Market Sense — 058
The Year Gone by!
Charles Dicken’s had written thus, “It was the best of times, it was the worst of times”. This is quite an apt description of the year gone by. It was a year with a lot of contradictions. Even as the economy is still struggling, markets reached their highest ever levels. IPO market had a boom time with the highest ever IPO in the Indian Market. Even as many people are still struggling to live, the salaries in the IT sector moved to record levels with people getting 50–100% hikes. For many whose near and dear ones were laid low by the virus, it was truly the worst of times. For those who lost their jobs or scratched out a living, it was a season of darkness. Vaccinations started during the fag end of 2020, but were stuck with the DELTA Variant and as vaccinations became more widespread OMICRON struck.
For the stock markets, it was the best of times. The highs in the commodity and stock markets can be explained by just three words Liquidity, Liquidity and Liquidity. As per Goldman Sachs report global inflows into equities surpassed $1 trillion in the past year, exceeding the combined total from the past 19 years.
After 18 months the scare of inflation is rearing its head over most of the economies. The US inflation is currently over 6%. The US Fed has started tightening the tap or reducing the liquidity flows. This has now put a slowdown on the stock prices and markets are witnessing a drawdown. Indian stock prices are also witling down in tandem.
Role of LUCK in Investment Success
Napolean Bonaparte always wanted the luckiest Generals to lead his battles. The investment world is no different. Luck plays a part in investment outcomes. Let’s have a look at importance of Luck in investment outcomes. Does luck play a huge role in determining your success in the market? It sure does, but crediting your entire success or failure to luck isn’t fair.
Though Luck plays an important part, we should not overrate it’s importance like, blaming everything that happens or does not happen to luck, stars, fate etc., Sometimes people may be ducking the responsibility of performance, which is often enhanced by the luck factor. But leaving everything to luck is to abdicate responsibility for creating something that you desire in your life — like riches, success, fame etc. Each of this happens a lot by design and the progress towards the goal here is either accelerated or delayed by luck.
Success Equation — Michael Mauboussin
When it comes to the markets, a lot of people believe that it is all a play of luck. Michael Mauboussin, in his book Success Equation examines the role of luck and skill in the markets. Here is a quote from the book. “I am fond of comparing trading and investing in markets with individual sport. I believe it is one of the closest analogies you can make for what happens in trading and investing.”
Mauboussin in his book places investing somewhere between betting on hockey and slot machines! According to Mauboussin, a game like chess is all skill. This is not to mean that something like the Russian Roulette does not involve skills- it does. But it requires a huge number of iterations to prove its role. Similarly, there will be some luck involved in winning a chess game too but that is a very small proportion.
Luck diminishes with Constant Practice, Good Process and Over Time
In investing, Mauboussin writes, that where some luck is involved in deciding the outcome, a good process will ensure
· some consistent outcome,
· over a longer period of time.
What does a long period of time provide?
· Practice and polish our skills
· Allow the market cycle and earnings to play out
· Reduce the level of engagement with the market
Constant Practice (Circle of Competence in Buffet Parlance) gives us time to polish and sharpen our skills. As we keep doing that we get better and make lesser mistakes.
Role of Time: What time really does is to help us absorb the losses incurred. Then it allows the market cycles of intermediate and long-term nature to play out. Thus, time in the market helps to boost the gains and reduce the impact of luck and consequently reduces the risk and volatility. Conversely the more you trade in the short term, the more risk an investor run.
So, by giving time to your trades and investments to come through, you automatically reduce one of the risks. Many big investors including Mr Buffet do not have a stock ticker at their office and only check the prices either weekly, monthly or even over much longer periods of time.
Thus, a process is the right way to get luck on our side. But the process necessarily has to run over a longer period of time. Create the process, work it diligently and see luck start working in your favor!
Fooled by Randomness
Thus wrote Nassim Nicholas Taleb’s in his famous book “Fooled by Randomness”
“$10 million earned through Russian roulette does not have the same value as $10 million earned through the diligent and artful practice of dentistry. They are the same, can buy the same goods, except that one’s dependence on randomness is greater than the other. To your accountant, though, they would be identical. Yet, deep down, I cannot help but consider them as qualitatively different.”
In the same way, when it comes to the stock market, all returns are not created equal. A return earned by an investor after investing in company XYZ may be vastly different from the same return earn by investor B.
It may happen that the investor A earned after diligently analyzing the stock and carrying out thorough research on the business. On the other hand, investor B may get lucky by buying the stock based on a tip from a friend and despite not understanding the business at all, but still making strong returns on it.
Markets are full of stories of people who have burnt their hands, just because they bet on getting lucky all the time. These are those individuals whom Mr.Taleb called as being Fooled by Randomness.
Conclusion & the Way Forward
Business and more particularly Investing is a game of infinite probabilities and optionalities. Any probabilistic game has an element of luck attached to it, though the importance may vary. A person who would have invested during the market bottom during the period April 2020 to Aug 2020 would have made tonnes of money.
Importance of luck in success if often missed or ignored by many. Most people believe that success is due to their skill whereas they failed because of other reasons or just plain unlucky. But very few people are humble enough to acknowledge that they are successful because of luck.
As they say Success has many Fathers and Failure is always an Orphan.
Happy Investing …..