When being greedy pays

Bombay Stock Exchange member Ramesh Damani told CNBC-TV18 that the famous cliche and the one he pays attention to is 'be fearful when others are greedy and be greedy when others are fearful'.

It kind of summarises the psychology that swings between the markets, which takes it back to the 2000 top when everyone is euphoric about technology or goes to the 2003 bottom, when everyone is fearful of the stock market as such.

The year 2000 was a great selling opportunity, 2003 was a great buying opportunity and the public was doing exactly the opposite.

Excerpts from an interview given to CNBC-TV18

Let's start with the note 'fearful when others are greedy'. What are the signs to watch out for, when we are getting close to a bear market?  

Let me put it this way, most of us in the stock market are actually fundamental analysts. We believe that you look at the price-earnings ratio, the compound annual growth rate, the discounted cash-flow model and those are all very worthy tools used in the stock market. But over a period of time, we need a roadmap on how markets behave?

The financial market existed for over 200 years and they behave in a pattern, a sense of rhythm and there was a gentleman - Joseph Granville, who has come out with a lot of theory behind the stock market's behaviour over a period of time.

Now Joseph Granville was a very well respected technical man in the late 1970s, in fact investors and brokers lived in mortal fear of him, because his sell advisory, buy advisory, could move markets almost a percentage, which is very hard to do for a Dow Jones average.

So he wrote what he called  the bear phases or the bull phases of the market and over time they have stood the test of time, they are relevant today as they were relevant when he wrote them, across markets also. So lot of things that I speak today are extracted from Joseph Granville's study of the market.

Joseph Granville made a prediction for the Dow this year, that it will crash. What is your reaction?

You have to take Joseph Granville with a pinch of salt. In the 1970s, as I told you he was very famous, he could move stocks on either side of the Atlantic, he was one of the most powerful voices. But he fell into disrepute by the eighties because of a series of bad calls. Most technical people tend to over exaggerate the importance of technical indicators but that should not detract from Joseph Granville's achievement.

A lot of the work he has done is almost like must-read literature on the stock market, and whether you agree with him or disagree with him, I think he deserves some reading, and today of course he is retired and no longer the force that he was, but still you go back and look at the work, it is astonishing that he had such clarity of thought even 25 years ago.

What do small investors need to watch out for? They are the ones who really burn their fingers most of the time. There are three phases to look out for in a bear market, so what are the symptoms? 

Before I do that, the first thing to remember about the stock market is that there are four seasons in the world. We can go from winter to spring to summer to fall. There are only two seasons in the stock market, one is bullish and one is bearish.

And just as we are very certain in the heart of winter that spring will fall in a few months, so there is no reason to be disappointed. So is it with the financial markets, as long as our capitalistic system is surviving and available, after every bear market there will be a bull market.

So the first thing that any investor needs to identify is the trend, ie. are we in a bullish market or are we in a bearish market? As you know from history and from evidence, that in a bull market, 9 out of 10 stocks go up, so the correct thing in the bull market is to remain invested.

Conversely in a bear market 9 out of 10 stocks will go down, so at that time it is very important that you have to decide which stock to hold, which stock to cash after the bull run. But the point is, not to get disappointed in the bear market. The bear market is a time when you sow the seeds to reap the windfall, a few months from now.

We are very close to the 6900 level. At this point, where is the market?

We are perhaps in the second stage of the bull market. You will figure that as Joseph Granville did, he divided the bear markets into three phases, bear phase one, bear phase two and bear phase three, and similarly, three parts of the bull phase. So to come back to the original question, what constitutes a bear market?

The classic definition of the bear market in a mature market is a 20 per cent slide from the top, that has been constituted as the start of the bear market. Now clearly on May 17, 2004, the market fell by 1700 points on the top, which is more than 20 per cent. So by that classic definition, we were in a bear market. But I think you have to allow a greater degree of latitude in emerging markets. Bear phase I is the start of the bear market.  
  
What are the symptoms of the first phase of a bear market?

During the first phase we are just getting out of a rampant bull market and we are now moving into the bear market, so public confidence is still very high in the stock market.  Typically in the first phase of the bear market, the news will continue to be good. The headline will continue to forecast good GDP growth, good profit growth, but the market will not react to the news.

The market will tend to sell-off even on good news, and if there is good news, it will turn a deaf ear to it. But it will react over bad news. So that's a very key psychological indicator. Only the big headline merger will occur at the top. The past six months or one year have been very rich for the primary market but once we enter a bear phase, the public appetite for new issues almost dries up.

When does the second phase of the bear market begin?

Again the news is very important. In news, the market would disregard bad news but will rally when you talk recovery. However news continues to be negative and market stops going up, the market doesn't react to news. Again it's one of the most important psychological dimensions of the markets - the way it reacts to news.

By now public confidence, in the market is also shaken because they are not seeing appreciation in their portfolio. So now, the public is starting to get a bit disgruntled over the market. Maybe this is not a bull market and maybe everything isn't rosy as is made out to be, so very quietly, almost invisibly the market slips from a bearish phase I to bearish phase II.     
  
Are there reasons why people stop reacting to news. What are the apprehensions in the minds of market players? 

The market is also an amazing discount machine and all marketmen believe that 'you buy the rumour and sell the news'. What happens in the market is that it typically tends to look at 6-12 months ahead, so while Infosys profits in 2000 were still a record, the market was looking one year ahead and seeing a slowdown taking place in America. It was seeing a appreciation of the rupee.

So it was knocking the tech stocks down, those who came into the news only six months or a year later, the market in its infinite wisdom, in its infinite ability to look ahead, was already at a discounting mechanism. So, typically don't focus on the today's headline, which is what the lay investors do, but look at six months ahead or a year ahead. Remember valuation in technology companies were the highest in 2000 and after that, they had four consecutive years of declining earnings. 
 
Now on to the third phase, which is perhaps the most dangerous where you will be sitting at the bottom of a market and you have to really struggle to get out. When does it really get bad and really acute?
 
Again it's almost invisible, there is no clear demarcation. According to a Chinese maxim, there is a single character that identifies the word crisis and opportunity. Phase three is typically a phase where the public panics and I would suggest that's the phase of maximum opportunity. In the last phase of a bear market, you know that the bull market is not far away. It still teaches us, whether it's the Dow Jones in the 1980s or whether it's our own Indian stock market or any market in the world, no bear market is permanent. But a bear market can wipe out 98% of stock gains.

What are the 2-3 points that will really stare in our face and tell you that this is the third phase and it's time that you get in now?      

It counterintuitive. It's against human instinct because the headlines in the paper will be very bearish. Tisco's profits are slashed, Indian tech exports are at an all-time low. The news consistently becomes bearish and the public is dumping bluechips. But at the same time, the smart money in the market, which we call 'informed money in the market', is buying because they are looking ahead of the market.

The primary markets would be bone dry, you will see a fall because now the public is dumping bluechips. So while there is no art-form to decide between the second and third phase, generally the more the desperation in the market, the more people there will be who say I am never going to come back in the stock market. Generally, it's a good time to start thinking about stocks again when the public gets fearful, you want to be greedy in terms of buying stock. 

So how does one know they are in the second phase of a bull market?

In the first phase, the market was shrugging off bad news as opposed to responding to good news. The second phase is almost like summer in the stock market. It's a season of good returns, season of happiness, everyone seems to have a good time in the stock market. The key thing to look up is the advanced decline line, which is carried by all national newspapers.

This is the number of stocks that moved up to the number of stocks that have declined. This tends to move up very rapidly during this phase. All news is bullish. The primary market is extremely strong and robust and a strong pipeline of issues is in place.

Is the third the final phase because that is the time to exit the markets?

Yes. All news tends to be very bullish and public confidence is the highest and as I say somewhat tongue-in-cheek, that the mother-in-law starts giving you tips. The principal behind it is that people who have no business being in the stock market, like the paanwala, the mother-in-law, start becoming experts on the market!

In your experience, what has been the most interesting bull and bear phases in the world's market?

A: All asset classes at all times are in a bull market or bear market. So we've had bull markets in gold, in silver, in US stocks, in Japanese stock. In 1964, Japan experienced  a bull market, after they hosted the Tokyo Olympics, which lasted for 25 years up to 1989. This took the Japanese index from a base of 1,000 to 14,000.

The principle here is, that the longer the bull market, the worst the bear market that follows. In 1989, one Japanese company Nippon Telephone & Telegraph was worth the entire the German stock market. So the fall we had is there still, the Nikkei is still at 10,000

The Nasdaq having hit 5,000, was I think a once in a lifetime bubble, we are probably not going to get back to 5,000 in the next five years. So the stronger the bull market, the longer the period you have to pay in the bear market. Our own market in 1992 topped at 4500, it did not decisively cross that level until the year 2002-03, so it took a period of 12 years for the market to cross the 1992 peak of 4500 on the Sensex.

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