Some crystal ball gazing for the equity markets

One of the things that I genuinely find irritating is when people tell me that anything can happen in the markets and therefore it is senseless to predict it. What is actually making no sense is to buy equity regularly without a care as to what level you are buying it at. Thus, even though I myself have subscribed to the philosophy of standard SIP for the last 7 years investing about 20 lacs in it, I have finally figured out the fundamental flaw in the approach.

Do not get me wrong here – the market movements are a lot of complex dynamics and there is no mathematical modelling possible to predict it, though enough people have been trying to do so for a long time. However, if you are aware of the business, economic and political fundamentals then it will be possible to forecast the broad medium term trends of the markets. This does not mean that one will get it right all the time, but even if you do so a majority of the times you will do very well for yourself.

What are the main factors that have a say in the Indian markets generally? The most important ones are as follows:-

  • Even today our markets are largely driven by FII money, so an inflow of this will help in raising market levels and an withdrawal of this will result in market corrections.
  • Whether FII money will come in or not depends to some extent on how they need this money for other global markets. So if they want to invest in Brazil or China, it is inevitable that they will have to withdraw money from the Indian markets.
  • FII reaction to negative news flows or sentiments is normally quick. In the last Lok Sabha election they bought into the market on the basis of exit poll predictions. Similarly this October they have been selling off thinking that there is a good chance for the BJP to lose the Bihar elections.
  • Company earning is of course the most important factor for an individual stock performance and the aggregate of all such performances have an impact on the overall market levels. Earning improvements have been expected for the last 2-3 quarters but such hopes have been belied.
  • Individual stocks can be badly impacted by negative news. For example DRL stock suffered heavily today as the US FDA issued a warning to the company. This not only had a sharp cut in the DRL price but also affected the overall sentiment of the market in a negative manner.
  • The overall political environment with specific links to policies and legislation also drives sentiment. The positive sentiment of the change in government in 2014 led to hugely positive sentiments and a spectacular rise in the markets. Similarly the failure of the government to get some of the key legislation done successfully has let to negative sentiments and have caused the markets to languish.

With an understanding of the above framework is it possible to call the Nifty levels in the medium term of 3-6 months? The significant events will be the Bihar results, the US Fed rate hike, the Q3 results, the lead up and aftermath of budget, Annual results, the state elections, monsoon outcome etc. While predicting the route the Nifty will take is almost an impossibility, I do think that 7000 level will find very strong support and it will be nearly impossible to cross 9000 for the Nifty. Within this 2000 points play, a much more likely range is 7500 to 8500, unless something really exceptional occurs in the business and political scenario either within India or globally.

With the caveat that I may be quite wrong, what should be the investment strategy in equity for the next one year if this range holds? Obviously, you want to buy at 7500 rather than 8500 but how to arrive at a mechanism for doing so? I will write about it in the next post.

Mutual fund buying – A follow up post

Well I was expecting a fair bit of response on my post of yesterday and it has happened along expected lines. A lot of readers could appreciate the fundamental logic behind my method and some wanted to follow it too. At the same time a few wanted me to explain with some example from earlier and also be clearer about how exactly the method will work. As a blogger, readers are the reason for why I write a post, so let me try and discuss more elaborately.

Let us take the example of ICICI Focused Blue Chip Fund and assume that we are using Nifty as the benchmark index for it. Now, if you look at some basic data of this fund for the direct plan of this fund for the past year, you’ll observe the following:-

  • 1 year return of this fund is 2.54 % while that of Nifty is in the negative zone. So as expected of an actively managed fund, it has done better than the index.
  • However, in this period the Nifty was fluctuating between levels of 7500 and 9000. If you look at the NAV of the fund over this period you will see that it has tracked the Nifty quite closely.
  • In this one year the CNX Nifty had levels of 8000 or lower on several days. Obviously the NAV of the fund would have been a low one on those days. 
  • The whole idea about my buying MF is based on tracking these possible lows and buying on those days.

Now many will say that this is in hindsight and what if Nifty had an unidirectional up-move? Well, this can happen but in that case you are anyway buying MF units at high NAV as far as standard SIP is concerned. Now, if you free yourself from the constraint of having to invest in every month the scenario changes rather dramatically. You have the money to invest, you can afford to wait till the market drops.

How do I know the market will drop? That is where you need some knowledge of the market and the business environment to take a call. However, it is really not practical that in our current environment the market will only move up. While the 200 DMA for CNX Nifty is going down, you can afford to wait and not buy. Use this tool which is easy to track – once the trend reverses go ahead and buy. Whether you want to buy at one go for the year or not is something you need to decide, even though I will not recommend that. For my own investment I think 4-6 purchases in a year will be the ideal figure.

OK, so for someone starting to invest in this fund today, what is really the outlook for the next one year by using the method that I have advocated? I definitely think there will be buying opportunities in the next 2-3 months. The next downtrend can be after the budget. Finally a poor monsoon and elections in the states will most probably result in another opportunity.

In summary, I plan to track the 200 DMA for Nifty closely and hope to invest 4 -6 times, most probably in December 2015, January 2016, July 2016 and September 2016. Of course, these can change if unexpected things happen such as the BJP winning the elections in West Bengal – highly improbable. In any event though my returns from these investments both short and long term is bound to be better that what my SIP returns from this fund has been in the past year.

I hope I have been able to convince you to try this out and check what happens for a year.

My investment plan for Mutual Funds

As I have written in several posts now in the blog, my current SIP in the mutual fund schemes that I had for the past 2 years has completed in October. Over the last 7 years and a bit, I have regularly invested in SIP mode and had rarely paused to analyse whether that was a good thing or not. However, once I started to look a little deeper into the issue, it was very clear to me that SIP was a particularly poor way to invest in MF schemes, more so with the markets that we have had over the last two years. Anyway let me not repeat myself here, this post is about how I am going to invest now. New readers can look up these posts if they are interested as to why I have come to this conclusion.

In my present situation, where I have an active income from my consultancy practice that is irregular, my sources of fund for investment can be somewhat erratic. On an average I would like to invest about 3 lacs a year in equity MF. This will be in 5 schemes as per the portfolio structure that I recommend. Though I am unhappy about how I have invested earlier, I am quite satisfied with my choice of funds. These funds are as given below:-

  1. ICICI Focused Blue chip Fund
  2. ICICI Value Discovery Fund
  3. HDFC Mid Cap Opportunities Fund
  4. DSP BR Micro Cap Fund
  5. ICICI Focused Blue Chip US Fund

Now, the way I want to invest in these could be a little different from how most investors would like to normally invest. The simple point is for equity investment when you are investing from a time perspective is really immaterial, what matters is at what level of the market or the stock you are investing in. The other aspect is how much amount you can invest at one go. Now, fortunately I will be able to invest even the entire amount if needed at any point in time. This is because some of my debt instruments keep maturing through the year and my Consultancy income, though not regular, is reasonably good in terms of cash flow when it happens. I do not think we will reach a situation in the next few months where there will be a need to invest 3 lacs at one go, but the ability to do this if required enables a rather flexible approach. This however, while a little out of the way, can be achieved easily with some planning by most people.

OK, so without much further ado this is what I plan to do:-

  • Align each fund to a relevant index for making the purchase decisions. For example Nifty will be the relevant index for ICICI Focused Blue Chip fund.
  • As of now Nifty current levels are significantly below the 200 DMA for Nifty. As Nifty goes down further the 200 DMA will also get dampened.
  • I plan to wait for the Bihar results and the US Fed rate hike in December. 
  • Assuming the 200 DMA of Nifty keeps falling I will start buying once every month for an amount of at least 10000 Rs at one go. I plan to buy a maximum of 6 times in a year.
  • Once Nifty 200 DMA starts to rise, I will stop buying and wait for the next down cycle.
  • My number of buys will typically be 4-6 in a year, that is every quarter or every 2 months.
  • A refinement can be to take the 200 DMA of the fund NAV and decide on purchase based on that.

I hope this method is clear to everyone. The basic idea is to buy at the low points of the index or fund NAV. Note that as long as you have a method, you need not worry about timing the market. The results here are bound to be better than the standard SIP where you are investing the same amount on the same day every month without any consideration for the market level. That is simply a totally wrong way to buy equity in any form.

In the environment we have in our country today, an unidirectional market either up or down will really not be there. As a result you will definitely get pockets of buying opportunity. It is important to use these opportunities and understand how it benefits your overall portfolio by doing so. The mindset of investing monthly and every month is pointless – what is important is the discipline of having the investment money available so that you can use it quickly when things change.

In the next post, I will take a practical example of asset allocation and demonstrate how one can very easily create a framework of investment with the logic of this post.

A layman’s guide to 200 DMA and how to use it

When you write a blog that has readers from all over, it is sometimes a challenge to decide how you need to pitch a topic. On one hand you can assume that your readers know most of the things you are referring to and just get on with the blog post. On the other you may have to explain the basic details elaborately, before getting on with the main topic. I have referred to 200 DMA as a basic indicator for deciding on when to buy in some of my posts. It was pointed out to me by a few readers that many may not really know what is 200 DMA, leave alone it’s significance.

Well, let me get down to the basics then – DMA full form is Daily Moving Average and 200 DMA is the Daily Moving Average over a 200 day period. You calculate it for Nifty by adding all the closing Nifty levels for the last 200 days and then dividing the sum by 200. So, obviously unless we are having a flat market for long the current level of Nifty will normally be different from the 200 DMA of Nifty. The other point to understand is this – we can have 200 DMA for any stock or for any other index as well. So 200 DMA of ITC is possible and so is 200 DMA of Sensex or CNX Mid cap index. Also, while 200 DMA is used very popularly you do have other indicators like 50 DMA, 30 DMA etc. These are also calculated as I have explained for 200 DMA.

Why is the 200 DMA the most popularly used indicator? Historically at some earlier point in time, stock markets used to be in business for 200 days a year. The 200 DMA would then represent the average value of the stock or particular index over the past year on a rolling basis. What is the significance of this? Well, one year is a fairly substantial period and the 200 DMA value will give you an indication compared to what the current market price (CMP) is. For example if the stock has been trading with a downward bias then in general CMP will be less than 200 DMA. It may not be a very good idea to buy such a stock when the 200 DMA is in a declining trend, even though the CMP by itself may look attractive. Similarly in a rising market the 200 DMA will show an increasing trend and it may make sense to consider buying any stock only after the 200 DMA trend gets to be a decreasing one, or at least flattens out considerably.

Let me try to explain this with the example of Nifty in the year 2015. On 3rd November 2014, Nifty was at 8324 and 200 DMA of Nifty was at 7191. Based on how the market has performed over the last one year, we can note the following:-

  • On 12th February 2015, Nifty was at 8711 and 200 DMA for Nifty was 8312.
  • On 22nd April 2015, Nifty was at 8429 and 200 DMA for Nifty was 8254
  • On 23rd April  2015, Nifty was at 8398 and 200 DMA for Nifty was 8564.
  • On 7th May 2015, Nifty was at 8057 and 200 DMA for Nifty was 8289
  • On 12th June 2015, Nifty was at 7982 and 200 DMA for Nifty was 8360.
  • On 25th August 2015, Nifty was at 7880 and 200 DMA for Nifty was 8456.
  • On 7th September 2015, Nifty was at 7558 and 200 DMA for Nifty was 8430.
  • On 29th October 2015, Nifty was at 8111 and 200 DMA for Nifty was 8378.

It is easy to see from this that the 200 DMA Nifty has started to decline for the last few days and this needs to be confirmed as a trend. Obviously, if the trend is confirmed then we are entering the buying zone for some of the Nifty stocks as well as for the MF schemes that have a high percentage of holding in the Nifty stocks. The maximum gap between the Nifty level and the 200 DMA was on 7th September but the Nifty found support at that level. I would say the 200 DMA has a high chance of declining further, based on whether BJP loses the Bihar elections. Crystal ball gazing is a tough task for our markets but I do think there is a possibility of the 200 DMA for Nifty reaching a level of 8100 or so by December end.

This will clearly mean that the Nifty will probably achieve levels higher than 200 DMA for the first time since 18th August, some time in January 2016. From now till then we will probably be in a strong buying zone. Of course, for individual stock or MF schemes you must also look at the 200 DMA levels for that stock or relevant index and see those trends for the past year. There are several web sites which will supply you with the relevant data you need to make buying decisions.

I hope with this I have been able to clear up the way in which you can make use of 200 DMA figures and trends. I will do another post on price triggers for stocks in the near future. But before that, I will write one about how I intend to use these indicators for my MF purchase, now that I have finally got out of SIP.

Planning a purchase – can you afford it?

As I wrote in a post before, my mentor in the personal finance space is Suze Orman. In her shows, she had a segment called, “Can I afford it” ? The idea was for people to call in with a purchase they had in mind. Suze would then evaluate their financial condition and then pronounce her judgment on whether the request was “approved” or “denied”. The requests for spending ranged from children’s private school fees to buying a boat and everything in between. This was a hugely popular segment and in true Indian TV industry style a couple of our shows tried to copy it. Obviously, it failed to take off as expected.

I think it will be a good idea to examine how she arrived at her pronouncements and see if we can apply some of her methods to determine the suitability of our spending. Suze had a fairly simple financial checklist for early denial of any spending which was not a mandatory expense. It went something like this:-

  •  Availability of an eight month emergency fund.
  • No credit card outstanding for more than the current cycle.
  •  Contribute fully to the 401K plans ( equivalent to our PF )
  • Spending not more than 4-6 months of take home pay ( except for house etc )

Anyone not fulfilling any of the above would be automatically denied, irrespective of whatever other asset base they had. The logic was simple – if you have been unable to inculcate some basic discipline in your financial life, you do not deserve to embark on any fresh spending. With shaky foundation, it is unwise to put more pressure of more floors in the building.

Once the basic criteria was fulfilled, Suze would go down to seeing whether the spending was linked to people or was just something for enhancing one’s self esteem. The other thing she looked at was the age of the person and how much amount there was in the investment account and retirement account. In her book, the retirement account was specifically for retirement whereas the investment account is for all other goals. Obviously, anyone over the age of 45 and not having enough in these accounts would often be denied for an expense which was really an indulgence, such as buying a boat.

Now, if we were to adopt her methods to decide whether we should or should not go for a spending which is out of the ordinary then it could go something like this:-

  1. Are you having an 8 month emergency fund ?
  2. Do you have adequate life and health insurance ?
  3. Do you always pay your credit card dues in full ?
  4. Do you have no loans or only a housing loan ?
  5. Will you be able to pay for the purchase directly ?
  6. Is the amount less than 4 months of your take home pay ?
  7. Do you have a financial plan and are investing for your goals ?
  8. Are all your goals funded adequately through your current investments ?
  9. Will you be able to stick to your investment plan, despite this spending ?
  10. Is this something that will bring happiness to you and your near and dear ones ?

If you are able to answer all of the above 10 questions with a “yes”, then I feel you have pretty much earned the right to go ahead and spend the money you need to. Sometimes, our money availability is good but we have neglected some of the things like an Emergency fund, due to sheer laziness. It will be good to fix such basic issues and then indulge in the spend.

Note that I have not included questions such as, “how much will this grow to if you invest in MF or stocks?” etc as that is not really the issue here. Investment and spending both have their own places and their own importance. As long as you fulfill the criteria, go ahead and spend for whatever purpose you wanted to – make sure that you enjoy it too.

The real truth about asset ownership & loans

Since the time I have started writing this blog, I have interacted with many people who are very proud of the assets that they own. These can be financial assets such as Stocks, Bonds or MF units. These can also be real assets such as a car , a house, Land etc. The one thing which nearly always surprises me is that how many of them do not understand a fundamental point about owning an asset – you really own an asset only when you have paid up in full for it.

Now many of you think that I am nit-picking here. After all even if you have bought a home by taking a hefty loan, the home is in your name, right? You are staying in it and can rent it out tomorrow if you want to. So why do I say that you do not really own it? OK, let us take a simple example to illustrate my point. Let us say you have recently bought an apartment that is priced at 80 lacs. You funded it with your own resources to the extent of 30 lacs and the rest was taken as a loan from the bank. I hope most of you know that the house is now held by the bank as a collateral, till you are able to pay off the entire 50 lacs loan. In fact, should you fail to do so, the bank is well within it’s rights to sell off the house in an auction and claim the 50 lacs plus any due interest from the proceeds of the sale. Obviously, if you really owned the house this will never happen.

So in reality, if you own a house which has a bank loan funding it, what do you own? Well, you do own the house partly, to the tune of the amount of money you have contributed towards the cost. In the above example, you paid 30 lacs out of 80 lacs so you own 37.5 % of the house to begin with. Now as you keep paying your EMI every month, your ownership of the house will keep increasing. Keep in mind though, in the first few years the rate will be slow as much of the EMI amount goes towards the interest component. So if the house price remained constant and your loan tenure was 20 years, you would approximately be adding to your ownership by 3 % every year.

Now, the good thing in our country is that the prices of real estate generally go up over time. Thus when we are looking at house ownership, the right aspect to consider is the worth of your holding rather than your % holding of original price. Let me make this clear by using the same example:-

  • Let us say in 10 years the price of the house has gone up to 1.4 crores.
  • Total amount paid off till 10th year is 60 lacs (say)
  • Outstanding loan to the bank is still 60 lacs ( with interest )
  • So your equity in the house now is 80 lacs. In reality it is more as you can pre-pay.
  • So with an appreciating asset where the rate of appreciation is greater than the interest rate it will in general make sense to get the asset on loan, even though your ownership of the asset is limited.

So is the home loan a “good loan” then as many people say? Not really as you end up paying about 1.2 crores for 50 lac loan and get full ownership of your apartment when it is 20 years old !! Your family may have been pushing you for years by then to get a newer apartment. In reality all loans are avoidable – they are however imperative at times simply as you do not have adequate money to cover for the asset. In such an event, take the loan but pre-pay it as soon as you can.

Now look at a situation such as a car where the asset is a depreciating one. Here it makes very little sense to take a loan as you will probably be still paying your EMI by the time you start thinking of getting a new car. If you assume the life of a car to be 10 years then under no circumstances should you look at a loan tenure of more than 5 years. And if you are the kind of person who wants to change his car every 5 years, then forget about loans and think of buying a car only when you are able to pay it off in full. A direct follow up from this will be this – never take loans for anything whose life is less than 5 years.

Asset ownership makes us feel good but we need to be clear about the affordability of it. For long term assets we can look at our long term earning potential and take a long term loan, with the knowledge that our asset is quite likely to appreciate. However, for assets with short life such as a smartphone, we need to be able to afford it today.If you have to buy it on loan and know that you will need to replace it after 3 years, then you really cannot afford it.

Think about what you just read and look back on some of the last few asset purchases that you did. You cannot change those now but you can make sure that in future you are buying assets that you can truly afford.