Market Cycles, Bubbles and Crises
Personal finance, investment philosophies and fun facts - all without the jargon.
Welcome to the fifth edition of the Bodhi Newsletter! In today’s edition, we cover:
Strategies for Personal Finance Management
The Economic Quake: Unravelling the 2008 Financial Crisis
Investor Spotlight: Madhu Kela
Market Cycles: An Explainer
The Dutch Tulip Mania Bubble
Personal Finance
Navigating Financial Uncertainty: Strategies for Personal Finance Management
By Rahul Gajare
1. Understanding Your Net Worth
A fundamental step in financial management is understanding your net worth. This involves calculating the sum of all assets and subtracting liabilities or debts. A negative net worth indicates a critical need to focus on saving more and reducing expenditure.
2. The ‘60 Solution’ Budgeting Method
The ‘60 Solution’ provides a straightforward approach to budget management. It involves categorising monthly income into essential expenses, discretionary spending, and savings (both short and long-term). This method encourages living within means while ensuring a balance between comfort and savings.
3. Utilising Digital Tools for Financial Tracking
In this digital era, leveraging tools like budgeting apps and spreadsheets is essential. These tools help track income and expenses, aiming to improve net worth and establish a stronger financial foundation.
4. Prioritising Financial Goals
During economic volatility, prioritizing financial goals is crucial. Key objectives include building an emergency fund covering 3-6 months of living expenses, paying off high-interest debts, and contributing to retirement savings. High-yield savings accounts, with rates near 5%, are recommended for emergency funds, as they offer quick access to funds when linked to a checking account.
5. Addressing the Rising Cost of Daily Expenses
With increasing daily expenses, managing budgets has become more challenging. Individuals report difficulties in covering bills and providing for families. This scenario underscores the importance of a well-structured budget and controlled spending.
6. Income Management vs. Debt Payments
A key insight from financial experts highlights that managing money effectively is not solely about the income earned but how it's managed. Minimizing debt payments and maximizing savings and investments is crucial for financial advancement, irrespective of income level.
The Economic Quake: Unravelling the 2008 Financial Crisis
By Arihant
The 2008 financial crisis stands out as a pivotal moment in financial history, serving as a stark reminder of the fragile balance that underpins our global financial system. It all began with the collapse of Lehman Brothers and the subsequent credit crunch, unleashing shockwaves that reverberated across economies worldwide and leaving an enduring impact on the financial landscape.
At its core, the crisis exposed the vulnerabilities inherent in a system overly reliant on complex financial instruments, particularly mortgage-backed securities. These once-praised instruments hailed as engines of economic growth, unravelled in a chain reaction that crippled major financial institutions, sending repercussions through housing markets, stock exchanges, and employment levels.
This chaotic event exposed the dangers of excessive risk-taking and a weak regulatory framework, emphasizing the critical need for prudence and forethought in the complex world of finance. Following that, adjustments were implemented to tighten risk management processes, increase transparency, and strengthen regulatory monitoring.
For those of us with aspirations in investing, the lessons from 2008 are paramount. Staying vigilant, keeping well-informed, and cultivating a profound understanding of the interconnected nature of financial markets is essential. Diversifying portfolios and adopting a cautious approach to risk-taking become indispensable tools for navigating the ever-changing financial terrain.
The 2008 financial crisis serves as a cautionary tale, reminding us that markets exhibit remarkable resilience but are not impervious to fragility. Approaching the world of finance with prudence and foresight allows us to contribute to a more stable and secure financial future.
Investor Spotlight
Madhu Kela
By Aditya Goel
"You need to be in control of your emotions when you are doing long-term investments. The rest of it can be learnt from many different places."
- Madhu Kela
India is currently experiencing a significant moment in its equity markets, marked by a surge in investment from retail investors. However, as retail investors, including ourselves, become more involved, it's crucial to ignore irrelevant distractions and focus on long-term wealth generation through investments, a strategy strongly advocated and perfected by prominent investor Madhusudan Kela!
Madhusudan Kela, commonly known as Madhu Kela, is recognized as one of India's leading financial personalities. Originating from the modest village of Kurud in Chhattisgarh, Kela has successfully accumulated a net worth exceeding ₹1000 crore.
Madhu Kela's tenure as the head of equity investments at Reliance Mutual Fund, starting in June 2004, marked a significant chapter in his career. It was under his leadership that the fund achieved a landmark success, becoming the first in India to surpass an Asset Under Management (AUM) of ₹1 lakh crore. The Reliance Growth Fund, led by Kela, realized an impressive Compound Annual Growth Rate (CAGR) of 32% from 2004 to 2010. His investment strategy was primarily focused on small and mid-cap companies with the potential for substantial growth.
Madhu Kela's approach to investing is varied, focusing particularly on the need for emotional discipline in long-term investment strategies. He believes that while most investment skills can be acquired from various resources, the challenge lies in overcoming behavioural biases that influence investment decisions. These biases, driven by emotions like optimism, pessimism, hope, and fear, can simultaneously affect an individual investor at different times or various investors as a group. Kela advocates for a deep understanding of these human tendencies and biases to sidestep them and achieve superior investment outcomes. He advises that overcoming these biases requires mindful and well-researched decision-making in each investment endeavour.
Kela recommends that investors adopt a comprehensive asset allocation strategy for long-term success. He believes that "Volatility can be your friend. It provides an opportunity to build positions in otherwise great companies.” Something that Jack Bogle, the late legendary investor and founder of The Vanguard Group also stated. According to Bogle, “Stay the course, Don’t let these changes in the market, even the big ones [like the financial crisis] … change your mind and never, never, never be in or out of the market. Always be in at a certain level.”
In conclusion, Madhu Kela's journey from a small village to becoming a titan in India's financial sector epitomizes the power of disciplined investing and emotional control. His success, fueled by insights from mentors like Rakesh Jhunjhunwala and George Soros, and influenced by authors like Peter Bregman, underscores the significance of long-term strategies and the importance of understanding behavioural biases in investment. Kela's emphasis on emotional discipline, coupled with his recommendations for asset allocation and embracing market volatility, aligns closely with the wisdom of other investment legends like Jack Bogle. Together, these principles form a robust framework for investors aiming to navigate the complexities of the market and achieve sustainable financial growth.
Market Cycles: The Highs and the Lows
By Arihant
An understanding of market cycles is among the many analytical tools in an investors toolbelt to assess when to enter and exit a position. All investors, even new ones, intuitively know that at different times the market trends up or down thus giving rise to stock market cycles. More formally the stock market cycle is typically broken down into a few broad stages.
Accumulation (Up-trend): This stage follows from a previous low in the market and occurs when investors begin buying again, leading to a recovery and eventually greater investment until the price is bid up to a high.
Downward Correction: At some point buyers begin selling their positions leading to a downtrend which is also referred to as a correction. As more people begin booking a profit or reduce their losses, the market tends to a low. The cycle will ultimately recover again giving rise to a new cycle.
It is important to emphasize that there is really no definite start and end point in this cycle as any point of time can be considered a starting point for analysis. Looking at the picture above many might get a false sense of confidence, believing that just buying during an uptrend guarantees returns. In reality it is very difficult to ever predict the current stage of the market purely on price movements. However, a fair assessment would require trying to answer questions such as:
How long have prices been falling or rising? Is there a possibility that stocks are now overvalued or undervalued?
Do market sentiments suggest that people are being driven by fear or greed? Is this an appropriate position to take?
Is the market making a recovery or have prices been rising for a long time?
Trying to answer these questions gives a more holistic picture of the current stage of the market and gives an investor an edge over others who only engage in superficial analysis.
Other ways of determining the stage of a cycle is through analysing government policy expectations. If there is belief in the market that governments are likely to engage in contractionary policy to limit growth due to overheating then this might lead to a slump. These policies are implemented to influence the cycles and therefore give a hint as to the current stage of the cycle.
A caveat within all of this is the fact that different assets typically follow different cyclical movements. The equity and bond market may be at completely different stages of the cycle. Additionally, the stock market cycle is also dependent on other cycles like the credit and real-estate cycle. For instance, when credit or borrowing is cheaper there is typically greater investment as seen during periods of boom. For this reason it is also important to keep track of credit, real-estate and economic cycles and determine how they affect the stock market cycle.
All in all, an understanding of cycles can be potent means of devising an investment strategy and evaluating the correct time to invest or reap profits before a downturn emerges.
The Dutch Tulip Mania Bubble
By Siddhant Goenka
A bubble is a market situation in which asset prices are highly inflated due to irrational expectations on part of the consumers. The first bubble was the Tulip Mania bubble, which arose in the 1600’s in Netherlands.
Tulips were worth almost as much as big properties in the 1600’s! Why?
Tulips are beautiful flowers produced mainly in the Netherlands. During the 1600’s, a virus infected these flowers which resulted in a change in the color from petals of single color to petals of multi-color. This, also known as tulip breaking, made tulips much more attractive increasing their demand. This resulted in a simultaneous price increase.
From early 1600 to 1620, prices rose exponentially and message spread that one could earn large sums of money by simply purchasing tulips or tulip bulbs and selling them at higher prices. A little later, the prices of tulip bulbs were more than that of the cultivated flowers which signaled more people to come into the market to make a quick buck. In fact, it has been recorded that sometimes, a tulip bulb changed possession more than 10 times a day. By 1637, a single tulip bulb was worth 10,000 guilders (the then currency of Netherlands), which at the time could purchase a lavish property in Netherlands.
Soon enough, futures contract started being circulated. A future is a type of contract where the consumer purchases a product and the producer delivers the product once it is ready. So, that contract became tradable as whoever had that contract had ownership of the bloomed tulip. It takes many years for a tulip to bloom and until that happened, you did not know what your tulip looked like and therefore, there was a lot of uncertainty regarding how the tulip was going to turn out. This uncertainty is factored into the price of the tulip. So now, tulips can be traded using contracts which allows the trade of tulips before they have bloomed and much more frequently. Now, the range of buyers of tulips increased from botanists to the general public as everyone wanted a piece of the cake. So, prices started skyrocketing. By the end of 1636, tulips were valued at a much higher price than what they were really worth and this is what made the tulip mania a bubble.
Since this was the first known bubble in the history of time, people did not have any suspicions about the price of the tulip till they were exceedingly high. As the people started wondering about a drop in the price of tulips, a lot of them wanted to secure their profits Thus, there was an increase in the number of sellers, which led to a reduction in the tulip’s price. Lower prices were an indication for selling and as sellers increased, prices fell even more. In this cycle, the tulip lost its value rather quickly and the tulip mania bubble had been burst.