Ten famous market sayings & their relevance for India
As in other spheres of life, there is no shortage of folk tales in investing. The history of the Indian stock market may be shorter compared to the developed markets globally, but that has not stopped investment gurus from trying to force-fit some of these sayings in the Indian context.
While some of these rules like 'Sell in May and go away' are based on the seasonality of stock markets, others may be more about following a particular investment strategy. Here's why it is wiser to base your investment decisions on data instead of being guided by these misplaced notions.
1) Sell in May and Go Away
What does this mean?
This favourite saying dates back to the period when London stock brokers went on long holidays during the summer months. The full saying is, " Sell in May and go away, stay away till St Leger day", referring to the last race in the British horse racing season which is around mid-September. With most brokers out of the trading ring, the trading volume was low and returns were muted.
Therefore, it was thought wise to sell off your stock holdings before you proceeded for a holiday and start with a clean slate on your return in October.
Does it hold for Indian markets?
If you look at the average daily returns of every month in the past 21 years, May generated muted returns during 1992-2002 as well as 2003-2013. However, the returns in May were negative only in 12 of the past 21 years. This midway figure doesn't suggest that this saying holds true for the Indian markets. Even in those 12 years, only in two years the negative returns in May correlates with a negative return in June.
So, the sell in May theory is quite insignificant in the Indian context. However, the market is rallying right now and we won't be surprised if this year's peak happens in May.
2) Mark Twain Effect
What does this mean?
October has historically been a notorious month for stock investments. Global stock markets have generated lower than average returns during this month and some of the major stock market crashes (like 1929, 1987 and 2008) occurred in October.
The October downturn has been termed the Mark Twain effect after the novelist's famous quote, "October. This is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August, and February".
Markets are also rife with rumours about how many of these industry demands will be met (or at least find mention in the budget speech). Based on this speculation, markets tend to move higher during the weeks preceding the Budget announcement. Once the budget is out of the way, the reality dawns and stock prices go back to their pre-budget levels.
Does it hold for Indian markets?
Yes, because Indian investors value their weekends just as much as their American counterparts. Most traders square off their positions on Thursdays and Fridays, and very few high-risk traders carry their positions to Mondays. Data of the past 20 years ratifies this hypothesis. For example, the average daily returns generated on Fridays was only 0.3% compared to the average 0.67% returns generated during the other four days.
7) Buy when there is blood on the street
What does this mean?
It is often said that you should buy when they sigh, and sell when they yell. In other words, you should do just the opposite of what everyone else is doing. Baron Rothschild, an 18th century British banker, famously said that " buy when there is blood on the street, even if the blood is your own". This assumes that valuations plummet when the stock markets hit a rough patch.
Investors who enter at this time have a greater possibility to earn higher returns. On the other hand, when the markets are humming with delight and everything is looking rosy, it may be the time to exit.
9) The cockroach theory
What does this mean?
The cockroach theory says that one bit of bad news is usually followed by more. If you see a cockroach in your house, it is evident that the bug is not alone. There must be more of them hiding somewhere. Similarly, when a company comes out with bad news after a long gap, expect more shocks to follow. In some cases, you may have noticed the bad news for the first time, but there may be other negatives that escaped your attention. The cockroach theory can be extended to an industry as well.
While some of these rules like 'Sell in May and go away' are based on the seasonality of stock markets, others may be more about following a particular investment strategy. Here's why it is wiser to base your investment decisions on data instead of being guided by these misplaced notions.
1) Sell in May and Go Away
What does this mean?
This favourite saying dates back to the period when London stock brokers went on long holidays during the summer months. The full saying is, " Sell in May and go away, stay away till St Leger day", referring to the last race in the British horse racing season which is around mid-September. With most brokers out of the trading ring, the trading volume was low and returns were muted.
Therefore, it was thought wise to sell off your stock holdings before you proceeded for a holiday and start with a clean slate on your return in October.
Does it hold for Indian markets?
If you look at the average daily returns of every month in the past 21 years, May generated muted returns during 1992-2002 as well as 2003-2013. However, the returns in May were negative only in 12 of the past 21 years. This midway figure doesn't suggest that this saying holds true for the Indian markets. Even in those 12 years, only in two years the negative returns in May correlates with a negative return in June.
So, the sell in May theory is quite insignificant in the Indian context. However, the market is rallying right now and we won't be surprised if this year's peak happens in May.
2) Mark Twain Effect
What does this mean?
October has historically been a notorious month for stock investments. Global stock markets have generated lower than average returns during this month and some of the major stock market crashes (like 1929, 1987 and 2008) occurred in October.
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The October downturn has been termed the Mark Twain effect after the novelist's famous quote, "October. This is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August, and February".
Does it hold for Indian markets?
The average monthly returns of the past 20 years suggest that the Mark Twain effectholds good for the Indian markets as well. The average monthly returns during October have been negative during both 10-year periods. The average October months returns came out to -0.124% compared to the grand average of 0.058%. However, its impact has reduced in recent times. For example, the average 0.033% fall in October has been less than the average 0.94% dip during January since 2003.
3) January Effect
What does this mean?
This phenomenon comes from a study of the US stock market which shows a general uptrend in stock prices during the month of January. Incidentally, the US financial year is from January to December. There is selling pressure in December because investors want to book profits or losses for setting off against other capital gains at the end of the financial year. But the sellers turn into buyers when the new financial year kicks off.
Does it hold for Indian markets?
The Indian financial year is from April to March, so there is no rush to sell in December. However another version of the 'year-end effect' is witnessed here. After negative returns in October due to the Mark Twain effect, the market makes a significant recovery during November and December. This turnaround is clearly visible in the average daily returns of the months since 1992.
In the past 21 years, November generated the highest monthly returns six times. The 'year-end effect' has become more pronounced in recent years. It could be that after a strong rally in November-December, investors have booked profits, leading to negative returns in January.
4) Pre-Budget Rally
What does this mean?
Stock markets tend to surge during the run up to Union budget and slide after it is announced. This happens because the budget in India is more than a financial statement of the government. It makes a lot of policy announcements, which explains why stock markets get excited about the exercise. Most industry associations lobby hard with the government for additional benefits and tax sops and come out with their wish lists of Budget expectations.
The average monthly returns of the past 20 years suggest that the Mark Twain effectholds good for the Indian markets as well. The average monthly returns during October have been negative during both 10-year periods. The average October months returns came out to -0.124% compared to the grand average of 0.058%. However, its impact has reduced in recent times. For example, the average 0.033% fall in October has been less than the average 0.94% dip during January since 2003.
3) January Effect
What does this mean?
This phenomenon comes from a study of the US stock market which shows a general uptrend in stock prices during the month of January. Incidentally, the US financial year is from January to December. There is selling pressure in December because investors want to book profits or losses for setting off against other capital gains at the end of the financial year. But the sellers turn into buyers when the new financial year kicks off.
Does it hold for Indian markets?
The Indian financial year is from April to March, so there is no rush to sell in December. However another version of the 'year-end effect' is witnessed here. After negative returns in October due to the Mark Twain effect, the market makes a significant recovery during November and December. This turnaround is clearly visible in the average daily returns of the months since 1992.
In the past 21 years, November generated the highest monthly returns six times. The 'year-end effect' has become more pronounced in recent years. It could be that after a strong rally in November-December, investors have booked profits, leading to negative returns in January.
4) Pre-Budget Rally
What does this mean?
Stock markets tend to surge during the run up to Union budget and slide after it is announced. This happens because the budget in India is more than a financial statement of the government. It makes a lot of policy announcements, which explains why stock markets get excited about the exercise. Most industry associations lobby hard with the government for additional benefits and tax sops and come out with their wish lists of Budget expectations.
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Markets are also rife with rumours about how many of these industry demands will be met (or at least find mention in the budget speech). Based on this speculation, markets tend to move higher during the weeks preceding the Budget announcement. Once the budget is out of the way, the reality dawns and stock prices go back to their pre-budget levels.
Does it hold for Indian markets?
This phenomenon is specific to India and is very evident in the way the markets react to the budget. We looked at the returns from the markets before and after the exact budget dates during the past 20 years. The pre-budget rally and post-budget crash are clearly visible. You may wonder why the pre-budget rally did not hold good for the 1-week period. This is because some market players book profits well in advance before the budget is announced.
5) Friday Effect
What does this mean?
Also known as the weekend effect, this suggests that returns on Mondays will be more volatile than on other days. This is because Monday trading has to discount more information that comes out during Saturday and Sunday.
This information may be company-specific events (declaration of results on weekends to reduce its impact on stock price) or macro events (political developments or a spike in crude price due to geo political tensions). Since they don't want to ruin their weekends, most traders square off their positions on Friday itself and, therefore, the returns on Fridays are generally muted.
This phenomenon is specific to India and is very evident in the way the markets react to the budget. We looked at the returns from the markets before and after the exact budget dates during the past 20 years. The pre-budget rally and post-budget crash are clearly visible. You may wonder why the pre-budget rally did not hold good for the 1-week period. This is because some market players book profits well in advance before the budget is announced.
5) Friday Effect
What does this mean?
Also known as the weekend effect, this suggests that returns on Mondays will be more volatile than on other days. This is because Monday trading has to discount more information that comes out during Saturday and Sunday.
This information may be company-specific events (declaration of results on weekends to reduce its impact on stock price) or macro events (political developments or a spike in crude price due to geo political tensions). Since they don't want to ruin their weekends, most traders square off their positions on Friday itself and, therefore, the returns on Fridays are generally muted.
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Does it hold for Indian markets?
Yes, because Indian investors value their weekends just as much as their American counterparts. Most traders square off their positions on Thursdays and Fridays, and very few high-risk traders carry their positions to Mondays. Data of the past 20 years ratifies this hypothesis. For example, the average daily returns generated on Fridays was only 0.3% compared to the average 0.67% returns generated during the other four days.
6) Elephants can't gallop
What does this mean?
If you want multi-baggers in your portfolio, you need to start searching among mid- and small-cap stocks. A company will grow very fast in the initial years because of its low base. However, the growth rate slows down once it achieves a certain size in terms of revenues. The proponents of this theory often point out that all blue-chip stocks were small caps at some point of time.
Besides, mid- and small-cap stocks are considered risky and usually trade at a discount to the large-cap stocks. This theory is applicable for mutual funds as well and the performance of a scheme suffers when it becomes too big.
Does it hold for Indian markets?
In India too, small-cap stocks have outperformed the large-cap stocks in the long term and the trend should continue in future as well. However, this holds true mostly during a bullish period as is visible from the 10-year chart. On the other hand, large caps tend to outperform mid caps during bearish phases and flat markets as visible during the past 5-year period.
What does this mean?
If you want multi-baggers in your portfolio, you need to start searching among mid- and small-cap stocks. A company will grow very fast in the initial years because of its low base. However, the growth rate slows down once it achieves a certain size in terms of revenues. The proponents of this theory often point out that all blue-chip stocks were small caps at some point of time.
Besides, mid- and small-cap stocks are considered risky and usually trade at a discount to the large-cap stocks. This theory is applicable for mutual funds as well and the performance of a scheme suffers when it becomes too big.
Does it hold for Indian markets?
In India too, small-cap stocks have outperformed the large-cap stocks in the long term and the trend should continue in future as well. However, this holds true mostly during a bullish period as is visible from the 10-year chart. On the other hand, large caps tend to outperform mid caps during bearish phases and flat markets as visible during the past 5-year period.
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7) Buy when there is blood on the street
What does this mean?
It is often said that you should buy when they sigh, and sell when they yell. In other words, you should do just the opposite of what everyone else is doing. Baron Rothschild, an 18th century British banker, famously said that " buy when there is blood on the street, even if the blood is your own". This assumes that valuations plummet when the stock markets hit a rough patch.
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Investors who enter at this time have a greater possibility to earn higher returns. On the other hand, when the markets are humming with delight and everything is looking rosy, it may be the time to exit.
Does it hold for Indian markets?
This is a cardinal rule of value investing and works perfectly in India as well. As visible from the Sensex PE chart, the best time to invest was when there was utter panic in the market - after the crashes in 1994, 2000 and 2008 when the Sensex trailing PE fell to 12.
8) You need stomach and not brains to make money
What does this mean?
If you want to make money from stocks in the long term, you should be ready to withstand the ups and downs in the short term. Only investors who have a strong stomach will be able to do this while others will panic and sell their holding whenever there is a downtrend in the market. Your ability to withstand the volatility and hold on to the stock for the long term is more important than your stock-picking skills.
Does it hold for Indian markets?
The virtues of long-term investing hold true for India as well. As visible from the Sensex rolling return table, the probability of gain and loss is very high for shorter holding periods. The risk comes down when the holding period becomes longer.
This is a cardinal rule of value investing and works perfectly in India as well. As visible from the Sensex PE chart, the best time to invest was when there was utter panic in the market - after the crashes in 1994, 2000 and 2008 when the Sensex trailing PE fell to 12.
8) You need stomach and not brains to make money
What does this mean?
If you want to make money from stocks in the long term, you should be ready to withstand the ups and downs in the short term. Only investors who have a strong stomach will be able to do this while others will panic and sell their holding whenever there is a downtrend in the market. Your ability to withstand the volatility and hold on to the stock for the long term is more important than your stock-picking skills.
Does it hold for Indian markets?
The virtues of long-term investing hold true for India as well. As visible from the Sensex rolling return table, the probability of gain and loss is very high for shorter holding periods. The risk comes down when the holding period becomes longer.
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9) The cockroach theory
What does this mean?
The cockroach theory says that one bit of bad news is usually followed by more. If you see a cockroach in your house, it is evident that the bug is not alone. There must be more of them hiding somewhere. Similarly, when a company comes out with bad news after a long gap, expect more shocks to follow. In some cases, you may have noticed the bad news for the first time, but there may be other negatives that escaped your attention. The cockroach theory can be extended to an industry as well.
Does it hold for Indian markets?
This is a universal rule and applies to the Indian market as well. Since the transparency level in corporate India is terribly low, the probability of cockroaches hiding in the woodwork is very high. Investors must keep their eyes and ears open for bad news and be ready to act as soon they get it.
10) Return of capital is more important than return on capital
What does this mean?
In the mad rush for returns, an investor should not lose sight of the basic rules of risk management. This is just a reminder that more than returns, one should focus on the safety of the investment. There is a non-linear relationship between gains and losses. For example, you need 100% gains to recover a 50% loss.
Does it hold for Indian markets?
This is another cardinal rule of investing and is, therefore, valid for India as well.
(with Sameer Bhardwaj)
This is a universal rule and applies to the Indian market as well. Since the transparency level in corporate India is terribly low, the probability of cockroaches hiding in the woodwork is very high. Investors must keep their eyes and ears open for bad news and be ready to act as soon they get it.
10) Return of capital is more important than return on capital
What does this mean?
In the mad rush for returns, an investor should not lose sight of the basic rules of risk management. This is just a reminder that more than returns, one should focus on the safety of the investment. There is a non-linear relationship between gains and losses. For example, you need 100% gains to recover a 50% loss.
Does it hold for Indian markets?
This is another cardinal rule of investing and is, therefore, valid for India as well.
(with Sameer Bhardwaj)
Source : By Narendra Nathan, ET Bureau
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