Confluence of Investor’s psychology and Market’s psychology – Part 1
We at Stallion never bet on Stocks, We are investing in a Process or Framework. Framework or Process are repeatable Patterns seen in the market. In this blog we discuss a Repeatable Pattern which we see Cycle after Cycle.
We all agree that markets have cycles and every cycle the stocks leading and lagging change but the patterns remain similar.
Our Goal at Stallion is to learn & build Frameworks around these repeatable Patterns & Hopefully profit from them. The Markets cycles typically Starts with an Anchor Stock (Leader) which is Great Quality & High Growth, Shifts to High Earnings Growth with No Longevity beyond 2 Years & Finally Poor Cousin 1 & Poor Cousin 2 Join the Market.
Of course the Party Typically ends with Defensive Stocks Breaking out of their Long Bases.
This blog discusses about having the right framework dealing in different market cycles by using a confluence of psychology of Market and its participants.
This part can be further divided in two parts –
1. Bull Market Cycles
2. Bear Market Cycles
Bull Market Cycles –
1. The Bear to Bull – No one believes it
2. Broadened Bull Market – Everyone makes money here
3. This time it’s a different rally
a) The Bear to Bull –
• How to identify – Look for large macro events, which everyone is scared of, and the market bounces with the worst news. Like the Global markets bottomed on the 17th June, the day Fed announced the first 75 bps rate hike. The subsequent 100 bps rate hike was most likely a non–event for the Market and there was little to no impact on the day of the event. Let’s take the case of IT Stocks in the Indian context, where the margins dipped due to steep salary hikes but growth wasn’t a problem.
The stocks went down almost 40–50% from the recent highs and are now up anywhere between 20–30% from lows. Basically, look out for bounces on extreme bad news, where the pricing in by Markets had started at least from last 2–3 quarters.
• Fundamental Setup – The stocks which have shown the best numbers in the quarters where markets were having a turbulent time, will continue to extend their outperformance.
Not all will be bull market leaders from here-on, but holding onto good numbers when markets are troubles helps you to outperform the markets, since these stocks would be either up by 20-50% or they would be consolidating with returns of – 10% to +10%, which in either case would be better than the markets.
There would be second set of stocks which are structural leaders which typically gain market share in all bad macro environment, buying them in the Capitulation makes sense, because 12-24 months of returns can be achieved in just 3-4 months.
• Technical Setup – There won’t be dips. Stocks will keep flying. It’s a chasers Markets. Chasing makes sense here. Stocks will look extended from the bottom, because the best ones will be up by >50% from their lows.
One will understand the chasers kind of markets, once the stock starts flying on numbers or on a company- specific event.
b) Broadened Bull Market –
• How to Identify – Typically the Bear to Bull Market setup stocks will start looking extended. Since, the smart fund managers now know which the least fallen stocks of the Bear market are. They may continue to lead in the bull market, but for a temporary 3-6 months, they would consolidate and let their
earnings growth catch-up with the valuations.
The 52-week high list expands from unknown names to somewhat known names. The confidence in the bull market increases for participants. The money making in this cycle is a bit easier. Typically the list of stocks in 52-week high or all-time high list expands to <30 stocks to >100 stocks in this phase. A lot to choose from the new leaders in the market.
• Technical Setup – Every breakout will work here. More ideas than money. Every day a new breakout day. Churning helps and it doesn’t helps, it works both ways in this phase. Don’t cut on underperformance of the stock, just cut it on a stop loss. Underperformance can actually turn to a big big outperformance in the next 2-3 months.
IPO highs as a strategy will work awesomely. The new money flowing into markets in this stage will chase IPO highs. And, also the seasoned players who failed to participate in the first Bear-to-Bull stage will look to deploy large cash% of their portfolios to newer stocks which doesn’t have any baggage typically, and if it belongs to Bull market Leader group with high growth rates, the moves can be swift and very much rewarding.
c) This time it’s a different Rally !
• How to Identify – People get extremely bullish on India. Instead of taking micro–calls on stocks, the focus of participants moves to taking Macro–calls on the stocks. If this will happen in this part of the World, those kind of stock will do well. The focus shifts to large govt policies driving growth in a particular sector or a set of companies. Here, the valuations for a stock is built on hopes (of “Yeh hoga toh woh hoga”) instead of delivery on earnings.
The management of the company is excited to unveil new plans which supports the govt vision. Play these stocks as a trade only, with a certain moving average as a stop loss, cut on the first danger, these stocks won’t be worth it because during a bear market they would down 40-50% from current levels.
• Fundamental Setup – Market participants are trying to find value in an expensive and an extended market. Peer valuations somewhat become the trend in town. Beware of Companies changing names which suits the current market narrative. Poor Cousins trades become extremely hot in this kind of Market environment. Buy a Cheaper already listed company against buying a New IPO coming at astronomical valuations. The cheaper counterpart can go up 2-3x just on this arbitrage.
Here, the existing ideas in the portfolio have run their course or the upside seems limited. Market participants’ starts finding weird value creation formulas which are obnoxiously just good on paper, but in reality not so great business models. Optically cheaper companies are just trades but with a lot of volatility and uncertainty. Better to be out of them, most likely would be break-even trades in totality, losing in some and making in some.
• Technical Setup – Breakouts are still working here, but the Leaders which used to breakout easily will show some hesitance. Even unclean technical charts work in this kind of phase. IPO High strategy is valid here as well. Since participants are looking for something new, they are adventurous with New IPOs. The risk-taking ability of participants is very high in this phase.
Typically, the high churn strategy will work here, since these are not the best stocks, there is no point holding onto them after a decent profit. But, have to be cautious again. Addition of High beta names in the Portfolio, will increase the Standard deviation of the total portfolio. Typically asset heavy sector and industry groups rally in this stage of the market, something like Power, Steel, mining, etc. Capital goods to some extent.
The visibility would be very good for all kind of orderbooks and execution. But, by the time market moves to Bull-to Bear scenario table again will change. These 3 points under the Bull Market Cycles sums up our insights in a Good Market.
We shall discuss the 3 points of Bear Market Cycles, as explained below, in our next blog, so stay tuned!
Bear Market Cycles –
• The Bull-to-Bear – No one believes it
• Stocks falling, but reasons to follow – 1 hit, 9 misses out of 10!
• The Capitulation – Only be ready to see MTM Fall, stocks will bounce only if you are holding the right ones !
Dislosure : https://www.stallionasset.com/disclaimer