Quote from 'Reminiscences of a Stock Market Operator'

The following is such a good quote that I couldn't but share it with all of you:

The training of a stock trader is like a medical education. The physician has to spend long years learning anatomy, physiology, materia medica and collateral subjects by the dozen. He learns the theory and then proceeds to devote his life to the practice. He observes and classifies all sorts of pathological phenomena. He learns to diagnose. If his diagnosis is correct, and that depends upon the accuracy of his observation, he ought to do pretty well in his prognosis, always keeping in mind, of course, that human fallibility and the utterly unforeseen will keep him from scoring 100 per cent of bull's-eyes.

And then, as he gains in experience, he learns not only to do the right thing but to do it instantly, so that many people will think he does it instinctively. It really isn't automatism. It is that he has diagnosed the case according to his observations of such cases during a period of many years; and, naturally, after he has diagnosed it, he can only treat it in the way that experience has taught him is the proper treatment.

You can transmit knowledge, that is, your particular collection of card-indexed facts but not your experience. A man may know what to do and lose money if he doesn't do it quickly enough.

You might want to read the book, but be warned that it was written about 75 years back so you could find it a bit old-fashioned.

The Dollar Crisis

I've been reading a book called 'The Dollar Crisis', which talks about how a rising US trade deficit is unsustainable and is sooner or later likely to be reduced through currency devaluation and general reduction in consumption and import. This will lead to severe repercussions for all export-oriented economies given that they basically survive on exports to the US (the Asian economies are the leaders in this respect, but India will also be affected) as well as other nations, since the world's reserve currency is the US dollar.

A slowdown in US imports will lead to a global slump and perhaps even a recession, creating worldwide stock and property market crashes, among other things. The good news is that prices of goods and services will most likely reduce, but if you're an investor that might not be much to cheer about! Further, if you are one of the many immigrants working in the US, I need not explain how a falling dollar will affect you. The book talks about currency devaluations of the order of 50% or more!!!

Reading all this has got me thinking about the general direction of the Indian economy, as the book provides multiple examples of 'bubble' economies, all of which showed similar trends in the years leading up to the inevitable crashes. We are all most familiar with the dot-com bust and perhaps the Asian crisis, but similar situations have been happening on a fairly regular basis e.g. Japan's bust in the early '90s, from which it is only now recovering...

The 'Crisis' In a Nutshell

Till early in the 20th century, the world followed what was called the 'gold standard', in which their money was backed by gold and, hence, redeemable as such. In such a system no country could afford to have a sustained net trade deficit as that would cause their gold reserves to deplete till it reached a stage when they no longer had enough gold to sustain their economy. Once this stage was reached, their economy would go into a recession and prices and wages would fall till they were low enough for their exports to become cheap so the rest of the world would start importing from them again, allowing their gold reserves to build up once more.

Today's system has no such checks and balances. The international standard is a set of currencies that float in value against each other, with the US dollar as the de facto reserve currency of the world. In such a situation, and with a strong dollar, there is nothing stopping the US from sustaining a large trade deficit (i.e. importing more than it exports). And since it is to the advantage of exporting nations like India, China and the Asian countries to keep their currency values low, they cannot take the US dollars they get from exports and convert them into their own currencies, as that would increase the value of their on currencies and hurt exports.

Therefore, these countries invest them back in the US and state them in the form of national reserves. Thus, the US gets goods and services and pays for them in dollars, which it then gets back in the form of investments. These investments are pumped into the US banking system, which it then lends out, thereby allowing businesses and consumers to buy more things, most of which are imported! This cycle allows the US to continue with a rising trade deficit. Thus, in effect, the US has been buying goods on credit!

This huge US trade deficit has been financing most of the economic growth in the Asian nations and other export-oriented economies, allowing for increased lending and creating jobs and wealth that are leading to economic booms and rising asset values (stocks, property etc). Therefore, a slowdown in US consumption will hurt these economies badly, leading to a very severe recession.

Since the US deficit is underpinned by the willingness of the rest of the world to continue to hold their reserves in dollar instruments, it is only a matter of time before it has to be curtailed as countries begin to get uneasy about the credit-worthiness of the US (after all, it cannot repay infinitely large sums of money) and either withdraw their funds or at least reduce their annual investments. The other possibility is that the US consumer, already neck-deep in debt thanks to all the low-cost credit they have had access to, is no longer able to service increasing debt repayments and chooses to cut back consumption, thereby reducing the extent of US imports.

Both of these scenarios spell doom for the rest of the world, as the net result will be for the US to have to sharply depreciate the dollar against countries with trade surpluses (China, India and the Asian economies) in order to reduce, and eventually reverse, the trade deficit.

The next post will focus on India

Ask Value Research (Only You Can't!)

This is just a quick post to update you about an excellent feature on Value Research Online, which, by the way, is probably the best Indian mutual funds site on the Internet. Check out their 'Ask!' feature wherein you could submit queries about mutual funds and get pretty insightful and well-researched answers from their experts.

Unfortunately they seem to have suspended fresh queries for lack of resources (I'm sure they must have been swamped by questions!), but a look at the answers they did post in the past would be extremely instructive for mutual funds investors. I hope they re-start the service soon but, till then, you could get your own answers by looking at the wealth of data and information available on the site itself.

Introducing...

1. Shai Dardashti on Grahamian Value, a really good blog on value investing and one of the most comprehensive such resources I've seen on the Net. Highly recommended for people who follow Buffet, Graham and other fundamental analysts of their ilk.
2. Value Stock Plus, which belies its name by spending a fair amount of time on global trends and movements of economies around the world, kind of like a CNN for the blogosphere! Check out the interesting comments on the Indian economy in this post and this one

I'd also take this opportunity to thank everyone who commented in response to my last post. Do keep coming back!

'Winning On Wall Street'

I recently stumbled across this book by Martin Zweig, a mutual fund manager who was quite well-known and respected in the '80s and '90s. It is simply amazing, especially for people like me who focus on fundamentals and have little or no idea on technical investing.

The most interesting aspect of 'Winning on Wall Street' is that, based on research into the long history of the Dow, Zweig outlines a set of parameters as well as a complete forecasting model that he used to forecast the onset of bull and bear markets on a consistent basis!

Imagine that - wouldn't you like to be able to tell when an upsurge is an aberration and when it is actually the start of something big and so get into the market early? Or when a small dip might be leading to a major market decline?

The only issue is that the model is based on the Dow and hence the triggers might not work for the Sensex / Nifty, though the parameters (like interest rates etc.) are universal. It needs someone to work out the values at which the Indian markets make their moves, which might not be possible as the Sensex data goes back only 20 years.

Would be worth a try, though. Even better would be marrying such an India-specific 'Zweig' forecasting model with a working stock-picking model based on fundamental analysis in order to get truly spectacular results.

The key takeaways for me are the list of parameters to consider when evaluating market moves and the relationships between them as proposed in the model.

The book is a little academic in nature, but simply written and definitely very high up in the list of investing books to read.

Note: For a list of other good books, please check out my previous post on the subject

An Aside

I recently received a mail from Vibhu urging me to list my favourite books on the site.

Given the nature of this blog, it seemed to me that I should focus on investing related books rather than a general reading list. That's of course not to say that I have this single-minded focus on reading management tomes. I do read serious, high-brow classics like Asterix, Tintin, Dilbert, Red Riding Hood... but then there's probably a different and better forum for holding forth on those!

The following are (in order of preference) on my list of 'highly recommended' books for investors like me:

1. One Up on Wall Street by Peter Lynch - excellent teachings on finding small and mid-cap winners. You can read an excellent synopsis of the book and Lynch's teachings here
2. Buffetology and The New Buffetology by Mary Buffet - Buffet's modus operandi, mainly oriented towards finding large-cap stocks at a good price
3. Rich Dad, Poor Dad - the book that inspired me to think about my finances and set me firmly on the path to a comfortable and early retirement (hope springs eternal...)
4. The Intelligent Investor by Benjamin Graham - quite a tome, but this is by the guru of value investing and eminently worth a read

These four books are enough to help any small investor do well in stocks, provided he / she is willing to devote time and effort towards understanding and applying the lessons in these books to their hard-earned money.