Saturday, November 17, 2012

Chapter 5: When the going gets tough, do nothing

Edward Kennedy 'Duke' Ellington was a well-known jazz pianist who later became a famous composer and bandleader. Considered by many to be one of the foremost influences in jazz music, his complex compositions and arrangements brought jazz to the mainstream of American music.

Several of his compositions have become jazz 'standards' - recorded and performed by a whole host of singers and musicians through the years. Some, like 'Caravan', became so popular that even pop instrumentalists performed and recorded the song.

One of Duke's compositions - 'Do nothing till you hear from me' - has relevance to the current state of the Indian stock market, if you replace 'me' with 'Mr Market'!

With the market hitting new highs every day, many small investors are utterly perplexed about what to do. Some feel this is a great time to buy. Others had seen their portfolios erode away in the bear market and are waiting for the next big correction to enter again. The more adventurous ones are writing puts and calls and probably making their brokers rich! Risk-averse investors are looking at bank fixed deposits and company deposits. But the really smart ones are riding out the market turmoil by doing nothing.

An avid mountain climber once commented about his frequent attempts at climbing the Everest: “I try to climb the Everest because it is there!” Well, the stock market is very much there - and will be there for quite some time longer! Does that mean that you should always be buying and selling?

Remember, 'do nothing' does not mean 'remain completely inactive'. This is a great time to do fundamental analysis of companies. Find out which ones are offering greater value in terms of dividend yields, price to book value ratios, operating cash flows, profit margins.

Make a short list of such companies and track them on a daily basis. Then wait to hear from ‘Mr Market’. He will start giving you diverse and interesting clues - such as, changes in interest rates, a decrease in the advance-to-decline ratio, an aversion to discussion about the stock market among your market-savvy friends.

The cumulative effect of such clues will indicate that the correction may be around the corner. Till you hear from me (I mean, ‘Mr Market’), take your spouse out for a candlelit dinner, take that dream holiday to Mauritius or Machu Picchu but do nothing about buying or selling in the stock market. If you absolutely must buy or sell, at least wait for the quarterly results before doing so.

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