As a fund manager, I perceive my role as that of the Chief Risk Officer. In investing, differentiating skill from luck in the short term is challenging. Even a monkey randomly selecting stocks with darts can make money in the short and medium term, possibly outperforming. However, true skill lies in understanding the limits of one’s knowledge and acknowledging the role of luck in results. This awareness becomes crucial in bull markets and manias. What truly distinguishes good investors is their ability to mitigate risks.
As a fund manager, I perceive my role as that of the Chief Risk Officer. In investing, differentiating skill from luck in the short term is challenging. Even a monkey randomly selecting stocks with darts can make money in the short and medium term, possibly outperforming. However, true skill lies in understanding the limits of one’s knowledge and acknowledging the role of luck in results. This awareness becomes crucial in bull markets and manias. What truly distinguishes good investors is their ability to mitigate risks.
Before risk mitigation, there must be risk identification. In the investing game, people tend to make money 85% of the time. However, it’s the fat tails that can erase all profits. Given the pronounced boom and bust cycles in the financial markets over the last two decades, fueled by extreme movements from the US Federal Reserve, focusing on fat tail risks has become even more critical.
While the stock market has performed exceptionally well, the near term appears uncertain. Indian investors, in particular, have shown excessive optimism and may have overlooked warning signs. I’ve endeavored to compile key risks and have cautioned those I’ve interacted with. Admittedly, I’ve been wrong with my timing in the past; I was early. Nevertheless, being early is preferable to being late. Forecasting the exact mile marker for a potential market downturn is nearly impossible, but it’s crucial to warn that driving fast in bad weather may lead to a crash. By the way, the driver often hits the brakes after the impact in a collision.
Consider this a letter helping to put present risks into perspective. A reminder: the markets are significantly overvalued, posing the number one risk.
US RISKS
- Higher Interest Rates
- End of Covid Stimulus
- Quantitative Tightening
- Deteriorating Leading Indicators
- Persistent Regional Bank Failures
- Commercial Real Estate Concerns
- Indebted US Consumer
- Rising Unemployment Rate
- Growing Bankruptcies
- The Treasury collapse
GLOBAL EVENTS THAT HAVE UNFOLDED
- The UK pension fund crisis
- German recession
- Ongoing Global wars
- Chinese Debt and Economic Downturn
- Japanese Inflation and the Japanese Yen
INDIAN RISKS
- The low Interest Rate Differential
- Yield Curve Inversion
- The Consumer Debt Bubble
- Fallen Rural Demand
All the mentioned risks carry significance and second-order effects. As an investor, it’s crucial to be aware of these risks. Given the extensive list, explaining each one would be akin to composing a thesis. I leave it to individuals to conduct research and draw conclusions, emphasizing the importance of awareness.
The common question arises: What has changed now? I feel compelled to address that. We have entered a high-risk zone as the US economy slows due to lag effects of Interest Rate hikes, liquidity contracts with quantitative tightening (QT), the impact of fiscal stimuli has waned, consumers are stretched, and earnings have stagnated (Except for AI). The positive factors that prolonged the good times have shifted in the last two months, carrying significant implications. Chances are, the current quarter may well be the beginning of the US recession. And remember, we live in a Inter-connected world. If US enters into a recession, the world will follow.
One key point concerning India is the hiring freeze in the Indian IT sector, which has traditionally been the backbone of the consumer base. This constitutes another catalyst that warrants attention, especially with the Consumer Debt Bubble.
In light of these risks, I strongly advise all investors to adopt a conservative and patient approach. Bad times often present the best opportunities, and opportunity favors the prepared mind.
Good times are succeeded by bad times, and bad times are succeeded by good times. This principle applies to both markets and life. Dealing with both with equanimity is crucial—a lesson I’ve learned the hard way recently.
– Dr.Siddharth K J
Fund Manager
KYNG Capital Management Pvt. Ltd.