Asset
classes have a tendency to show extreme movements many times. Sometimes, they
may be so generous that they may move up and scale new heights regardless of
the fundamentals and political and economic scenario of the country or the
world, while there may be times when unfavourable situations may make them go
down so drastically that overall asset classes become ridiculously cheap. These
wild movements of the asset classes, many a times, play havoc for a general
small time investor/ speculator. It is at these times that general public lose
faith in the markets and are driven by emotions while buying or selling asset
classes. They tend to buy at the highest levels and sell at the lowest levels
succumbing to the elation and depression respectively. However, a patient
investor and an intelligent speculator would reap huge gains in these
situations.
These
extreme movements of the markets like the ones seen in 2008 (because of
sub-prime crisis) or 2001 (because of technology bubble burst) or 1979-80
(because of silver market mania) are not a new age 20th or 21st
century phenomenon. Trading in asset classes dates back to centuries and these movements
also find their way in history. Let me apprise you all to the famous “Tulip mania”
that gripped the Dutch as far back as first half of the 17th
century. It is generally and arguably considered as the first recorded
speculative bubble in the history of asset markets-
Tulip
was different from every flower because of its saturated intense petal colour
and was regarded as a coveted luxury item in many parts of the world. Tulip
grew from a bulb that normally takes 7-12 years to grow from the seed. Accordingly,
bulb was a sought after commodity. Bulbs not infected by mosaic virus produced
petals with single colours, while certain virus infected tulips produced petals
with vivid and spectacular colours making them rare and desirable commodity. By
1634 as a result of demand from French, speculators began to enter the market.
A formal futures market in 1636 was established by the Dutch where contracts to
buy bulbs were bought and sold. The contract prices of rare bulbs continued to
rise throughout 1636 but by November of 1636, price of common, non infected
bulbs also began to rise. Besides the reason stated above, price rise was also
due to the fact that the trading public was speculating that soon a legislation
was under way which would convert the futures contracts entered into by the
trading public for tulip bulbs into options contracts, thus, greatly limiting
the liability of the buyer of tulip bulbs in the market as he can always pay a
penalty amount (call premium) and avoid the contract in case the prices of
bulbs fell. Accordingly, the prices rose to astronomical levels by the end of
1636 and early 1637. Everyone thought that the party will last forever. Higher
prices would only go higher. People purchased at such sky high prices intending
to resell the bulbs at a profit. Finally around February 1637, the “party”
stopped and prices fell dramatically. While some economists are of the view
that the fall in prices was due to the
outbreak of bubonic plague in Haarlem (a city in the Netherlands), others are
of the view that the fall was due to halting of trading in tulip contracts by
the Dutch authorities. Whatever be the case, one can imagine, at the peak, some
of the bulbs costed around 10 – 14 times the annual earnings of a skilled
craftsman while when the prices of the bulbs fell; the fall was so severe and
intense that some of them collapsed 99% of the peak traded price.
The
above event clearly highlights the fact that time and again, prices of asset
classes have risen and fallen and would continue to do so in future also.
Sometimes the rise may be quick while the fall may be painfully slow, while at
times, it may be the other way around. However, many times it so happens that
both the rise and the fall is so sudden that it does not give time to even
experienced investors/ speculators to digest the fact. Accordingly, the
investing/ speculating public tends to lose faith in the markets. As an Indian,
I can personally recount many people losing faith in the stock markets after
the sensational crash of 2008 when the Sensex fell from 21000 levels to as low
as 7700 levels in the same year. It was very simple to understand that the
level of 21000 was fundamentally not the right level to enter the market in
January 2008, considering a major investment bank Bear Stearns’ two hedge funds
had just collapsed in July 2007 and the whole investment bank was on the brink
of a collapse. Furthermore, the US housing market was showing signs of extreme
weakness due to default on sub-prime loans with many economists warning of a
systemic collapse of the housing market. The concept doing the rounds that time
was that India and some other emerging markets are decoupled (separated and
insulated) from the happenings in the US. However, the “foolish” experts forgot
to realise that in this era of globalisation, every country (except extremely
backward/ tribal areas of the world) is linked to the other. Furthermore, if we
analyse more, even the level of 7700 or so attained in October 2008, was so
absurd that great quality stocks with relatively stable business outlook were
available at throwaway prices. Both, the intelligent investors and the smart speculators
could have and certainly may have made huge gains.
Thus,
it is clear; the markets and asset classes will show absurdly high and low
levels at times and it is upto the investing/ speculating public to make the
best use of these movements. We are all aware that the prices of stocks, shares
and commodities change on a daily basis even though the fundamentals
surrounding them do not change so often. However, when we are speaking of
excessive highs and suicidal lows of the market, we are speaking about change
in fundamentals and other reasons governing their pricing and value. But, the
highs become excessive and the lows become suicidal because of the psychology
of people. If the value of an asset class is “1/2x” and the value determined by
fundamentals is “x”, the prices would tend to rise inevitably. However, the
speculative and “insane party” at times, tends to stretch the prices to absurd
levels of “2x” or even “4x”. Such high prices are not sustainable for long term
as sanity tends to enter the market sooner or later and the prices correct
themselves to “x”. Conversely, an overvalued asset trading at “2y” may be
fairly valued at “y” but while the prices tend to fall, they may fall
dramatically downwards to values like “1/2y” or “1/3y” only to rise back again
to “y”. No doubt, these excessive highs and suicidal lows cause immense pain to
most of the speculators/ investors of asset classes, however it is also at the
same time giving them an opportunity; an opportunity to reap huge profits from
these situations. When the prices fall to absurdly low levels, the assets
should be bought while when they rise to high levels, they should be
immediately sold if kept in portfolio or short sold (and later bought at lower
levels to square off the position). These movements should not be treated as an
enemy that takes away wealth of investors/ speculators, but should be treated
as a friend that gives them the golden opportunity every time to earn huge.
However,
patience and discipline is the key. One has to master the art of valuation of
asset classes and have conviction in one’s ability. For this, one should start
with smaller amounts and over the years, try to hone and fine-tune the art of
valuation in a strictly disciplined manner. If this is done properly, one would
automatically start treating the excessive highs and suicidal lows as the best
thing that could happen in the market and accordingly, make big bucks out of
it. In the Indian scenario right now, we are seeing huge rise in the prices of
real estate in many select urban pockets. Even the world recession of 2008-09
did not have any major impact in the prices of residential properties in areas
like Delhi, Mumbai, Bangalore, Chennai, Ahmedabad, etc. This is primarily due
to increasing urbanisation, better infrastructure in the above mentioned cities
and the general trend of people living in smaller towns or rural areas to flock
to those cities in search of jobs. However, even if we consider all these
reasons and a few others also, such high prices may not be justified and we may
soon see a downward spiral in prices in these areas. But, why the prices are
still on the rise is due to the following reasons –
1. Large
amount of black money in the unregulated property market in India
2. Greater
personal interest of property brokers, who in collusion with real estate
developers practically buy the properties on their own account many times and
control their supply. Consequently, they later sell them at a substantial profit.
However,
this “insane party” may either continue and real estate prices may further rise
to even higher levels or the prices may move laterally for a long time now or
they may fall. All depends on the uncertain future but if stringent regulations
to control the real estate sector by having a real estate regulator (a proposal
that has already been considered by the Central Government) is enacted or
regulations like tax collected at source (TCS) on the sale of property (a
proposal introduced in Finance Bill, 2012 but did not pass to become a law) is
enacted, the prices of real estate in many urban pockets may take an immediate
hit. Whether this hit may turn out to be a suicidal low for the sector is yet
to be seen but all depends on investor/ speculator sentiment.
For
every seller of an asset class, there is a buyer of that asset class and vice-versa.
However, sometimes, buyers tend to dominate the pricing while at times sellers
tend to dominate, leading to high and low prices respectively for the asset
classes. But what an investor/ speculator should be aware of is “insanity” in
the market and as much as possible try to benefit out of it rather than become
another sheep in the herd. At this moment, I would like to conclude by quoting
a phrase from Warren Buffett’s 2001 letter to shareholders of Berkshire
Hathaway – “Try to be fearful when others
are greedy and greedy when others are fearful”. This is the mantra to
master the extremism and absurdity in the pricing of asset classes in the
market.
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