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The Expected Unexpected

When the markets crashed last week, a lot of people were surprised, which by itself is a bigger surprise! After all, wasn't such a meltdown expected to happen? Wasn't it the expected unexpected?

When I wrote about the differences between speculation and investment last week, I didn't know how quickly would the stock markets provide a vivid demonstration of the differences between speculators and investors. On January 21st and 22nd, as the stock markets collapsed with a speed that had never been seen before, these differences became crystal clear. The speculators were the ones whose losses were out of all proportion to the amount by which the indices had fallen. If the indices were down 10-15 per cent, the speculators were the ones who'd lost 50 per cent or more of their investment. In many cases, they lost their entire investments. How did they manage to lose so much? Obviously, by trading on margin in stocks that had no real basis for their inflated prices. 'Trading on margin', basically means investing on borrowed money. It's like buying stocks by making a small down payment. It drastically magnifies the profits on can make when stocks are rising. And obviously, when stocks fall sharply, it is one of the fastest and most efficient ways of losing money.

Unfortunately, the speculators were also the ones that the media's hysterical the-sky-is-falling coverage was focussed on. I saw this news story on a major website that said that the Ahmedabad police had posted some of its men at the Lake Kankaria in the city to ward off any suicide attempts. Interestingly, I chanced upon this story because a popular US news aggregation site had a link to it with the headline 'Cops secure the largest lake in the trading city of Ahmedabad, India to prevent suicides after market crash,' sort of implying that Indian stock traders were leaping into lakes in droves and the police were struggling to contain them. So that's another big difference between speculators and investors-when the stock markets crash, the privilege of being talked about on TV belongs entirely to speculators and the poor investors with their paltry losses are just not interesting enough to anyone. Investors had lost lots of money too, but losses were generally smaller than the gains they'd made in the months and years before that. For example, most mutual funds losses (and gains later in the week) were broadly in line with indices. Moreover, there were no surprises. Funds in the more conservative categories fell less and the more aggressive funds fell more. All in all, there were no mutual funds that went even close to being in a long-term or even a medium term loss. This was also true of any well-thought stock portfolio.

However, this lack of surprises seemed a world apart from noise that was made around the crash. Through all the breast-beating that was happening, what came through clearly was that the stock market crash had genuinely come as a surprise to a certain set of people. But this surprise itself is a bit of a surprise. Even though the speed of collapse on last Monday and Tuesday was quicker than anticipated, there was nothing surprising about the fact that stocks dropped. The US credit crunch, the huge bank losses, the impending slowdown and their possible impact on FII inflows and the general likelihood of these factors creating a market panic have been widely known for a long time. They've been written about, discussed and analysed for a few months now. So what was all the shock and awe about? These kinds of things happen and will continue to happen in the stock markets. While what happened could be called unexpected, it was an expected unexpected, and not an unexpected unexpected.