We Study Billionaires - The Investor’s Podcast Network - TIP583: Preparing for the Bear Market to Come w/ Gautam Baid

Starting point is 00:00:00 You're listening to TIP. On today's episode, I'm joined by Gautum Bade. Gatum is the managing partner of Stellar Wealth Partners India Fund, a Delaware-based investment partnership, which is available to accredited investors in the U.S. Gautom is also the equity advisor of Complete Circle Stellar Wealth, PMS, a portfolio management service which is available to Indian citizens in NRIs globally. Both funds are modeled after the Buffett Partnership fee structure

Starting point is 00:00:28 and invest in listed Indian equities with a long-term, fundamental, and value-oriented approach. If you've been following along with the show, you'd also know that Gotham is the author of the international bestseller on value investing, The Joys of Compounding. On today's show, we're going to be discussing his new book, The Making of a Value Investor, which will be released on October 25, 2023. During this chat, we cover the impetus for Godham writing a second book, why journaling is such an important practice for value investors, why judging market sentiment is important and how investors can go about doing so,

Starting point is 00:01:02 his biggest Eureka moment in his journaling process, why we should let our portfolio winners run, his thoughts on the importance of liquidity, the telltale signs that a bear market is complete, what companies you shouldn't average down on in a bare market, how we can use the wisdom of markets to our advantage, and how investors can best prepare themselves for the next bare market. As always, it was such a pleasure having got him on the show again.

Starting point is 00:01:27 His first book, The Joys of Compounding, it was so good. I actually did a five-part review of it earlier this year. That started with episode 534 and then I worked from there in the podcast feed. The Joys of Compounding was a book I received countless messages about, as so many of our listeners were so grateful to discover it because of the show. So I'm really glad that Gettom joined me here to talk about his second book on today's show. Also, my first discussion on the show with Gautum was on episode 566 for those who might have missed that discussion. With that, here is my chat with Gautum Bade. You are listening to The Investors Podcast, where we study the financial markets and read the books that influence self-made billionaires the most.

Starting point is 00:02:10 We keep you informed and prepared for the unexpected. Welcome to the Investors Podcast. I'm your host, Clay Fink, and today we bring back Gautum Bade, Gautum. Welcome back to the show. Thank you for having me, Claire. It's a pleasure to be back on your show. Well, back on episode 566, we discussed your first book, The Joys of Compounding, which was an international bestseller. Sitting right behind me, it's one of my very favorite investing books.

Starting point is 00:02:45 But today, we're going to be covering your newly released book titled The Making of a Value Investor. To start, how about you just talk to us a little bit about the book and what the impetus was for writing this? Sure. So I spent $10 on purchasing a journal in late 2014, and I considered that. to be one of the best value investments I've ever made. Ever since that day, I've been keeping track of my investing decisions and subsequent developments in my investment journal. And my writing frequency in the journal witnessed a sharp increase from 2018 onwards. And why is that? It's because the biggest learnings always come from a bear market. And those lessons bear fruit for an entire

Starting point is 00:03:25 lifetime. So I experienced a brutal bear market, India from January 2018 to February 2020, followed by the pandemic-induced market crash in March 2020. And this book covers the journey of my evolution as an investor during a very market and my learnings and reflections along the way as regards the impetus for writing this book. So I often post on social media platforms like LinkedIn and Twitter about the benefits and importance of maintaining an investment journal. And the genesis of this book lies in the response to a tweet of mine on August 26th last year. So one of my followers in Twitter suggested to me,

Starting point is 00:04:02 why don't you publish all your biggest learnings and lessons from your investment journal into a book? So I found the idea to be very helpful and interesting. And shortly thereafter, I started working on the book. And it took me approximately 12 months to complete writing it. And lo and behold, here we are with the book scheduled to release on 25th October worldwide. Well, you mentioned your biggest learnings are from a bear market. Since your second book, you know, you're sharing your journal.

Starting point is 00:04:29 and everything you've written down over this period of a bare market. What were some of your biggest learnings from the journaling process? Because I'm sure many investors, maybe they just don't make the time for journaling. So I'm curious if you could share why you see this is so important, given that it's your second book that you're releasing. Sure. So this habit of journaling has helped me tremendously in improving myself and learning a lot about myself, both as an investor and an individual.

Starting point is 00:04:56 I receive a lot of valuable feedback from journaling and I use it to correct my personal behavioral biases because like Charlie Munger has taught us, you know, it's a moral duty to be as rational as possible. None of us can be 100% rational, but you can try to minimize our biases to the maximum possible extent. This is where journaling comes in handy because all investors make mistakes. But the great investors repeat old mistakes less often. This is where the journal comes in handy because, you know, it's very difficult to make the same mistake to if you've actually gone through your past mistakes in your journal, and that way you basically improve as an investor. I've also maintained the personal archive of media commentary and investor behavior during various episodes of market panic during the last nine years, and I find it highly beneficial to refer to this information whenever the market undergoes its periodic severe corrections. Because what I've realized over time is that human nature in the markets

Starting point is 00:05:52 has not really changed much over time. And this is again where the journal really comes in. handy. So it helps you maintain your emotional calm during periods of market turbulence and to not pay too much attention to the noise and to refocus your attention back to what really matters in investing, which is the micro individual businesses and their industry developments. That is the best that you can do, nothing else. So always be humble. And it's also important to remember that, you know, just writing things down. You can't remember everything in your brain. And when you do, you know, try and remember so many of these different things, oftentimes you're misremembered.

Starting point is 00:06:26 remembering what it is, you know, you thought at the time. And once you write things on paper, you really can't lie to yourself. So you mentioned the aspect of human psychology and it doesn't change over time. And in your book, you talk a lot about what's happening in these various points and what the investor sentiment was at the time. So could you talk more about investor sentiment and how we can go about, you know, judging investor sentiment? Because there's different points in your book where you're saying, you know, there's capitulation in the market, people are selling with no regard to valuation. So how do you go about judging the sentiment? Yeah, just your general thoughts on this.

Starting point is 00:07:06 To actually, understanding the prevailing market sentiment and investor sentiment is very important, even though it is short-term in nature, but it's important. Why is that so? It's because fundamentals do not determine the price for a stock at any given point of time. Demand and supply does, And that is why it is so important to understand sentiment, because that is what drives the demand and supply dynamics in the short run. And there are two very effective ways to judge prevailing market sentiment. Number one is the IPO or initial public offering market. And number two is the quality of investor portfolio. So let me talk about both these points separately.

Starting point is 00:07:41 Initial public offerings or IPOs are a very effective indicator for judging market sentiment. During stage one, good companies come out with IPOs at cheap valuations or reasonable valuings. valuations during stage two, good companies come out with IPOs at expensive valuations or very expensive valuations. And in stage three, bad companies, many of which do not have been having any earnings, come out with IPOs at ludicrous valuations and which are heavily oversubscribed by retail investors whose surging presence in the markets is a late cycle indicator. And very high levels of margin funding, both in the primary and secondary market, is a predominant characteristic of the final blowout phase of any bull market. So this is why IPO and margin funding and basically are very good indicators of market sentiment. Second is the quality of investor portfolios. So as a bull market matures, many investors move their portfolios from high quality stocks,

Starting point is 00:08:37 having steady growth and high returns on equity to stocks having higher revenue growth, but inferior return ratios and poor management qualities. And then they move on to commodities and cyclicals. Then they move on to turnarounds, which are currently loss making, then they move on to turnarounds, which are currently loss making, making, then they move to microcaps with limited history of operations, and then finally they move to highly leverage companies with projections of rapid revenue growth. At this point, the bull market usually tops out, and at the end of the euphoric phase, most investor portfolios have only junk stocks left in them. During the subsequent bear market, which follows,

Starting point is 00:09:11 both quality and junk stocks fall. Quality eventually recovers back fully, whereas the junk stocks lie for many years, and it is only after going through the pain of a couple of such cycles that as an investor, you develop the discipline to resist the incessant urge to go down the quality curve and chase quicker returns. Related to the second point you mentioned there, the quality of the investor portfolio, is there sort of a science to figuring out what the quality is of a portfolio, or is it just a matter of analyzing those around you and your environment and the news headlines, or Is there sort of other ways of going about this?

Starting point is 00:09:48 The most effective way for me, personally speaking, is a few WhatsApp groups of investing, which I'm part of. So when investors start discussing only the junk quality stocks like deep cyclicals, microcaps, loss-making companies, and when there is widespread euphoria for these kind of stocks, that is when basically I get to know that, okay, right now it is completely risk on, and investors are throwing caution to the winds, and they're just focusing on trying to make money as fast as possible. And it is this urge to make quick money and make money as fast as possible. You know, when there's greed in the air and you can literally sense it, that, you know, people

Starting point is 00:10:23 are just not exercising caution, they're not focusing on quality, they're not focusing on the past track record. It's all future projection based. Everyone is just investing on the future instead of actually looking at the past, what the company has done. Even bigger way to judge sentiment in such cases is when you see a big surge in stock prices of holding companies, because, you know, holding companies, stock prices generally grow up only during the last stage of a bull market. You also see a plethora of IPOs from a single sector coming during the peak of the frenzy in that particular sector, during the end of that sector will build market. And finally, and most importantly, you'll often see new metrics of valuation suddenly popping up during the final stage of a euphoric bull market.

Starting point is 00:11:04 So in the case of the late 1990s, it was number of eyeballs or clicks on the internet. And similarly, in 2021, during the meme stock, Euphoria, you had. some new metrics coming out. So if new metrics of valuation start being discussed, that you know, this is a new era, this time it's different. It's never different. The principles laid down by Graham and the intelligent investor have stood this test of time. And those three key principles are what we need to always focus on as value investors.

Starting point is 00:11:33 Yeah, for me, a lot of judging sentiment is looking at what's going on on Twitter. And I think, you know, as you get more experience of markets and After reading through your journal, it's quite obvious that price drives perception. So when prices are low, people look for reasons why prices are low and potentially why prices are going to go even lower. And then when prices are high, people look for reasons. They're strong confirmation bias. They look for reasons why prices are high and try and find reasons to justify why they're

Starting point is 00:12:05 going to go even higher. So the narrative is driven more so by prices than by the fundamentals. And I think that's one of the most important things as a value investor is trying to see that market sentiment and differentiate the price and the fundamental. Correct. I absolutely agree with you. And successful in investing is all about having people agree with you later because the alignment between price and value can be greatly distorted in the short run by technical and psychological factors. But as Benjamin Graham has taught us, in the short run, the market is a voting machine. But in the long run, it's a vague machine.

Starting point is 00:12:41 So, and ironically, in order to generate alpha, investors do need the markets to be efficient eventually because the markets need to realize that they have made a mistake in valuing a company and then the market needs to correct it. Otherwise, mispracings would persist forever and in such a market, no one could reliably outperform. So you're absolutely right that in the short run price does drive perception, but that is what allows value investors to exploit Mr. Market to our advantage because he's a manic depressive. He either becomes overly exuberant or it becomes overly depressive. I wanted to share some of your journal entries here and just give you some of my favorite ones,

Starting point is 00:13:21 give you a chance to elaborate on them. The first one I'll read here is an important lesson for me in my investing journey. If it is a good quality business with high growth prospects for a long period of time, then it is okay to pay a high PE and sacrifice the first year return. The returns from the second to fifth years will compensate for the flat return. turn in the first year, end quote. And I tend to agree with you on this in that I'd prefer to, you know, pay up for quality, at least pay up in terms of seeing an obfically high valuation multiple, rather than putting a bigger emphasis on a lower multiple and less emphasis on business quality.

Starting point is 00:13:59 And I agree that having that multi-year view is important. So I'd love for you to expand more on this and having that longer-term view and putting more emphasis on quality. So for businesses that will grow their earnings, even at a moderate pace, but for a very long period of time, the optically high price to earning multiples that determine value investors is in reality pretty low. This means that if you buy a strongly moated business at what appears to be a full price based on current year earnings, you will still end up compounding your money at a higher rate than the discount rate you used to arrive at the fair value for the business. and the longer the comparative advantage period for a business, the more the business is likely to be worth than what many market participants think. Durability of the moat is the key factor here. So the market tends to underappreciate companies that have really strong modes because

Starting point is 00:14:51 that durability allows the company's runway to last much more longer than what many people expect. So for long-term investing, the focus needs to shift away from N3P multiples to duration of the comparative advantage period. buying a stock is not that difficult in today's information age. Holding onto it amid all the noise in the digital age, that is what is more difficult. And if you want to hold on to a stock for the long run, you have to focus on two key things, which I've talked about in my book as well, whether the company's growing revenues at a healthy clip and whether the original competitive advantage, which you bought the business for, is that still in place?

Starting point is 00:15:27 As long as these two things are in place, just stay put because the competitive advantage of the business will allow it to earn returns on capital, above the cost of capital. And for such kind of businesses, the maximum delta, the maximum rate of change, the maximum intrinsic value creation takes place when they focus on improving revenue growth. So for companies with high returns on capital, which are enabled in turn by their competitive advantage, as long as revenue growth is healthy in double digits or more, just stay put. You'll do very well over the long run and you have to just hold on during the periodic time corrections and the stock price sell-offs during market falls.

Starting point is 00:16:01 But you'll make a pretty good CAGR if you can simply hold on. Because in order to have a 10-bagger or a 20-bagger, you need to hold on to a 10-bagger or a 20-bagger. But during phases of euphoria, in the urge to make quicker money, we just sell our family silver and buy junk-quality stocks, that is not what is really helpful for investing. Yeah, I totally agree with you. And you talk about, you know, the biggest edge a lot of investors can have is a behavioral edge. And Bill Miller's talked about, you know, the three edges you can have is informational, analytical, and behavioral. And of all individual investors, you know, behavioral is the key one to where we can really find that edge and find that advantage. Anyone can go out and buy a stock today. But how many people

Starting point is 00:16:46 can buy a good quality company and just sit on it for five plus years? That's pretty true. I mean, just look at what happened last day with not a stock recommendation, but just look at what happened with Google. The moment Microsoft took a dig in chat GPT and Google's bar did not really do well in the beginning, Google's stock press fell down to $80. And today it is $140. Did the intrinsic value of Google changed by hundreds of billions of dollars in a matter of six months? No, right? But we just get so lost in the information overload that we panic and sell our high-quality blue chip stocks.

Starting point is 00:17:19 That is not how long-term wealth is created. Buffett became Buffett because he was able to compound his money at a healthy clip for more than six to seven decades. That is what made him perfect. So I'm not saying that you have to cling on to a single stock for the longer, but at least remain invested inside the market with a good portfolio over the long run, only consider selling the high quality stocks when they become absolutely overvalued. For example, 150, 200p multiples. If they start trading at those kind of multiples, then consider selling them.

Starting point is 00:17:46 But I've seen over time in the market scale that for these high quality growth stocks, they start off from a cheap valuation, then they become reasonably valued, then they become expensively valued, then they become very expensive. And then finally, they become absolutely overvalued. But you have to create wealth. In the true sense, you have to hold on for that entire duration during the high growth phase of a company. Because the market in those cases keeps discounting earnings many years out. And that is how you get valuation re-rating, and that is how you get life-changing multivaggers in the stock market.

Starting point is 00:18:18 I'll turn to another excerpt from your book here. We need to humbly acknowledge the fact that a long-term investment of five to seven years is becoming increasingly difficult in today's dynamic world. If a company doesn't adapt to changing environments or coming disruptions, its business model could become obsolete before you know it. Don't get married to your stocks and don't fall in love with management. Many investors' portfolios got eroded in this bear market because of inertia and complacency. So I'd like for you to talk more about this need to continually reassess our investments

Starting point is 00:18:51 in a world that is changing more rapidly than ever. It pays to have a long-term view, but a long-term view must be combined with an investment process which is willing to continually question the core investment thesis and investors should exercise active patients, that is, diligently verifying their original investment thesis on a regular basis and doing nothing until something materially negative or adverse emerges. All too often, investors become very complacent and stop questioning their holdings when the stock presses are going up. They resume analyzing in detail only when the stock presses start falling. But don't do that. Don't analyze your holdings only when their stock presses fall. Just because the prices of the

Starting point is 00:19:32 stocks in your portfolio are going up doesn't mean that there is nothing wrong taking place in the underlying business. So be very vigilant. Things are changing at a very rapid clip because of technology around the world. And we always need to focus on terminal value because that is where 70 to 80% of the intrinsic value of any business resides. The terminal value is getting adversely impacted by any competitive development or any technological advancement, then you have to take action accordingly. Let's take a quick break and hear from today's sponsors. All right. I want you guys to imagine spending three days in Oslo at the height of the summer. You've got long days of daylight, incredible food, floating saunas on the Oslo Fjord,

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Starting point is 00:24:15 compounding is convex on the upside and concave on the downside, positive asymmetry. Few understand this, but the day you do, it will change your investing perspective forever. So what do you mean here by compounding is convex on the upside and concave on the downside? Well, this was one of the biggest Eureka moments in my investing journey, and I'm sure this is also going to be a big Eureka moment for many listeners to our podcast today. If they can understand this power of this positive asymmetry in compounding, then it can potentially change their perspective about investing forever. So we often hear about the power of compounding in terms of, you know, if you compound your money at 20% for 25 years, you get a hundred bagger, or if you compound your money at 26% for 20 years, you get a hundred bagger. But the true power of compounding lies in this positive asymmetry, which I'm talking about.

Starting point is 00:25:07 So when I say it's convex on the upside and concave on the downside, what it means is compounding increases, at an increase, rate on the upside and it decreases at a decreasing rate on the downside. Let me explain this with a help of an example. Let's assume that you have bought two stocks for $100 each and the first stock goes up by 26% in year 1 and becomes 126 and the second stock decreases by 26% in year 1 and becomes 74. So net net at the end of year 1, you have made 0 return, right? What do you think would happen by the end of year 10 if every year stock 1 goes up by 26% and stock 2 decreases by 26%?

Starting point is 00:25:41 What do you think would happen at the end of year 10? What would be your CAGR? You basically made zero at the end of year one. Any idea what would be your CAGR at the end of year 10? You're really putting me on the spot here. I'm going to say something greater than 15% is what I'm going to guess. So the actual answer is 17.6%. So at the end of year 10, even though stock two went to 0.01, almost went to 0, at an aggregate

Starting point is 00:26:08 portfolio level, you still ended up making 17.6%. And this finding was a eureka moment for me because this is where the real power of compounding lies. The real power of compounding lies in its ability to empower you and enable you to be wrong, 50% of the time and still make very handsome returns over time because there is no limit to the upside. But the bottom, the downside is capped at zero. Right. So basically, this is, you know, the true eureka moment for me. Because, you know, what this made me realize is that if you can simply hold on to your

Starting point is 00:26:41 winners for the long run. The overall portfolio return will be taken care of. Now, I'll give you a live example from my own India fund, which I've been running for the last 12 months. So our India fund went live on 3rd October last year. It's up 18% in the first 12 months. And when I was doing a portfolio attribution analysis to see which stocks contributed the most, surprising to me that four stocks out of the initial 23 stocks accounted for more than 80% of the overall return of the fund in the first 12 months. The other 19 stocks hardly contributed. And this is again the power of compounding at play, convexity on the upside, you let the winners run, let them become big winners because investing is a probabilistic activity. You're going to be wrong a lot of the

Starting point is 00:27:21 time, but as long as you make your winners count and don't blow up in any of the other picks, you'll do very, very well at an aggregate portfolio level, very powerful principle, positive asymmetry, and just reinforces the power of holding onto your winners. Thank you for sharing that. It's very interesting how, you know, it's so difficult, just to find the winners, but it's just as difficult just to hang on to them because it can be so easy after you see just a five bagger, for example, in five or ten years, just to let go of it and think you can go and find the next big winner. When in reality, we should be likely be a very reluctant seller as long as the business continues to perform.

Starting point is 00:28:01 I would like to share two pieces of statistics here. Just to know, because this is such an important topic that very few people talk about the importance of holding on, I want to share two statistics here with your audience so that they understand just why it is so critical and important to hold onto your winners for dear life. Between 1926 and 2018 in the US market, only 4% of all listed equities accounted for 100% of the wealth creation. I'll again speak. In those 92 years, only 4% of all listed equities in this country accounted for 100% of the wealth creation, which means that once you have found the goose that lays the golden eggs, don't kill the goose. hold on to it for DLI because 96% will fail or not really work out.

Starting point is 00:28:41 It's only those 4%. So when you find one of them, if you're lucky enough to find one of them in your lifetime, make them count. So that's the first statistic from the US market. Now I'll share. And this powered law is not just applicable in the US markets, applicable to markets around the world, including India. In India, between 1990 and 2018, during those 28 years, only 1% of all listed equities

Starting point is 00:29:05 accounted for 90% of the wealth creation or market cap creation in India. Just think about that. Just 1% out of 4,000 listed companies, which means that if you found, if you were lucky enough to identify one or two out of those 40 stocks in that 30-year period, you should have held onto it to really change your life as an investor. So, you know, it's very easy to identify winning stock, but it's not easy to hold onto it. So once you have found a great company growing at a healthy clip and it continues to grow at a healthy. and it's maintaining its competitive advantage. Hold on to it. I want to jump to a different topic that I don't think is discussed too often. One of your entries,

Starting point is 00:29:47 it referenced Stan Drunken Miller, who's this legendary macro investor, just had an absolutely incredible track record. And he said that liquidity is the most important thing in the market. And you go out, you live your day-to-day lives. Like liquidity, it seems like a entail. tangible thing that you know it exists and you know there's periods of where capital is scarce in times where capital is abundant but you don't really see it all that much in your day-to-day lives. Maybe you can see it at the business you work with. But I'm curious to get your thoughts on liquidity, how you go about judging it and

Starting point is 00:30:24 what you're seeing maybe today in terms of liquidity because a lot of people seem to be confused with where we're at today, whether the bear market's over or whether, you know, we may see another leg down. So I invest only in the Indian stock market. So I'll speak in the Indian market context. How do I go about judging liquidity? So I'll look at the trend in the monthly domestic investor and foreign investor flows. And that gives me a pretty good idea about where liquidity is headed.

Starting point is 00:30:48 So for a long time, foreign investors used to dominate the flows in the Indian equity market. But today, it is the domestic institutional investors or the domestic investors who are basically controlling the narrative now and who have taken the mantle of leadership. and it is the individual investor who's powering the current ongoing bull market in India. And monthly investments in equity mutual funds in India for the month of September, crossed $2 billion for the first time ever. And just to give you some context, this monthly investment in domestic equity mutual funds in India was less than half a billion dollars six years ago.

Starting point is 00:31:24 So in just six years, the monthly flows from individual investors has more than quadrupled. And to understand why is this happening, why is this happening? Why is there such a big surge in financialization of savings? We need to look at history. So look at the history of US, Japan, and China. When those countries' GDP doubled from $3 trillion to $6 trillion, so their stock markets did not just double. Their stock markets tripled or even quadripled.

Starting point is 00:31:49 And why did that happen? It's because when a nation transitions from a low per capita income country to a middle income per capita country, the basic spending on items like food does not go up much, but these categories of branded discretionary consumption and financialization of savings. These two categories simply explode. Today, India is at 3.4 trillion dollars of GDP and in the last few years we are already seeing this trend of financialization of savings playing out. A quadrupling of flows in domestic equity mutual funds is just the beginning. I think the day is not too far when the domestic investor flows will actually surpass the foreign investor flows in India and

Starting point is 00:32:25 then we won't be dependent on foreign investor money anymore. And this is again, like I wrote writing my book, this is the reason why quality stocks in India just do not correct much. Because at every low level, there's so much domestic money coming in to the market every month that the domestic mutual fund managers and local fund managers of private funds, they are just waiting on the sidelines with so much liquidity to buy these stocks. So this is again why, you know, if you invest in good quality stocks in India, the drawdowns are basically limited and minimized to the maximum extent possible. So when you say financialization of savings, is that just referring to more and more people

Starting point is 00:33:02 having access to brokerage accounts and getting access to the world of investing? Not just access to brokerage account. It also means access to banking accounts. So driven by our prime minister's Jandan Yojana in the last few years, there's been a surge in financial inclusion in the country. And a lot of people are also opening bank accounts. They're also accessing a lot of financial services through digital medium, like, you know, mobile apps. and they like. And financialization of savings does not only include the stock market. It also

Starting point is 00:33:30 includes various aspects of financial services like wealth management, insurance and asset management, and estate planning. So this is an area on which I'm very bullish and I'm expressing this bullishness through a few holdings in my India fund as well. So they're holding some of the leading wealth managers of India listed wealth managers of India in our fund. And I think this industry is poised to grow at a very healthy clip for a very long period of time for the next decade. I wanted to jump to your lessons from the bear market in India because that's what much of your journal and your book is covering. So let's start with tracking the bear market and watching prices just continually

Starting point is 00:34:09 fall and fall and people selling irrespective evaluations. I'm curious if you were seeing any signs that marked the end of the bear market in India and how we may be able to be on the lookout for in future bear markets of signs we can look for to mark the end of a bear market and the entering of a bull market. Yes, so bear markets are very treacherous and very painful. There's a reason for that because there are so many false starts, which gave rise to false hope among investors that the bear market is finally coming to an end. If you closely observe in my book, you'll notice that, you know, I've mentioned that during

Starting point is 00:34:47 February 2019, when there was a big hope among investors that the bear market is finally coming to an end because of the strikes. by the Indian army in Pakistan, many people thought that, okay, now this will bolster the current political dispensations chances to come back with the full majority. And therefore, there was a brief bear market rally. And then the investors' hopes got dashed shortly thereafter. Then in May 2019, when the Modi government came to power again with a full majority, again, there was a very sharp bear market rally. And people were expecting the bear market to end. Again, our hopes got dashed after that. And then in September 2019, when we had that history, we had that history,

Starting point is 00:35:25 historic corporate tax cut in India. Then again, I've written in my book, including myself, you know, I mean, I expected, okay, now the bear market will finally end. This is, this has to wait. Now the pain has to stop. But again, our hopes were dashed and again, the bear market resumed. So three separate bear market rallies, basically, you know, just sucked us in back in and just made us complacent again that, okay, the bad times is over.

Starting point is 00:35:45 But the bear market is not over till the last bull gives up. And by 23rd March 2020, I can assure you, almost everyone in the world had almost given up. By the end of it all, like I write in my book, investors were posting philosophical messages about life. That's the meaning of life in general on WhatsApp groups. That was just how responded everyone was. You'll get to know the exact bottom, only in hindsight. In this case, the global markets, including India, bottomed on 23rd March 2020. But generally, a new bull market kicks off with a few consecutive months of hugely positive market breadth.

Starting point is 00:36:19 This is what was missing during those three bear market rallies. It just lasted a few weeks, but not for a few months. And by June 2020, after the first three months after the bear market ended, it was now clear to me that, okay, now I think we can reasonably say that the bear market has ended. And there are three telltale signs for a new bull market to begin. Low starting valuations, which are based on depressed corporate earnings with strong capacity to recover or grow and loosening liquidity from very tight levels. And the three ingredients for a bear market to begin are high valuations on peak corporate earnings based on inflated margins and tightening liquidity from very loose levels. So basically, this is exactly what happened in late 2021 when these three phenomena played out.

Starting point is 00:37:09 That is when you had that 15 month long difficult bear market in US tech. So this is not this broad parameters may help you. But to be honest, practically speaking, you get to know the exact peak in the exact bottom only hindsight. Right. That's exactly what comes to mind when you say that. You said, you know, you could see the growth for a few weeks, but a few months is kind of when you know you're in the bull market. And you talk about this in your book where, you know, it's much better not to try and time this stuff and time when the bottom is going to be because it's only in hindsight when you know for certain. We should always just be looking to continue to buy things for less than their worth and

Starting point is 00:37:47 having that long-term time horizon rather than trying to get Q and jump in and out of the market. That's really. That's really it. That's the best we can do. And I've tried this enough in the last 16 years of investing, tried to trade in and out. And based on market sentiment, what I expect the market to do without realizing that the best stocks, the biggest winners in the market clay, they tend to make their biggest moves. No, doing flat or age bond markets.

Starting point is 00:38:14 And this is again something which you learn only from experience that, you know, these big winners, what they do is they go up sharply during range-bound market when the market is doing nothing. Basically, you know, like in India, for example, like the past also and in the US as well, they've had many range-borne markets. Like, I'll give you some numbers here just to illustrate this point. It's very important. So between 31st December and 1964 and 31st December, 1981, the Dowjoux Industrial average in US meant from 874 to 875, a single point move.

Starting point is 00:38:44 It went up by one point in 17 years. Yet Warren Buffett compounded his capital at more than 20% over those 17 long years when the market gives zero. And that is the hallmark of a true stock picker. It's very easy to make money. And there is, you know, euphoria all around. Liquidity is very wholesome. And, you know, bull market sentiment is prevalent. But the true test of a good investor is how much you're able to protect yourself and your clients during a bear market.

Starting point is 00:39:11 And whether you're able to generate alpha, during range bond markets. We have to only accept the fact that during bear markets and everything falls, even our portfolio will fall. In the book, like I write about my experiences in March 2020, so by February 2020, I'd already transition to becoming a very high-quality focused investor, focusing on high-quality equities only. And yet, when March 2020 came,

Starting point is 00:39:34 even my portfolio fell 30-35% in a single month along with the index. Because in a month, when Apple, Google, Microsoft are falling 30-35% in 3-35% in 3-30% in three, four weeks. And what can you do? You can just accept this volatility or just accept that, you know, this is a general norm for equity market that you will get these periodic phases of fear and pain once every decade. But you have to take the pain if you want to enjoy the long-term gain.

Starting point is 00:40:00 There's no way getting around it. In bear markets can also give us very good opportunities to add to high-quality companies. And on page 157, you talked about, when it's appropriate and when it's not appropriate to average down during the bear market. So what did you find in your research on this? Sure. So there are four key points here. You must not average down much on highly leveraged business models like bank, banking.

Starting point is 00:40:29 You must not average down much in operationally leveraged or operationally levered models like commodities. You must not average down in businesses which are facing technical or technological obsolescence. You absolutely must not average down in the highly levered business models involving fraud. You can average down or you should average down in stocks of structural growth businesses with a large size of opportunity and having sector leadership. And this is the single biggest advantage of investing in quality because when you invest in quality, it empowers you and it enables you to view every market correction as a buying opportunity. And this is what helped me stay the course during March 2020.

Starting point is 00:41:15 If you know on the second last page of the book, you may recall that unlike 2018 and 19 when I felt nervous and actions are anxious on many occasions during market sell-offs, this time I know that I'm in the safe hands of quality and that my portfolio's recovery. Eventually recovery is a matter of when, not if. So investing in quality empowers you to stay the e-course. I think that's one of the single biggest advantages of being a high-quality equity-focused investor. Let's take a quick break and hear from today's sponsors. No, it's not your imagination, risk and regulation are ramping up, and customers now expect

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Starting point is 00:44:38 is 7.8%. Past performance does not guarantee future results, current distribution rate as of 1231, 2025. Carefully consider the investment material before investing, including objectives, risks, charges, and expenses. This and other information can be found in the income funds prospectus at fundrise.com slash income. This is a paid advertisement. All right, back to the show. When I have looked back to 2022, I think about all these names that were just high-furtains. flyers in 2021 and then their growth slowed down and then the stock just got hammered. I think it's much harder to average down psychologically and buy more into something like that versus something that's just consistently delivering the consistent high quality growth that they're doing. So like

Starting point is 00:45:26 top line revenue continues and increase, I think investors really pick up on that consistency and, you know, it's not so choppy in terms of like tremendous growth one year and growth that slowed way down the next. And, you know, I think there's sort of the predictability in determining that quality there. And also something that's able to continue to grow and weather through those troubled times makes it much easier to buy into quality companies. I agree. And in the book, I've also mentioned this, so that, you know, this bear market made me realize why psychologically I'm not really suited for very, very sharp volatility of 70% on the way up and the way down. I think for me, minimizing volatility, you know,

Starting point is 00:46:07 by building a very robust portfolio, prudently diversimate portfolio. I think that is what really suits my temperament. So this is, again, something which you have to go through the grind and the experience to actually discover your own investing style. So I wanted to pull in one more quote here because I think it's just so important when it comes to understanding our biases. You're right. Many times investors who have seen a bear market are unable to participate

Starting point is 00:46:31 in the subsequent bull market due to price anchoring. focus on finding value, not on trying to get the lowest price. And I think this is just so, so important, especially if your goal is to own high quality businesses, because high quality businesses, over time, they generally tend to continue to hit new all-time highs at just about every year. It can be difficult for us, you know, as investors, because it's so easy to get anchored on where you could have bought the company one year or maybe even three or six months ago. True.

Starting point is 00:47:02 But this is again what makes Warren Buffett the greatest of all time, right? He bought Apple that had already not reached cult status and more than a trillion dollars of market cap. And yet he made the biggest amount of money of his entire investment career in Apple itself. He did not do price anchoring. He focused on finding value. He bought Apple stock and it was out of favor. But Buffett had the vision to visualize Apple as a consumer brand company, branded consumer company, not as a hardware company. He was able to look at the high switching.

Starting point is 00:47:32 cost and the strong customer loyalty for the product. And he focused on the qualitative attributes which mattered and not the prevailing market sentiment. And this is, again, the hallmark of a great investor. It is your independent thinking to take a view which is different from that of consensus. Because if you take the same view as that of the consensus, then how can you outperform? One more quote I wanted to mention here too is different stocks require varying degrees of patience. What did you mean by this quote here? This is a very important code actually and it's true that different stocks require different degrees of patience.

Starting point is 00:48:08 Be very patient with able management teams operating in structural growth industries. And if you can find such companies in the small cap or midcap space with a large addressable market opportunity and having sector leadership, then be the most patient with such investments. It's very, very important because then you have struck the gold mine. Very, very important. And, you know, there are certain embedded optionalities in a business which the market cannot price upfront for management that can scale. Businesses led by dynamic management tend to keep springing positive surprises by pivoting into adjacent areas within their industry. And they keep expanding the terminal value, something which is quite difficult to model in an Excel spreadsheet.

Starting point is 00:48:53 So this is why, you know, you tend to keep getting positive surprises when you partner with very capable. managements and you tend to keep getting negative surprises when you partner with fraudulent management. Again, you know, the power of management in long-term wealth creation just cannot be overemphasized. It is so, so important. And this is again, something, it's a soft factor, but there's something which again, you get to appreciate only with the passage of time and experience. This is why I've talked about the importance of management so much in my new book at multiple

Starting point is 00:49:22 places. You'll see, I'm repeating the same point again and again because this principle is getting reinforced in my mind again and again throughout the, as the bear market picked up. team because I was noticing that the average or below average management's their companies were struggling a lot. Whereas the strong capable management, they capitalized on the bear market and the depressed industry conditions to capture market share away from their competitors. And this market share capture during recessions and bear markets is a source of great value creation for shareholders over time over the long run. That's why you should have focused on

Starting point is 00:49:54 sector leadership and strong management teams. I had a question here on the wisdom of markets. Many people echo Benjamin Graham saying that the market is a manic depressive, which it sometimes can be, but there's also a lot of wisdom that can be found in market prices, and how markets react during different periods of the bear and bull markets. And you have one journal entry here. You talk about watching which stocks don't correct with the broader market, and which ones are the first to hit new highs when the market stabilizes. So can you talk to us about how market prices give us valuable information in signals about a company. Sure.

Starting point is 00:50:35 So as an active and highly engaged investor, over time, you develop what is known as a feel for the market. So what do I mean by that? If a group of stocks from a single industry are all weighing up rapidly for a few successive days in a row, then that is a strong signal to you being given by the market, that the underlying fortunes of that industry may be turning around and should be investigated further. In fact, this is one of the best ways to identify inflection points in any given sector or industry.

Starting point is 00:51:04 And this is just the starting point for research. This is not a necessary condition that you will find that the industry is turned around, but it should make you sit up and take notice. I'll tell you what I do in such cases. The moment I see a particular industry, stocks from a single industry is suddenly going up together as a group for a few days in a row from very depressed levels. I immediately download the latest earnings conference called transcripts of the leading companies in that sector. and try to read between the lines about what the management is saying because you may get clues from what the management is trying to say in that latest or most recent earnings conference call

Starting point is 00:51:37 and most of the time you'll observe that the stocks which are going up do not have been have any current earnings to speak of. They're currently loss making or because of the industry down cycle, but we get to realize only in hindsight that the market in fact was a very smart discounting machine. So just try or, you know, try your best to, you know, do some scuttlebird, try to connect with industry sources to get a sense of what's happening on the ground. Because by the time, it's reflected in the reported numbers, by that time the stock presses would have run up. So you have to do the work. Pay attention to the market. Pay attention to what the market is trying to tell you and then start the work at your end. One interesting point that Chris Mayer has told me in relation

Starting point is 00:52:16 to this is, you know, as value investors, oftentimes we're looking for something that, you know, seems to be trading at a good price. So oftentimes we can see, oh, this stock's down 20%, but the fundamentals haven't really changed with it. So today seems like a discount relative to recent prices. One comment he made to me was that sometimes the market can get ahead of a company's future growth. So a company might be at all-time highs. And you're like, oh, well, I'm not getting a bargain because you have that anchor of where the price was before. But sometimes the market can see a quality management team continuing to capitalize on the opportunities ahead. And even if a stock's at an all-time high, sometimes they can still be trading well below its intrinsic

Starting point is 00:52:56 value. Very true. So any stock which became a thousand bagger or a 10,000 bagger or a hundred bagger hit an all-time high, hundreds and thousands of time in its journey, right? So unless you buy a stock at an all-time high, how will you make money? It's obvious. It seems very obvious in hindsight. And in fact, I'll give you one more example here.

Starting point is 00:53:15 So, no, any stock in the world, which has compounded at 18 to 20 percent for the last 20, 30 years, was by definition undervalued at all points of time throughout those 30 years and while it was hitting all-time highs. This is why I always seen to talk about focusing on underlying value and not focusing on the stock price. And this is what differentiates value investors from momentum price chasers. I had one question here about the Fed. In late 2018, you talked about how markets were falling and since inflation was low at the time, you expected the Fed to intervene to avoid a meltdown. Today, you know, the Fed is all what a lot of people want to talk about. There's a ton of pressure on them. There's a ton of pressure and concerns around inflation.

Starting point is 00:54:01 So I'm curious how you're thinking about the Fed's policies today and its impact on markets. Well, it's really interesting that you asked me this question because just yesterday night, well, before going to bed, I was reading Howard Mark's latest memo, which is titled Further Thoughts on the Biggest C-Chain. So last year in December, he published a memo called a very big C change in the markets. And just yesterday night, a new memo came out titled Further Thoughts on C Change. So in that, Howard Marx is trying to bring out this very point that we are the era of zero interest rates is over.

Starting point is 00:54:35 And now we investors will have to work harder to make good returns from equities because now equities as an asset class faces a very strong challenge from a very viable alternative fixed income, which was not an alternative for the last 13 years since 2008 in 2020. 2008, the Federal Reserve cut interest rates all the way to zero. And for the next 13 years till 2021 end, it basically stayed near that levels. So money making was relatively pretty easy, except for a brief period in between because of COVID. But now that money market funds are giving you more than 5% and the Federal Reserve is clinging on to this higher for longer narrative, that's likely to act as a headwind for equities over

Starting point is 00:55:15 the medium term. what may happen here is the markets may become range bound, the markets may go into a long-term time correction, but individual bottom-up stock pickers will be very handsily handsily rewarded. I think this is the time for active management to shine and to make a very strong comeback after almost more than a decade of underperformance. So this is what my view is. And as far as the Federal Reserve is concerned, I think they have very less headroom today to cut rates to very low levels.

Starting point is 00:55:42 And late 2018, they're driven by the stock market sell off. Jerome Powell made a statement in January 2019, then he said, okay, I get your message. I will not be that restrictive anymore. Then he started cutting rates by the middle of the year. But this time around, even though the federalism may want to help the markets recover, but their hands are basically tied by the very steeply entrenched inflation, which does not look like going back to 2%, which the feds target anytime soon.

Starting point is 00:56:09 I think we are in a higher for longer regime for quite a few years down the line. And I think if you look at the Federal reserves dot plot, I mean, they forecast that they don't see the inflation going back to 2% anytime soon within the next two years. So we should definitely pay respect to valuations in such an environment. And this is not the time to take excessive risk. This is the time to cut leverage from your asset allocation, cut high risk from your asset allocation, focus on quality, be prudent, and pay respective valuations. I think that is how I would approach investing in this environment.

Starting point is 00:56:40 And conventional wisdom, you know, says with higher interest rates, you're going to see lower stock valuations. It seems a bit too simplistic for me, you know, after being in the markets for a certain period of time, you tend to kind of become skeptical of if X, then Y type statements like that. I'm curious what your thoughts are on, you know, how interest rates should be impacting valuations and whether that impacts how you're valuing companies today versus two, three years ago. So I've talked about this in my book as well, that as long as interest rates go up in an orderly manner, stock prices can go up at the same time as well. So by middle of 2007, the Fed fund rate was 5.25%. It was only after many years of tightening that we finally had

Starting point is 00:57:29 the subprime crisis and the stock market crash in 2008 and 9. But for many years, between 2003, to 2007, yet a multi-year bull market because interest rates went up in an orderly fashion. But this time around, because interest rates have gone from zero to five percent in just a matter of one year, it's a pace of increase which matters to the market, not the absolute increase, but the sharpness of the increase because interest rates have gone up so fast in such a short, short span of time at a time when global debt has crossed $100 trillion and US federal debt has crossed $33 trillion dollars and cannot fathom or imagine a scenario in the future when something bad is going to happen because you have a scenario where trillions of dollars of debt has been taken

Starting point is 00:58:12 and interest rates are going up at the same time. So something, some big financial accident is around the corner. We already saw the initial teaser of the teaser of this in March when signature bank, First Republic Bank and a few other banks basically collapsed. So I think, you know, you will see a lot of regional bank failures over the next few years because of this high interest rate environment because what's going to happen is a lot of people are going to basically go opt for the large, larger, safer banks because they perceive them to be safer and there'll be a deposit flight away from the regional banks. And they are also very heavily exposed to the commercial real estate market. And we all know that commercial real estate market is in a big mess. I think regional banks

Starting point is 00:58:51 are going to be the very big pain point for the U.S. stock market over the next few years. Well, I guess that begs the question. You know, we may see another bear market here in the near future. You mentioned avoiding highly leveraged companies. How else can investors best prepare themselves for bear market? This is a very, very important question, play, that as an investor, how can you be best prepared to survive the periodic severe bear market corrections and the future bear markets in your lifetime? Ensure that you have tennis balls or high-quality stocks in your portfolio and not eggs or junk-quality

Starting point is 00:59:29 bad stocks, which will splatter after hitting the floor. Many individuals make large paper fortunes in bull markets, but eventually lose all of it when the bear market ultimately arrives. So during the bear market crash, both quality and junk stocks fall. Quality eventually bounces back to all-time highs after the recovery, whereas the junk stocks never recover or lie low for many, many years. And how much you're able to recover after the recovery, how much you're able to retain after the recovery from a bear market is far more important than how much paper profit.

Starting point is 01:00:02 You make during a bull market and quality of the business and quality of the management matters the most in retaining long-term wealth. This is again, you know, one of the single biggest learnings for me in my career that, you know, just focus on quality of the business and quality of the management because this is what's going to allow you to stay the course to have the courage to buy more during market corrections and well markets. And it will also help minimize drawdowns to the maximum extent because there's always, you know, a demand for high quality equities in any stock market. So, you know, the bear market is over, the first round of buying comes in the high quality stocks only. So not only does it provide you healthy returns over time. It also helps minimize drawdowns. And you know, the point about drawdowns, even though these value investors do not equate volatility with risk, the point about drawdowns has become significant when you're putting large amounts of capital to work, especially when you're running a asset management business or

Starting point is 01:00:54 a fund management management business. And I've worked as a fund manager at a mutual fund before. So I know there are two things which clients do not like. Clients do not like, even if it's a portfolio of 25, 30 stocks, if any single stock blows up 80% 90%, even though the overall portfolio impact is muted, clients do not like any single stock blowing up like that. And if the market, if the relevant benchmark index is falling 30% percent, and your fund is down 50% or more, that is also something which clients do not like.

Starting point is 01:01:20 Clients basically want you to fall slightly less than your benchmark during market sell offs and rise more than the benchmark during market recovery over the long term, you'll end up with a healthy CAGR. And this is how you build a sustainable long term investment business. This is again a very important point for all emerging fund managers to take care of. Because we may be comfortable with volatility. We may be comfortable with 40, 50% drawdowns. You know, for us, for us, it is like child's play now.

Starting point is 01:01:46 But clients, you know, for whom this is not the primary profession, they get scared and they then want to redraw their capital at the worst possible time when they see their account values crash like that. So, you know, you have to be practical about it, take a very objective view about these things and try to follow a philosophy which allows you to have a long-term track record and with, you know, good study rates of return over time. The CAGR should be healthy and you should try to minimize volatility to the maximum extent you can. In discussing the Fed, you mentioned the banking sector.

Starting point is 01:02:18 I'm curious if since you talk about the banking sector a lot during your book, is that, you know, a key part of, you know, managing your fund and companies you own. today and what are your general thoughts in banking and how it relates to India? In lending businesses, the jockey is much more important than the horse. It's all about management, management and management. And one that has been tested across at least a couple of cycles. The market rightly pays up for management quality in this particular industry. And for investors in a lending business, it is all about trust. Trust is a vital ingredient for valuations in a lending business because at the end of the day, as an investor,

Starting point is 01:02:57 you cannot really look into each and every loan that they give out. And in an opaque business such as lending, your primary bet is trust in the management. So management, a factor is the most important when investing in a highly leveraged business like lending. This is also what Warren Buffett has advocated in the past when he invested in many leading banks in the US. Management is what he looks for. That is the foremost important factor in his mind when investing in banks and lenders. And what you want to focus on in lending is growth is very easy to come by because, you're giving away money, what is important is the cost of that growth. So be very very

Starting point is 01:03:31 of lenders who are chasing hypergrowth or trying to grow at a very rapidly by just giving away money indiscriminately. Focus on the asset quality or the quality of the loan book. And the more granular, the more number of accounts that you have, instead of being concentrated in a few large accounts, the better of you will be as a bank or a lender. I wanted to read one last journal entry here and give you a chance to share your thoughts around it. Most experienced investors will attest to the fact that it's not about money after a certain level. It's about passion and love for stocks in investing. You can't really make it big if you are doing this only to get rich. So I'll just throw this over to you and allow you to expand

Starting point is 01:04:13 on it. This is a topic which I'm very passionate about, Clay, and investing success is very challenging over a long time period. It is essential to have great enthusiasm for the intellectual process of investing in order to sustain in this field for a long period of time. Because without the inner strength of our passion for investing to carry us during the periodic phases of pain and suffering, it is unlikely that we will be able to survive in this field for long. Personally speaking, stock market investing remains the most fascinating analytical sport I've ever come across and it is my lens to understanding in the world. Because of investing, I feel more connected to the world around me. To be a truly passionate investor means that you're always thinking about the future in the direction of the world.

Starting point is 01:04:59 And as a result, you're always enthusiastically observing everything around you. And investing isn't just a process of wealth creation clay. And it is a source of great happiness and sheer intellectual delight for the truly passionate investor. I wouldn't want to live life any other way. And I feel that, you know, I feel very fortunate and blessed that I've discovered my passion in life. And I truly love what I do every day. Well, I can really resonate with what you say there. I feel very grateful to have the opportunity to have you on the show yet again. And, you know, grateful to, you know, say I get to read your books as a source of income, which is just really amazing. And you mentioned, you know, investing being a sport. And Dan Rasmussen, a previous

Starting point is 01:05:39 guest here on the show, he referred to investing as the intellectual Olympics. And I just love that. And it's just so interesting and the learning never ends. So thank you so much for joining me for the second time. And as always, I want to give you a chance to give a hand off to your book, your fund, and anything else you'd like to share with our audience. Sure. So readers can order the copy of my new book on Amazon. And if anyone wants to learn more about Stella Wealth Partners India Fund, they can visit StellaWealthIndia.com.

Starting point is 01:06:09 Awesome. Well, thank you so much again. Thank you so much, Clay. This was fun. Thank you for listening to TIP. Make sure to subscribe to Millennial Investing by the Investors Podcast Network and learn how to achieve financial independence. To access our show notes, transcripts or courses, go to theinvestorspodcast.com.

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