The lockdown’s extended, and here’s another thought we’re running through as we progress, in our CovidLockdown Diary.
The markets are going up. But India’s barely showing the tip of the numbers in the lockdown, even as the west shows initial signs of having peaked with numbers falling. And it is now that we understand: The liquidity crisis that had driven the markets down seems to be easing dramatically. (Read: Follow the Money – How a Global Liquidity Crisis Beat Us Before The Coronavirus)
But look at the stocks in the market. Yes, indeed, there will be a massive slowdown in the economy, but it won’t be permanent. A year or two from now, we will be back and the stocks that have fallen will recover, but some more than others.
If you’ve never invested, you’re probably thanking your stars. And some of you will consider investing because hey, it’s fallen all this much.
But there’s a lot of you that already own stocks. Stocks that have fallen, and hard. And the crisis has taken them down.
They are good stocks. Stocks you’ve nurtured over months and perhaps even analysed in some detail and you think to your self – this airline is a good airline. It will survive.
And that translates to “I should hold this stock“.
This is usually a good answer.
Not always. And perhaps not in a crisis.
What’s different in a crisis?
Any crisis will involve people selling stocks and most times that selling is across the board. Massive selling, from the likes of FIIs, will create abnormally low prices across all stocks. A crisis will create opportunities in some areas, and completely violate your thesis in others.
For instance if you liked Airlines, and had a few airline stocks, this virus has changed the stakes there completely. It will take them a long time to head back to normalcy, but in the meantime, there may be others, like Pharma, where things are looking much better.
As you look now, you might find a few things:
- A few stocks you had liked but were too expensive are now better priced
- Your portfolio is skewed towards one sector and you need to readjust
- Stocks you own have fallen too, substantially.
The problem is: do you sell the stocks you own and buy the others?
Firstly, Why Switch?
Consider that even a no-debt stock may be down 30% now, and at a very attractive level. You didn’t like it then, but now it looks better. It might just be that:
- Largecaps have fallen, and they are more attractive. Liquidity chases the larger caps, especially the well run companies. A switch from one of your smaller cap companies to a less expensive large cap is likely going to help the portfolio recover faster.
- You don’t have additional cash. A move from debt to equity is useful, but some may not want additional exposure. In this case, you have to rotate one of your positions with a new entrant and rejig the portfolio rather than allocate new money.
- A new sector might just become prominent. It’s pharma during the Covid lockdown. It could be alcohol next. The sector would have not been important earlier, and suddenly it’s big and healthy.
- The whole portfolio may need a rejig. Most portfolios built in good times have a few stocks that don’t have the strength to bear a crisis. It may be time to go more defensive, build more sector parity, reduce number of stocks in one sector etc.
The system just makes you feel that if you started from scratch, you wouldn’t have selected this stock. That gives you an idea – why not replace it?
The recovery cycle of the new stocks may be much shorter than your current ones, and make you feel better in terms of coverage and safety as well.
The Behavioural Problem: It’s in your head
No one likes to take a loss. Selling a stock 40% below where you bought it is very very difficult. It’s justifiable when the company isn’t doing something horribly wrong. But to get out just because you found something better seems…disloyal and unnecessary.
We feel we should give our stocks a lot of time. They have potential, you think. That’s why you bought them.
Also, if only you waited a few months, the stocks will recover. It’s all right, I can wait and then get out at “even”, you think in your mind.
These are behavioral issues. Stocks don’t love you back, so there’s no real question of loyalty. And if better opportunities beckon, you take them.
As for the getting out at even thing: if you sell and book a 40% loss, and take on a different stock which goes up 66% you are actually back to even; however, you will feel even better because the gain looks larger. (Think of it: Rs. 100 down to Rs. 60 is 40% down, and Rs. 60 back to Rs. 100 is 66% up)
The behavioural challenge is the biggest one because you hate to feel two things: Loss, and regret. If the stock goes up after you sell, you’ll feel even worse.
All at one go? Some now, some later?
If it’s painful, I wouldn’t take multiple cuts. Once is enough. Cut the position, move on to the next one and remove the earlier one from your watchlist.
If you’re not entirely convinced of a replacement stock, then one way to do this would be to sell half and buy only half a position of the new stock. Then you can “test” your theory that the replacement is a better one. This part is more cumbersome because you have to re-evaluate over time.
Don’t Afraid To Be Wrong
No one has ever seen what a coronavirus lockdown will do to an economy. We think it’s going to be really horrible. We don’t know how our behaviour will change. We don’t know the social, political and economic impact. We would be lying to ourselves that we know anything much about the aftermath.
In that situation, all you’re going to do is to take positions based on some hypothesis. You might think a lot about this hypothesis. But don’t get married to it.
Things will change, and your “replacement” stock may no longer look viable. Financials could be in deeper trouble than we think, or in less. Who’s to know now?
Here’s a scenario: Let’s just say one idea was to sell that NBFC because oh my goodness it is microfinance and the lowest income people are in serious trouble. Then, miraculously, (assume) it turns out that these are the very people that need credit after the lockdown ends, and they will use that money to get going again and repay them. And the RBI offers them intermediate support so they are able to lend. So you see that very sector recover much faster, will you stay out of the sector forever?
You have to swivel, strafe, pivot, and whatever other adjective they use nowadays to mean “I changed my mind”. Just change according to the times. There’s no meaning in looking only at past balance sheets, and there’s no meaning in being married to hypothesis of the future.
Regret is our enemy because we can’t get over the feeling that we should have been smart enough to do the right thing.
The fear of future regret – What if I sell now and it goes up? – is one of the reasons we hate to sell.
The other is the fear of taking losses – where people have told you that if you sell, you convert a notional loss to a real one. Notional losses are as real as your fretting about your portfolio losing money – if you haven’t sold, then why hurt when it’s down 20%? Sometimes you have to just take the loss and move on.
Every crisis will be overcome, eventually. Fear and panic cause people to freeze – and in many cases, it’s perfectly fine to not act at all. But in a crisis, you might find the time to work a better thought process. If there are better positions to take, and you know there are opportunities you like and threats you don’t, a portfolio rejig is the right thing to do.
