We all have a peculiar investing style that suits our temperament, skills, experience, biases etc. Typically such a style has been developed over several years of mistakes and successes. However, we all know that it doesn’t work all the time and that’s true even for most successful investors. This is because market at different stages of the bull-bear cycle reward different styles differently.
I am not trying to find a style/strategy that works all the time because I don’t think there is such a strategy and even if there is one, actual outcome will depend on how well it is timed and executed. Instead, I have been thinking about what strategies work in different stages of the bull-bear market cycle and how can we adopt those and more importantly time it and execute it well. This is like trying to select right type of clothing for different seasons of nature except that different phases of the market cycle are not as predictable as seasons of the nature.
Chart below represent different types of stock that outperform during different phases of bull-bear cycle.
Stocks that outperform in different phases of market cycle.
This diagram is prepared based on my experience of several bears and corrections watching low quality stocks posting huge returns, hyped stocks reaching unbelievable levels, spectacular crashes, secular growth stories, die-hard stocks etc.
For years I have been focusing on growth-at-reasonable-value approach to investing. That’s been my style. As this diagram suggests it does not work all the time as growth stocks don’t grow all the time and even if they do they don’t remain at reasonable value all the time. Especially during the bear markets, its frustrating to watch prices go down when companies are posting good numbers. That’s because the style is out of favor. Its like wearing shorts in winter.
In a market like we are now, we can see that high quality stocks like HDFC Bank, Asian Paints, HUL, TCS etc just refuse to drop while low quality stocks are unable to find a bottom. But when market turn, these low quality stocks will be the biggest winners to the frustration of the stock pickers who focus on quality. However, such low quality stocks quickly go out of favor as sooner than later price catches up to their fundamentals.
Action then shifts to growth stocks that are still selling at reasonable value. Depending on how long the bull lives, and economy remains in goldilock state, these stocks can provide good compounding.
Eventually though, herds drive their valuations to dizzy levels and the only ones that appear fairly valued are the story stocks or hyped stocks as their valuations are not based on tangibles like sales and earnings but intangibles like future prospects, management vision, emerging moats etc.
Such castle in the air stories finally begin to crumble under their own weight and we know who’s swimming naked. Strong, high quality, somewhat unexciting companies with proven track record suddenly appear good investments and such stock defy gravity and stay strong while rest of the market rapidly reverts to mean and then overshoots on the downside. And the cycle completes, only to restart.
Investing in each of these phases require different skill set and temperament and that’s the reason no one can beat the market all the time. Its difficult to switch from one style to another quickly, if at all. Imagine someone selling HDFC and buying DHFL. Timing is the key here since strategies quickly go out of favor.
Sticking to a strategy that works over a market cycle is not a bad approach but one must understand when their strategy is unlikely to work and its better to stay out of the market rather than trying to outsmart the market with skills that have little chance of success. I have to say I learned this lesson the hard way.
What’s worst is adopting the strategy that has worked in the recent past. Its like wearing winter jacket just when winter is ending. Its like switching to HDFC after losing money in DHFL. Personally, I am testing waters with strategies that I either haven’t practiced until now or didn’t time it well. Will know in a year if I sink or float.