Beating the market – India Outlook H2, 2009

The first rule of investment psychology is that mastering the market is easier than mastering yourself. Behaviorologists put it differently. They say that if a majority cannot do it, then beating the market is an illusion. The subject has merit, but the gurus are still busy highlighting how flawed conventional technical and fundamental research is rather than making predictions themselves. They also say that market behaviour is like the toss of a coin, markets cant add and subtract, more risk does not mean more return, beta is dead and as are other generalisations.
Behaviorologists dont have a strategy for 2009 or till 2012. The subject still focuses on the mistakes of majority, rather than the approach of smart investors like John Paulson, who pocketed a billion dollars betting on the crisis. And he was not just alone. Jim Simons of Renaissance Technologies delivered 58 per cent returns for 2008. A specialist in risk arbitrage, Paulson topped the charts by minimising market correlations and long short risk arbitrage strategies.
And some of these funds have survived despite a 40 per cent fee. They delivered more than 70 per cent annual returns in 2007. A recent Bloomberg story on richest hedge funds only confirms the point further that for a majority crying over a crisis, there will always be smart investors thriving. Medallion is almost exclusively owned by Renaissance employees, who include mathematicians, astrophysicists, statisticians and computer programmers. Just like others, they too search for patterns.
We started the year with the call of decade high on Sensex in 2008. We saw the drop till January 21 as a correction when we wrote Understanding corrections. We projected 18,000 as a key inflexion point. Prices pushed up from 15,332 till 18,895. Later, on March 31, we wrote about the Three legged bear, when we said, Though marginal, we have seen an intermediate low in March. The prices continued to hold up till 16 May, as prices continued to hover near 18,000 levels (17,735).
Then we had the August 4, The late economic cycle write-up, where we talked about abstaining from early and mid economic sector components. It was then that we clearly shifted our stand from investment to trading and talked about few weeks of upside and how a bounce back till Q1 2009 was a low probability scenario. We said 18,000 was a best case. Prices bounced till 15,579 and turned back on September 11, 2008. We also wrote about The OCT decline where we said October lows have extreme sentiments linked to them, making them potential bottoms. Not only did prices fall from a high of 15,107 by 50 per cent till 7,697, but October 27 lows held and prices moved up 42 per cent. We are in January 2009 now and we dont have a turn down yet.
If you ask a behavioural guru to define accuracy, this is what he will say. The difference in forecasted and actual is accuracy. According to fractal geometry, this is incomplete information. It is the degree that you are studying, which will define accuracy. Degree, meaning the time frame, multi month, multi week, multi day or multi hour. Accuracy on different time frames will be measured differently, and this is one huge gap in the subject, as it does not define the concept of a degree.
In the last one year, there were nearly 13 intermediate (multiple week) trends and about 40 minor trends (multi day) that we tracked. An average intermediate move was about 23 per cent. The total absolute actual move on Sensex for the year (both up and down intermediate trends) was above 300 per cent. A real accuracy report should be benchmarked against this gross move and not just against the net Sensex return for the year (-56%), which is normally done.
What now? Starting Aug 1992, Sensex has shown an average 40 month cycle. Three of the 40-month cycles make a decade cycle. The first decade cycle ended in 2002 and the second decade cycle should end somewhere around 2012. We are now in the last 3.3 year up cycle. Since the markets have erased most of the gains made since the decade up cycle which started in Sep 2001, the expected bounce should be choppy and time consuming.
We wont be surprised if prices retest October lows or breach them marginally in early Q2, 2009. And this means selective stock picking and  minimising market exposure by doing quantitative long short strategies. 13,000-15,000 is an achievable high for Sensex in 2009.
BSE Metals was the worst performing sector of the year at -72 returns. We expect it to deliver better returns, at least for Q1 2009. We also expect BSE Oil to outperform Sensex over Q1 2009. Indian markets still lack instruments for doing advanced quantitative strategies. But long BSE500 and short Sensex also seems an attractive pair for Q1 2009. In conclusion, don’t get too much into the negative mode despite all crisis and a majority of this is foolish talk.
Try looking top down, give more weightage to back tested systems, understand fractals and cycles and read behavioural finance, it will definitely help you remove biases, even if it does not give you a market beating forecast.