'Certain' environment is a myth

Quick question: When was the last time you woke up  in the morning and felt completely certain about the way your day would pan out? Sure, you may have aimed at accomplishing a series of tasks and also meticulously planned your path. Despite this, you tacitly knew and acknowledged that there was always the possibility that things may not turn out as planned. This, however, did not paralyse you and make you sit at home.

The point I am making is we live in an uncertain world. While some factors are within our control, there are others which are not. That is why I am puzzled to hear some market mavens advise stock market investors to desist from investing now and step in when things are certain.

Investors appear to be taking this advice rather seriously. We read reports in various media as to how retail investors globally have jettisoned stocks and fled to safer havens such as gold. This phenomenon is not restricted to India alone. The abiding global sentiment prevailing today is that stocks are ‘risky’ and should therefore be avoided. The grief-inducing headlines in various newspapers are further cementing this belief. Everyone says they will invest when times are ‘more certain’.

But is ‘risk’ always positively correlated with ‘uncertainty’? The question may seem rhetorical, but it is not.

While the term ‘risk’ may mean different things to different investors, to an equity investor it usually refers to the possibility of capital loss. But this loss could occur at any time, not only when the times are uncertain. Besides, the definition of ‘uncertainty’ itself is not cast in stone. Also, the occurrence of an event will not have the same impact on all. For instance, if Greece leaves the euro zone later this year, it may adversely impact most Greek companies, but will have no impact on most Indian companies. Similarly, a petrol price hike in India may cause an uproar over here, but will not incense a driver in the USA.

Coming back to my earlier contention, it is worth pondering over the question as to when was the last time everything was ‘certain’. Uncertainty has always been a part of the economic and political landscape for the past few centuries, both here and abroad. Investors who wait for the last cloud to clear will be waiting forever.

I strongly believe that beyond a certain point, risk actually reduces as prices fall, even if the degree of uncertainty remains at an elevated level. I may be wrong, but I believe that we appear to be in that phase at present. Prices of many good stocks have fallen precipitously, but the level of uncertainty remains stubbornly high.

A slew of reforms have been announced over the past few weeks. Consequently, the broad indices have risen by around 8% from the recent lows. In this case, the risk of policy paralysis appears to have been tided over, but the uncertainty regarding implementation remains. This is a good example of how stock prices do not wait for crystal-clear clarity to emerge. Today, valuations are attractive although they may not be compelling. However, waiting for that ‘most’ compelling valuation is a mug’s game. It is great if you get it, but it is possible that the bus will leave before you get on to it.

Will prices fall some more from here on? Sure, they may… but a temporary loss is not the same as a permanent loss. Investors should fear the latter much more.

Permanent capital loss is more likely to occur when you buy stocks during exuberant times when everything looks rosy (Imagine purchasing DLF/Suzlon in December 2007 when the whole world was convinced about the India real estate and infrastructure story) rather than buying during seemingly gloomy times. As Warren Buffett is believed to have said “You pay a very high price for a cheery consensus”. Think about it.