Saturday, October 24, 2009

Shape of Things to Come

This is the editor's note that appeared in the September issue of Wealth Insight magazine. The cover story, 'Recession is Dead', argued the case for the recovery that the global economies have effected from the meltdown position they once were threatened with, especially focussing on the position in India.

Our cover story is a cheerful one. I firmly believe that at this point of time, there’s a lot more economic good news than there’s bad news. As our article points out, the recovery has defied the most pessimistic expectations and has been rapid and sustained. For equity investors, the bonanza has been tangible.

It’s not quite one year since the global crisis broke. It is clear now that last year’s collapse of equity prices had two phases. There was a ‘normal’ bear phase that started in January and lasted till August. And then there was the all-is-doomed phase in which people seriously doubted the survival of the world economy and the capitalist system and so on and so forth.

It is important to note what exactly we are recovering from. To a great extent, we’re all over-relieved at the turn of events. I freely admit that articles like our cover story are an over-reaction to the actual degree of up-turn that has happened. However, they’re also justified. We may be seeing just the beginnings of the much-cheered green shoots, but that’s a big relief from our biggest fears of last year. There are plenty of dark spots on the horizon, but none of them look like show-stoppers, and that’s very good news indeed.

The important question that then arises is how accurate is our analysis. It would be customary for a magazine editor to defend his articles and claim that they represent the best possible forecast, but I’m not going to do that. This stuff is not that certain. Some days back, while reading an article in Scientific American on the science behind economic boom-bust cycles, I came across an interesting comparison between science and economics. Economists, the article said, suffered from ‘physics envy’. Economics is not physics. Physicists have three laws that can describe 99 per cent of the world. Economists, in contrast, have 99 laws that can describe three per cent of the world. Predicting, or even recognising, recessions and recoveries is not just an inexact science, but not a science at all. We can see some signs that indicate a certain outcome, but we could easily be missing others that may be indicating quite the opposite.

So, does it look like a recovery is on its way? Yes it does. Is it a sure shot? Certainly not! However, that actually shouldn’t matter to us as investors. The collapse and recovery of last year should make it clear to us that no matter how dark the outlook at any point of time, it’s better to always be on the lookout for buying good stocks at good prices rather than be overly influenced by generalities of the economy and the global situation. To a considerable degree, choosing stocks and making investments is a relative exercise. It doesn’t matter how the whole picture looks at any specific point of time. What matters is that the actual investments you are making are better than other investments. Eventually, those companies will do well and when things turn around, you will reap the benefits.

This recession was feared to be an ‘L’ shaped one or at best a ‘U’ shaped one. In reality, it has turned out to be a ‘V’ shaped one. However, investors who try to move in and out of stocks by double-guessing stock momentum as well as the macro picture are more likely to end up with a series of ‘W’s or perhaps even ‘M’s. Or perhaps we need to look closer home. How about a IÉ or a ³? Do these shapes better describe the way your investments are behaving?

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