The 10 blunders to avoid when markets are touching all-time highs

In the long run everything is driven by fundamentals without an exception but in the short run, everything is driven by operators and insiders, says Guptha

The euphoria is palpable. The anchors at the top TV channels have already printed T-Shirts of "Nifty - 21000". The Nasdaq is about to finally breach its life high (or at least it was just a few days ago) in a few days, and there has never been a better time to believe that "This time it’s different".

I have been in markets since 1993, and like most 50-year-olds, I have seen a few booms, busts, scams, and financial crises. As a fund manager, sometimes my clients ask me: When markets are at all-time highs and making new highs every day, why are you not investing our money and simply holding on to cash.

I give all my clients two choices: Take back your money or be patient. But I ain’t changing my philosophy because of the pressure of capital deployment.

Even though I am always fully invested (personally) in markets (levered to 120 percent) I am still almost always fearful, as Socrates keeps knocking subconsciously within me with his words: "Fools are always confident, and the wise are always in doubt".

Perhaps I am a mad, raging bull in bear clothing. The bull in me keeps me hopeful, and the bear in me allows me to be patient, cognizant of risks, and non-greedy when everyone around me is convinced that this time it’s different. Perhaps that’s why our portfolios have been the least volatile and have beaten markets with the least amount of palpitations for our clients over the long term.

But the 10 lessons (and a bonus) that I have learned over the years and tried to imbibe in my investing style are as follows.

1. Be bullish, not foolish

If the world is progressing and must keep moving ahead (with inventions, technology, opportunities, AI, et al), markets will always go up over the long term. That allows us and encourages us to be perma-bull a la Rakesh Jhunjhunwala. Sensex at 60,000 seemed like an impossibility some 10 years ago. Today, it's 66,000. So being a bull almost always helps in the long run.

But in the short run, becoming a muppet in the hands of commentators is the worst punishment one can allow oneself to be inflicted with. The narratives that emerge at the seeming peak of the markets are always almost misleading and suicidal.

Lesson

When a stock, an idea, or a sector is being pushed feverishly – AVOID.

2. Breakout stocks

Finfluencers are running paid courses on breakout stock strategy, and thousands of gullible retail investors fall for this trap.

In the long run, everything is driven by fundamentals without exception (or else Yes Bank wouldn’t have become a No Bank and Suzlon would still be a blue chip), but in the short run, everything is driven by operators and insiders. How else do most shares start to perform or go down just before a major corporate announcement? Examples are galore, not only in Indian markets but in the US as well.

Stocks break out not because the companies have become fundamentally adroit. They break out because too much money is chasing too few stocks. And that can make any s*** break out. Sub-Rs 1,000 crore companies that suddenly get new narratives built around them, coupled with incessant peddling of ‘the new promise in Lala land’ on social media and sometimes on business channels, always prove to be traps and wealth destroyers. It's surprising that almost all breakouts happen only when markets are peaking.

If Infosys, ICICI Bank, or the likes break out, it's great and merits attention, but when stocks break out because of positive news (in most cases planted) while promoters are happily offloading their stake, not only should you be fearful, but you should also contemplate sitting out of the markets for a while. As Buffet famously quoted: "Only when the tide goes out do you discover who is swimming naked".

Lesson

If you are a superman and can get on a bullet train (that’s running towards an abyss) and get off it just in time, a breakout investment strategy is okay. Else you will almost always get scorched.

3. Beating the estimates

When rivers start flowing above the danger mark, the powers that be worry little about the river or the impending danger. They just raise the danger sign by a few feet so that the river remains below the danger mark. Such is the story of the estimates made by analysts. All estimates are always beaten because estimates are not based on free cash flow (FCF) or earnings yield but on the collective intelligence of sub-optimal and mostly clueless analysts who are experts in guesswork.

And sometimes estimates get beaten because of a low base effect, one-off income, etc. For this, one needs to delve deep into the financial statements. But beating the estimates is one of the most specious narratives to misguide the Do It Yourself (DIY) and the gullible investor.

Imagine Nykaa listed at a peak valuation of some Rs 1,16,000 crore (nearly $15 billion), and analysts hailed it as a profitable company going into the initial public offering (IPO) while the Nayars privatised their profits and socialised the losses. Its present earnings per share (EPS) is some 7 paise and is trading at 70 percent below its listing price. It is discounted at a whopping over 2,200 times.

Over the long term, there are just three things that matter for a strong stock performance that has any likelihood of creating wealth for shareholders. These are: Valuation, Free Cash, and Management Intent.

Lesson

Stick to the basic principles of investment that have existed for decades. Analysts and their estimates can be great entertainment, not the bedrock of sound investment strategies.

4. Feeling good about bad data

Bad data is bad, and good is good. However, markets have started interpreting this inversely. Can you imagine that if the US jobs and inflation data are good, markets react negatively, and vice versa? Eventually, reality will catch up, and markets will realise that job losses aren’t good in the long run as data leads reality by a few months. Yet in the short run, bad data almost always pleases the market until it doesn’t.

Lesson

If the data is correct, then trust the data and not the convenient interpretation of it. (eg. Bad data will lead to interest rate cuts, and the party of excesses will continue). Eventually, something that’s good for the economy will manifest itself into goodness, and something that’s bad will manifest itself accordingly in the not-so-distant future.

5. Discounting the distant future in present valuations

The decision to make a capital expenditure by a company or, set up a new factory, or a newly acquired business contract spread over multiple years almost always takes the stock price to tizzy heights. And the human mind is wired to feel bullish on news that has not produced a single cent yet and no one really knows when it will – these traps are best avoided as euphoria almost always fizzles out. Does anyone remember the infra theme of 2006-2008? Most of those companies aren’t even listed anymore. The present defence theme is no different. Be cautious when buying into future stories.

Lesson

If a company is good, it will keep creating consistent shareholder wealth. And any prudent investor will make money in that company’s lifecycle. (Buffet invested so late in Apple’s lifecycle – And how - he didn’t miss any bus or opportunity.) Don’t invest just on the promise of a rosy future. Wait for your time.

6.The FOMO factor

History is replete with examples, and I have experienced it personally. If one really is in love with a stock and wants to create a position, the irresistibility upon hearing TV commentators and news flow is intense. But almost always, every single stock that you want to buy today will be available a bit cheaper a few weeks or months down the line, even if it’s the HDFCs or the Bajajs of the world. All one needs is a bit of patience to wait and build a stronger conviction while the target or lower price is achieved. If the fear of missing out (FOMO) could be quantified, it's directly proportional to the level of the indices. Most bitcoin retail aficionados invested between $50,000–68,000. If Bitcoin is really a store of value, why aren’t they doubling down at $20,000?

Lesson

Investments made in a state of FOMO are never great ideas. Date your stock, understand it better, observe it for a few quarters, and then say Yes. You will never go wrong.

7. Recency bias

Anyone who has vivid memories of 2000 and 2009 and remembers Pentafour Software, DSQ, HFCL, Global Tele, and JP Associates, would resonate well with the perils of recency bias. When most of these shares fell from (approx.) Rs 3,000 levels by 20 percent people rushed to sell their family silver and real estate to capture the opportunity of owning these blue chips of those times. Well eventually, all of these companies got delisted, and JP is now at an unfathomable level of Rs 8.

The point to remember is that a stock at Rs 1,000 can well become a penny stock, and the adage "how much more can it fall" is stupidity.

Lesson

Not only should you never catch a falling knife, but don’t invest in story stocks. Companies that peddle stories and not profits will always destroy their shareholders’ wealth.

8. Herd mentality

Speciality chemicals was as crowded a trade 18 months ago as banking is now. Finfluencers were allowed to blatantly push narratives on TV channels and the entire sector has destroyed a considerable amount of over the last two years. Indian Banks are trading at reasonably rich valuations while the chief executive officers (CEOs) of the same banks are subtly raising red flags on growth and margins. Yet the BAAP (buy at any price) brigade is relentless. While the banking sector is the bedrock of economic growth in any country, valuations do matter.

Lesson

When everyone is chasing the same theme, it almost always spells trouble. DotCom in the 2000s and housing in the 2008s met with the same fate. AI is the new darling theme. Let's see what happens to AI and chip companies a few quarters down the line.

9. Cutting the flowers and watering the weeds

Peter Lynch famously said the above. I know more than a dozen people who are in love with Yes Bank and Vodafone rather than ICICI Bank and Bharti. A large number of DIY investors feel that the chances of a penny stock doubling are far higher than those of a respectable and fairly priced stock. The ‘averaging on the way down’ brigade of Yes Bank, Unitech, and JP Associates will continue to sell their winners while collecting mountains of trash.

Eventually, such investors get ejected from the markets forever.

Lesson

The performance of a company gets reflected in numbers, numbers get reflected in the balance sheet and the balance sheet gets reflected in the stock price. Stocks are where they are for a reason. A red-black on a roulette table offers a better probability of winning than holding onto the Yes’s and Vodafone’s of the world in the hope of their springing magic.

10. Falling in love with stocks or promoters

I recently heard a well-known fund manager mention in a podcast how he was in awe of Mr. Ghosh and Bandhan Bank. This adulation towards a particular management clouded his ability to see the fortunes turning for the worse at the bank, and eventually, he had to exit the investment at a big loss to his investors.

It is easy to fall in love with stocks/sectors that have given good returns in the past. But this should not blind one’s rational thinking to changing times. One key TV commentator keeps peddling the idea that the next HDFC Bank is the HDFC Bank itself, while the stock underperformed Nifty by a huge margin in the last 2.5 years and ICICI Bank snatched the mantle of growth and consistency in the Indian banking space.

Positive management commentary is another trap that most investors love to fall into. Bias clouds their judgements and their performance as well. And most investors get satisfied by just commentary. Which promoter will ever say that his future is bleak or give a negative commentary?

Lesson

Don’t cling to stocks where data or price are supportive or where the business model itself could face a headwind. If at all possible, cling to relationships, great friendships, and emotions, not stocks and commentary.

Bonus: Checking the price and not value

We all aspire to upgrade our standard of living (car, house, holiday destinations, etc.) and happily pay a premium for superior quality and size. But some of the most prudent investors, and sometimes fund managers as well, take refuge in substandard, low-priced stocks (penny stocks) in the hope of a dramatic turnaround or a story that’s likely to unfold in some distant future. The propensity to indulge in this investment strategy is directly proportional to index levels.

Lesson

If there is a 1 percent chance that your investment behaviour is vaguely similar to gambling, you are most likely to get into trouble. The probability of landing a multi-bagger amidst an ocean of crappy stocks is like finding a unicorn in a herd of donkeys.

If one could just avoid stupidities in the investment journey over decades, there is no force that can stop you from compounding your wealth at an appreciable rate. And compounding – the eighth wonder – is everything, isn’t it?

(Manu Rishi Guptha is a fund manager known for his incisive and sharp commentaries on the markets and stocks he owns. He can be reached at @manurishiguptha. The opinions in this article are his own and not those of this publication.)