Down down down down...

Wow, what a sell off. The market is down around 20% in the last week alone. This is the same as the 1987 crash except that it took a week as opposed to a single day (and the fundamentals then were better). So again coming back to the million dollar question..Is it buying time yet? I addressed capitulation before and determined there's still time, plenty of time. Really? But oil and gas sector is down around 60-80%, quality companies are selling for 1/6th the value they were selling at before and the market is factoring in $60 oil. Well there might be some bargains in this market but lets go through a quiz first; this is courtesy of Prof. Sanjay Bakshi of the Fundoo Professor fame, he teaches Behavioral finance (as important as knowing the numbers) and manages a hedge fund.

So here goes. You go to a store too buy a cell phone and its retailing for $500. The store clerk tells you that if you walk 10 blocks you can get the same phone for $400 (the clerks incentive structure is suspect!). Would you walk 10 blocks to save $100? 90% people would say yes (the rest are just plain old lazy)!

Now that you have a phone, you want to go buy a car and the car is retailing for $20,000. The salesman again tells you that if you walk 10 blocks you can get the same car for $19,900! Save yourself a $100. Would walk 10 blocks to save $100? Very few people here would say yes even though its the same $100. You are buying things that cost very different amounts, but the change to your net worth is the same $100. So rationally, it makes sense to walk and get your car cheaper!!

Professor Baskhi explains it as follows, "The brain, operating at the subconscious level, is often influenced by the presence of false “anchors”. Anchors are pieces of information to which a mind tends to latch on to while making a decision. And the human mind will often latch on to false anchors created by various influences like availability or contrast."

A stock many have fallen and fallen hard, but that does not mean we should look at where the stock was trading just a few months ago and 'anchor' our expectations! That would be a wrong way to look at it. The crash has indeed produced bargains, but these bargains are only to be had after a lot of research and due diligence. It should be determined that the stock is 'safe', has a strong balance sheet and can weather the downturn, if extended. Cheapness can take two forms: (1) Is the stock cheap because its market cap is way below its Book Value (the real book value as determined by you, and don't count the banks here) (2) Is the stock cheap as determined by the future cash flows it will produce. I believe, that in these environments, you can find both, cheap (both type) and safe. Some stocks in the oil and gas sector may have come down so that it is easily determinable that their assets (ignore them if their cost/bbl are high) are worth more than their market cap (after debt). These things take a lot of work and effort. So dig away and find these gems, demand a greater margin of safety but anchoring to the highs, well....