hedidn’t deploy all his cash, but used it wisely to buy only when good opportunities were presented to him.
CLIFF ASNESS
Co-Founder of AQR Capital Management