Investing

Investing is difficult.

But not investing – sitting with cash and not finding stocks worth buying – is more painful.

After all, to most of us, activity equals achievement.

The need to remain active at all times is what leads CEOs to make bad capital allocation decisions, especially during heady times. And that is what leads most investors – big or small – to buy overpriced stocks.

We all want to be in the thick of action – largely because we hate the feeling of missing out on the party.

But then, as Charlie Munger says…

It takes character to sit there with all that cash and do nothing. I didn’t get to where I am by going after mediocre opportunities.

What to Do When There’s Nothing to Buy?
This is one of the most common questions I am being asked these days.

“I am not finding value in the stock market anymore,” asked a friend. “What should I do now?”

“Accumulate cash,” I replied.

“But that’s tough.” he said.

“Why?” I asked.

“Because cash in bank is a wasted opportunity,” he replied. “And why should I hold cash when it is paying nothing while stocks can grow my money much faster?”

Over the years and after learning my lessons (from not holding cash) the hard way, I’ve found several reasons to ‘hold cash’ when I have nothing to buy. Here are the biggest two –

1. When cash is paying nothing and stocks have a greater probability of losing, nothing beats losing.
2. If I don’t have cash, it is almost impossible for me to take advantage of opportunities that may present themselves in the future.

Accepting these reasons has made me fearless of holding/accumulating cash when I do not find (much) value in the stock market.

Of course, this is not with the intent to time the market – which is impossible. The intent is to avoid acting when I find no reasons to act.

As Seth Klarman wrote in his wonderful paper titled The Painful Decision to Hold Cash, the idea is to –

…remain liquid, defy the steady drumbeat of performance pressures, and wait for the prices of at least some securities to drop. (One doesn’t need the entire market to become inexpensive to put significant money to work, just a limited number of securities.)

But then, as Klarman also wrote –

Human beings are only endowed with so much patience, after all. Few are able to look past near-term returns, and today anything appears to offer better returns than cash.

Also, given their relative-performance-oriented, competitive nature, investors loathe the possibility of underperformance that comes from sitting on the sidelines; they find it better to be in the game (unless, of course, the market drops). Most significantly, they remain highly skewed toward the greed end (how much can you make?) and away from the fear end (how much can you lose?) of the spectrum of investor emotions. In short, investors remain the consummate yield gluttons, seeking high return without regard for the likelihood of actually achieving it or for the risk incurred in the process.

You see, investing doesn’t always mean “buying something”.

In fact, as Warren Buffett said –

Much success can be attributed to inactivity. Most investors cannot resist the temptation to constantly buy and sell.

Here is an insight from Prof. Sanjay Bakshi whom I asked this question few years back –

There is no “nothing to buy” situation. If you ignore transaction costs and taxes, you are in-effect, selling every stock you want to hold, and buying it back at market price everyday. Remaining invested in a position is the functional equivalent of selling it for cash and deploying that cash in the position at its prevailing market price.

I think you mean “nothing new to buy.” But if you think about that carefully, there is a disconnect. If you are, in effect, “buying” your existing positions every day, then when you say there is nothing “new “to buy, aren’t you also, in effect saying that you prefer to own what you do but don’t want to deploy new cash in those very positions? Now there may be good reasons for not deploying new cash in old positions but the reason cannot be that your old positions are overvalued, for if they are overvalued, then why are you, in effect, buying them today?

Two good reasons to not deploy new cash in old positions could be: (1) need to diversify; (2) setting aside capital in expectation of a new, lucrative opportunity arriving in due course in which you prefer to hold cash (Mr. Buffett uses this “carrying-a-loaded-gun-waiting-for-the-right-elephant-to-appear” approach).

If there is nothing new to buy, by doing nothing, you’re still buying cash. Cash has huge option value, but delivers negative real rates of return. Sometimes, in life, when all choices are bad, you simply choose the least worse choice.

What else could you do? Holding cash which earns a small negative return may not be a great choice, but it’s better than holding other assets which can greatly depreciate in value.

Another advice when investors face such difficult choices is this: Lower Your Expectations.

Finally, here is what Vinod Sethi, the ex-MD and CIO of Morgan Stanley India advised in the second episode of The One Percent Show –

People have this natural urge that if I have spent 100 hours doing something, then I must act. Whereas my view is that act when prices are going to go up or down, not when you have completed your homework. The market is not waiting for you to complete your homework for the prices to go up or down. I would always urge a lot of my analysts, including myself, to delink analysis from decision-making. Because you have spent a hundred hours on something, you don’t need to act.

The key to being a good money manager is to not act, or not link your hard work to your action. Delink the two. Keep working, because the point of conviction and intuition comes when it comes. But at that time, your homework should be complete. That time you shouldn’t be running around doing homework, because that intuition point will happen when it happens. It is all sitting in your brain. But you act when your intuition wakes up. In a way, the market whispers in your ear.

At the end of the day, I’d say that’s what it is. Because there are 10,000 listed stocks and why would you zone in on something? You need to do a lot of work, but don’t believe or don’t live under the delusion that your work has got you this brilliant idea.

The work has given you the foundation for good seeds to grow. It’s like a garden, which has been well fertilized and watered for some roses to bloom. That’s your research on a daily basis. But the act of the rose coming is when there is a confluence of events, like when a stock is dirt cheap or forgotten or expensive. There’s the real world out there and you’re ready with your homework.

Let’s put it this way. It is like there’s a woolly mammoth coming at you and I give you a gun with a few bullets. There are two ways you can respond. I’ve given you a gun with bullets, so you can start firing. The other way to look at it is to just sit and fire when the woolly mammoth shows up. So, research is like loading the gun, having the bullets. The opportunity is the mammoth showing up. They’re not linked. Having a gun gives you the arrogance that I will fire and can hit the mammoth. That is a classic mistake of most analysts.

In short, keep doing your work of identifying great investment opportunities, but if the prices are not right, and there is no margin of safety, don’t act. Least of it, don’t act just because you have done the hard work. Stocks do not bother about your hard work.

But when the time is right, and you are ready, as Vinod said, the market will whisper in your ear.

Act then.

That’s about it from me for today.

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Thank you for your time.

Regards,
Vishal