“Markets are overheated”

“Economists are sounding caution. Indian markets will correct soon.”

“Market is not discounting the 3rd wave of Covid. Beware.”

“Banks are not expected to do well but stock prices are increasing. Unbelievable.”

“Real estate is a fraud sector. This is an operator managed stock.”

“FMCG is the safest sector to invest especially in the current market.”

and many more similar statements that we regularly hear or make about the markets.

These statements are supposed to convey well researched views based on facts. However, what they mostly carry are individual biases based on individual’s own positions.

• If I have a position in FMCG, I will promote it over say real estate where I don’t have a position;
• If I am majorly deployed in the market, I will hate to call it overheated and vice a versa

You may counter and comment where is the problem?

Isn’t someone’s positions anyways based on his well researched views and therefore he is just communicating those views to the wider audience?

As they say, perfection is a myth !

• We don’t manage our affairs as efficiently as we should
• We make mistakes all the time, especially in stock investing
• Greed and fear are for real and they do significantly impact our actions

Result – our stock market positions are based on many other factors that have nothing to do with the on-ground market realities.

Let’s dig deeper into some of those factors –

1. Every investor has his likes and dislikes

It can be based on –

• Past experiences
• Knowledge, Circle of competence

I will take my examples –

• I had bad experience with infrastructure and real estate sectors and therefore never invest into those.
• Heavily leveraged companies are not for me and therefore I mostly avoid metals and cement.
• Being an auto and banking analyst, I continuously look for opportunities there.
• I had good returns from FMCG with minimal volatility and hence find them safe.
• I identified Pharma as a sector coming out of a long consolidation and hence is biased towards that

My positions obviously reflect the above. If you notice –  all of this is not necessarily reflective of the current actual market conditions.

In the scenario, I am bound to look and comment at infrastructure as a false rally, lagging FMCG undervalued, microscopic analysis of auto and financials and any sell off in pharma as an opportunity to buy !

2. An individual’s position management is a greater function of his personal risk and return expectations than actual market conditions

Let’s look at some practical examples –

• I buy an undervalued auto stock at 14 P/E… stock moves in my direction… and I exit at 21 P/E in a couple of months booking quick 50% gains. My bullishness on the stock would have turned into caution, although factually the Company’s turnaround journey may have just started.
• Someone may be a day trader settling his positions by the end of every day. His commentary about markets will be very different from say a swing trader or a long term investor.
• An investor with 12-15% return expectations from market will have starkly different views as against someone who is aiming to generate >25%. The former would be happy investing in defensives and the latter in cyclicals. Accordingly, the former would call the current markets overheated whereas the latter an opportunity.

In all the above situations, there can be a stark difference between market views and reality.

3. No one wants to be proven wrong

Many of us take our positions after lot of analysis.

Consequently, we are not very nimble to change though the situation may be warranting it.

We may have missed factoring in something or there might have been a sudden change impacting the sector’s fortunes.

Under the circumstances we may be aware about the headwinds in the short term though we are unsure about the extent of the impact.

Consequently, we continue to look and comment about the positives ignoring the changed realities.

Allow me again to explain this with a personal example –

I have been bullish on an under performing mid cap FMCG stock for sometime now and reasonably invested into it. However, quarter on quarter during conference calls, I have observed that analysts are still not completely convinced about it. That also continues to reflect on the Company’s stock performance.

However, given my commitment towards the stock, I keep giving benefit of doubt to the stock and assume that the best is about to happen.

All my analysis on the stock in ‘private’ discussions is focused around highlighting the positives and trying to mitigate the negatives.

Facts and views again become unknown to each other !

Above were just some examples to convey the point. There are many more factors.

Fact is – We call markets efficient and find it beautiful when price movement is aligned with our positions and we call it fraud, inefficient, operator driven when it does not.

What’s the solution – “Acceptance”

• acceptance that we can not know everything;
• acceptance that we can be wrong;
• acceptance that we are just individuals and market doesn’t really care about any individual. It has no idea about our identity or our positions.

It’s fine to have positions suiting our own personal investing strategy. However, frustration is bound to creep in if we expect markets to reflect that. How can market reflect every individual’s personal investing strategy?

Other related articles you may find interesting –

• Risk hai toh ishq hai
• Stock selection: Key hacks to avoid big mistakes
• Why success can be so elusive in stock markets?