MANEUVERS IN THE STOCK MARKET: THE DEVIL'S GAME

When I was working in the Securities Department of Tobank and Halkbank from 1991 to 1997, I had to face four situations at the same: the investment fund, the bank's stock portfolio, the customers' portfolios and my own portfolio. It was a delicate balance that I had to deal everyday for most of the time; all the eyes were upon me as I was the only one doing the securities analysis and establishing the portfolios' structure and composition.

Regarding the dealing with the investment fund, I had to take into account the constraints set by the law in one hand and the ones imposed by the bank itself on the other hand. Thus, the maneuver involved a constant re-balancing of the fund in order to meet the criteria set by both sides. For example, the law stipulated that the part of the stock present in the A type investment fund was not to drop below 25% whereas for the B type of investment fund, the stock ratio could not be more than 20%. This was the reason why most of the B type funds were either liquid funds with Treasury bills having a maturity of less than 3 months or bond funds or currency funds (which in turn, were state bonds that were sold on the foreign markets in USD or in DM). Consequently, I had to follow these guidelines and watch constantly the balance between the stocks and the bonds. Somehow, the bank had a different view regarding the A type fund as it wanted it to have a yield that was not more than what they were offering for a drawing account.

As far as the bank's portfolio was concerned, I got involved directly in Tobank between October 1991 and January 1992, and in Halkbank from July 1993 until January 1997. There were no real constraints in the management and the composition of the stock portfolio other than some broad lines dealing with liquidity and return. At the beginning of my portfolio management adventure, the management of the department did not trust me as I was a rookie in their eyes. And my ideas about the portfolio management and stock selection methods were seen as dubious in many respects. Consequently, my task was to persuade my superiors that my ideas were correct and thus achieve freedom of decision from above and collaboration from below. Nevertheless, the opportunity came in front of me in August 1991 when the manager of the securities department M.C.C. had gathered the team in order to teach us the sorter analysis. At first glance, it was great and we all jumped on it. But, after few weeks, I started to rebel against it and stated to the manager that it was too long and it was taking too much time and that we had to simplify it. I had proposed to drop the number of criteria from 50 to 20 in the first stage which he accepted. The second version of the sorter was better but I was not satisfied with it as I wanted something simpler and more direct.

As far as my stock selection is concerned, I favor a group approach; I try to buy groups of stocks that meet some simple criterion for being undervalued such as low price to book value or low P/E ratios, regardless of the industry and very little attention to the individual company, provided that there is an adequate balance between value and financial risk.

Due to the time horizon that was shortening after that the government had set the date of the elections for October 17th 1991, we decided to speed up the selection process. In the first week of October, I came up with a prototype of stock selection involving the combination of price elements and half a dozen of financial ratios, bringing the number of criteria down to 10. With this model, I analyzed 80 stocks and picked the top 8 stocks that were to be invested in dollar equal basis to a portfolio worth 100.000 USD. We formed the portfolio during the week of the elections when the ISE index stood at 2400. Needless to say, the investment fund was a big bond portfolio and I never touched it. Regarding the customers' portfolios, I had organized them in a similar fashion to the bank's portfolio but with a twist in the size of the portfolio. For most cases, I had to concentrate the portfolio in one or two stocks. Nevertheless, when the market rebounded and reached 5128 in the third week of January 1991, our portfolio had a return of 220% and the customers' portfolio had all beaten the market's return at various rates. For my part, I went from 1000 USD to 5000 USD...

When the manager T.K. left Halkbank's department of securities in July 1993 (Tobank was merged with Halkbank in May 22nd 1992 by a ministerial decree), I was called in to take a look at the bank's portfolio. When I inspected it, I found out two things: first, the bank's portfolio looked like the Noah's Arc for there was absolutely no consistency among the stocks present in it and it looked more like a zoo than a concrete stock portfolio; second, the portfolio had lost 50% of its value (dropped from 2 million USD to 1 million USD) despite the market had doubled in terms of USD since the beginning of the year. In the mean time, when I worked in the research department of Halkbank Securities Department, I had organized the customers' portfolios which fared quite well until the end of the year attaining a return of 500% in USD whereas the market itself had a return of 300% in USD. I turned to the newly appointed manager Y.Y. and told him that we had to liquidate the portfolio in order to clear our minds and start on a white page. He was white himself when he heard that but after a second thought, he accepted my proposition and liquidated the portfolio. I started to look around for opportunities when a news arrived to the department stating that the energy sector was going into a strike. The prices of all the energy stocks dropped (we were saying energy in the market but in reality, they were petrochemical companies). My attention was concentrated on two stocks: Tupras and Petkim. Both stocks had dropped by more than 50% in a short notice. I turned to the manager and said that we should invest the whole portfolio in Tupras. He was stunned when he heard that and said that he would fire me if the portfolio were to lose money and I accepted it.

I had to talk with our broker K.I. regarding as to how I would operate. We held a meeting on the evening before the start of the buying operation where my colleague and my friend A.A, the broker K.I., the manager Y.Y. and myself attended. I was in charge of the tactical aspect of the operation, mainly investing the whole portfolio in Tupras while the broker was to follow my orders and A.A. would monitor the operation in the name of Y.Y. On that evening, when I went home, I grabbed my grandfather`s field glasses without informing my grandmother (she would have killed me).

The story of this field glasses is interesting. My grandfather was a brigadier general of the Turkish Army and retired in 1961 but in may 1942, a Turkish military delegation went to Germany to meet the German High Command posted in Wolfschanze in East Prussia. My grandfather spoke French and he acted as a translator during the meeting and the Germans having liked him very much, had given him a medal and Hitler had given him through Field Marshal Keitel the field glasses.

So, I ended up using it in the stock exchange where the stocks were written on the boards and I had to stand behind a bar and watch the board with the field glasses and give the orders to the broker through hand signs. The other brokers who knew me were a bit surprised to see me like that but I must say, the scene was exciting. It took me 5 days to invest the portfolio into Tupras without causing a distortion on the stock board. And I repeated the same procedure on the sell.

Shortly after the operation was completed, news reached that the strike was over and the stocks doubled in a short notice. I had also recommended this stock as well as Petkim to the customers but their position was less important as they had portfolios of 8 to 10 companies.

Then, in the fall of 1993, I had bought Bagfas, a major fertilizer company which had returned 30% and in early December, I bought Eregli at 5.000 TL and decided to sell it at 7.500 TL but the manager Y.Y. told me to wait a bit; I was shocked but I had to comply and he sold the position at 8.500 TL.

At the end of the year, the portfolio had reached 3.150.000 USD and the manager Y.Y. transferred it to the top management. Consequently, I concentrated on the customers. During the first week of January 1993, the stock market was brewing and the prices were skyrocketing and I was busy to downsize the customers`portfolios and switching them to repos as I was seeing an overvaluation of the market; a herd-like mentality was sweeping the stock market. At the beginning of the second week, I had forced the clients to liquidate all their positions and place their money in repos until I told them to enter into the stock market. On the 13th of January 1994, the credit rating of Turkey dropped and the stock market started to fall dramatically from 30000 level. The second cut in Turkey's credit rating made the matters worse and the stock market continued its sharp decline until reaching 12800 in February 15th 1994. In the meantime, the USD had surged from 15.000 TL to 38.000 TL with O/N repos soaring from 70% to 400%.

During this terrible period, a customer that I had never seen before was sent to my desk by the manager Y.Y. The person in question had invested 500.000 USD in July 1990 when the ISE had reached 5700 just before the invasion of Kuwait and now, he had 125.000 USD left. He was working in the construction business and was upset to hear that there was a research department and that he was not told about it. Nevertheless, he asked me what could be done with his portfolio. After examining it, I saw that it had the similar problem with the bank`s portfolio in the summer of 1993 and the market in February 1994 was in its abyss. Consequently, I proposed him a daring plan: sell off the portfolio and concentrate on a blue chip, Petkim. He paused for a minute and went to see the manager. Shortly after, the manager came to my desk with him and explained to him that I was correct and that he backed me on this matter. So, the customer invested all his portfolio in Petkim at 3.000 TL or 0.10 USD. The following year in April, when the stock had surged to 50.000 TL, I called him but his son answered and I asked his father. He told me that he was deceased and that he was in charge of the portfolio. It was very sad to hear that but I recuperated rapidly and told him to liquidate the whole portfolio which he did promptly next day by coming to my desk. The position was sold at 50.000 TL and the portfolio at that moment was worth 1.3 million USD...

During this period, the investment funds of the bank had fallen drastically in value and real terms, the stocks as well the bonds were in a terrible shape but I only got the details by pure coincidence. In the second half of the February 1994, the manager in charge of the investment funds at the headquarters in Ankara had called the broker. But as he was not there, the manager was transferred to me and I had learnt that the selected stocks were proposed by the broker in question who, in my eyes, could not count up to three financially speaking. He was collecting the hot tips circulating in the stock exchange and then passing them to the headquarters which in turn was forming the stock composition of the funds. I requested the list of it and after inspecting it, I prepared a drastic plan of action which I submitted to my manager Y.Y. who in turn, approved and sent it to the headquarters. The plan was simple: liquidate the whole stock component and redesign the portfolio by investing in deeply undervalued stocks but with limited stock diversification by paying close attention to the trading volume. I had also advised them to avoid touching the bonds and that they were to replace them with high yield bonds when the previous bonds expired. In August 1994, the market had doubled in value whereas the fund's switch of bonds coupled with the appreciation of the stocks had seen its stock component rise from 25% to 40% and was set to beat the yearly inflation rate before October. But the headquarters' call for restructuring the funds in order to meet the 75% per year while the inflation was at a level of 150% was more than appalling but I had to comply.

I can say that the funds' composition, though similar in many respects, had divergent objectives and no operational objective seemed to be envisaged by the headquarters. Looking at them from a professional point of view, the scheme did not appear at all promising and despite my efforts to restore the situation, top management's strange objectives prevailed.

I want to pause here in order to explain my thoughts regarding the issue of portfolio management. In most cases, the finance books tell us that we have to wait for the stock to reach its intrinsic value before selling it and when that stock is bought, we should not move if it drops below our purchase price for it is of temporary nature. I disagree with this because if you buy a stock below its book value while its intrinsic value is significant, despite the reality of the concept, it is very frustrating to see the position slide. Consequently, I was placing a protective stop below my purchase price in order to limit the loss. But as I was buying the stock at a big discount to its book value, the protective stop was almost never reached. On the other hand, along with selling the stock when it reached its intrinsic value, I was using trailing stops which were capturing about 70% of the move. Depending on the situation, I would adopt one of the two approaches as I saw fit. But when I was dealing with situations where one could not know with certainty as to how the stock would behave, I was inclined to use the trailing stop whereas when I was quite confident about a particular stock, I was preferring to wait its price reach its intrinsic value.

Various fashionable investment approaches used by the market participants have the advantage of simplicity, though hardly the charm of novelty. Consequently, one has to look to alternative approaches. Generally, the investment portfolios have a limited component of stocks which renders them to have low returns, thus pointless in terms of attractiveness. Thus, any subdivision of the limited capital would be the greatest mistake that one can make in the investment arena. But it is precisely this that the investors tend to do in practice.

The essential of the whole investment scheme is that we invest all the available limited capital in one company at a decisive moment; to have such a strong price appreciation that we need not to worry about the risk of loss; and then immediately exploit any profit gained on paper by placing a trailing stop without bothering to wait for the price correction.

Generally, top management cannot grasp the significance of active portfolio management. They want to have a carefully planned measures of investment based on definite, pre-arranged circumstances . They want a complete picture of the market before deciding on any undertaking. Once the decision is taken, it will be carried out according to a plan, one might say almost methodically. This mania for planned control, in which nothing should be left to chance, leads to the organization of the portfolio in a form that will not destroy the general scheme.

Using leverage in investments produce superior returns when the going is good, but produces also a loss when events fail to conform to the expectations. One of the main difficulties in judging is the level of risk in which one can feel safe. There are no universally valid yardsticks: each situation needs to be considered on its own merit. In the final analysis, one must rely upon its instincts for survival (leverage works in both directions: one has to be on the right side of the market in order to benefit from it).

I don't invest in companies according to orthodox set of rules: I am always more interested in understanding the changes that occur in the rules of the game. I start with a hypothesis relating to an individual company after I have done an analysis of it which provides me with some kind of an impression. I then turn this impression into a hypothesis by formulating it and test it in the market place. If the hypothesis is right, I obtain a good return but if the hypothesis is wrong, I lose money at which point, I have to contain my losses through the uses of a protective stop (a method that produces outstanding results during good periods and helps to contain losses during bad periods must be declared a success).

The stock market is like a casino and my approach of formulating hypotheses and testing them against the market has a tendency to become worse than useless: by the time I recognize a market trend and formulate a hypothesis to explain it, the trend has changed already and I have to find a new hypothesis. The result is that I am always lagging behind the market and keep on getting whipsawed until I abandon the hopeless struggle. I can argue that an approach which allows me to recognize when it does not work is a valid approach; still, it is somehow more convincing to demonstrate it at a juncture when it does work.

If you try to propound an unformulated hypothesis, what you will get is a hit-or-miss result. By contrast, when you deliberately formulate your hypotheses, you can consistently outperform the market averages, provided that your specific predictions are not too far off the mark. I can say that the process of treating the stock market as a mechanism for testing hypotheses is an effective approach: it produces results that are better than a random walk.

I want to add a word about the management itself on these matters. My approach to the stock market is abstract in a broad sense. It takes a form that is very personal and emotional: investing is associated with fear and pain whereas success is met with relief. Nevertheless, based on my experience on this field, the stock market's behavior is forming in my mind a different attitude: I have a low regard for the sagacity of the so-called market professionals and the more influential is their position, the less I am considering them capable of making the right decisions. Worse, they are so detached from the reality that their decision has a tendency to fall behind the events and quite often, their decisions turn out to be the wrong ones and we suffer from the consequences. For example, the headquarters of Halkbank was in Ankara but the stock market operations were in Istanbul and to make the matters worse, there was a lack of understanding and coordination between the two and that was causing a lot of trouble. Both sides were operating on their own and in moments of crisis, the problem was becoming plain to see for everybody. But the top management had other priorities.

During this period, I took the initiative of taking contact with the top management, especially with the manager of the Capital Markets Directory. I found out that he had little knowledge of what we were doing and I had to  explain to him what was going on and sent him a fax that summarized our dealing and our approach. Two days later, he showed up in our department and I was able to clarify him amply on the matters discussed above. After a brief meeting, he agreed that I would prepare the stock list with the portfolio composition and sent it to him after my manager's approval. Thus a liaison had been established between the headquarters and our department which worked pretty well.

It is essentially very important to work with a team where people know each other well and there should be a trust. When the manager gives an order with a few words, the personnel who receives the directive must understand it not only at his own level but also at the level of the department which will reinforce the effectiveness of its application. Consequently, a few words will suffice to operate effectively without having to go on length over the issues. In the stock market, things change rapidly and there is no time to discuss the matters during the phase of operations. Generally, I would discuss the situation with my superiors for 5 minutes and receive the directives (and not the orders) that I would apply as I saw fit because in a rapidly changing situations, I had to take the initiative as to how I had to tackle the problem, even if it meant to go against the directive itself. Unless the person is stupid, he will perfectly understand the concept behind the directive and act accordingly, provided that he is more or less competent on the matter.

Frequently, this understanding of the matters implies that one knows what's on the mind of the manager or the person who is operating. This can be reinforced by close collaboration between the personnel making up the team by, for example, organizing sporting events once a week where two teams would be set up and thus permit a kind of team play. This will have a direct impact upon the work. In North America, the teams are set as ad hoc where people don't know each other and have to collaborate. Quite often, the team members display their ideas and concepts to other members who accept them or not. When I went to the Ryerson University to take a course in investments, I was placed in a team of 4 where the students had no idea about how to operate the portfolio other than just selecting randomly the stocks and place them in the portfolio. My style being different, it did not work as the time period was short. But the management of the team was brilliant as I had given them the necessary directives as to how we would tackle the project. When one is dealing with a team made up of rookies, he has to educate them and provide them with a sense of trust. The number of team works that I had undertaken during the course of my studies in the secondary school and the high school were barely 10 and none of them fared well. It was only in the university and in the army that things changed because we were in the same boat. And when I transferred those skills to the securities department, it was a success. 

In today's working environment, people rely too much on computers and software. This creates a problem of too much dependency on these things and one gets rapidly detached from the reality when facing an amalgam of data pouring like a rain in front of you. We had learned in the high school and in the university as well as in the army not to rely too much upon electronic stuff as we were the ones who were making the decisions. The program delivers you a set of results and you are the one who is going to decide of what to do. But when you are dealing with a fast moving environment, the computers are of little help and time is more valuable than ever. The reliance of the computers hampers the decision process by lagging behind the events. We had developed an approach where the commitment of the team was deliberately set to a limited number of persons. In Halkbank, there were 3 persons dealing with the stock portfolio: the manager, the broker and myself. I had a simple computer screen in front of me where I was using the lotus 123 for my analysis of stocks and the monitoring of various portfolios. The analysis of the stocks was simple but very efficient and I was not wasting my time over the stock issues and thus I was able to concentrate on how to operate the stock portfolios efficiently.  

I can say that the concept of management we used in the securities department was a broad concept, embracing a theory of the nature of the capital market, character and leadership traits, command and control, senior-subordinate relationships, and training and education. It is a comprehensive approach to the management as a whole. The concept emphasizes the manager's intent, which gives the subordinate a base from which to make his own decisions, so that they are in harmony with the overall plan. The department was using mission statements in the form of the manager's intent. The manager then assigned tasks to subordinate sections to carry out his intent. The subordinate section's leader decided upon a specific course of action which became his resolution. It is more than a method of giving orders, actually more akin to a habit of thought. usually the manager would provide a single statement about the operation; the job of working out the details is left wholly to the subordinate section's leader without supervision. It was simply granted that everyone would exercise initiative to get the task accomplished.

To foster this kind of individual initiative is a major goal of the personnel and the manager's training. Through the personnel's training,  the individual's decision is honored, and if wrong, corrected without condemnation. To do otherwise will stilt initiative. When properly trained, the personnel finds it unnecessary to receive detailed specifics from their superiors in the form of orders and directives. Their thinking is not limited to specified doctrine or techniques but has to do more with a professional devotion to fulfilling the manager's intention. It is much better to make a decision now, than to spend considerable time to find the best possible solution or worse, to wait for accurate information before taking action. This attitude extends down the hierarchy, to the individual personnel. In a situation when the contact with the manager is lost, the subordinate leaders is counted on to take the action they thinks is appropriate, rather than to stop and wait until contact is reestablished. This aggressive attitude allowed us to take advantage of temporary profitable situation. A subordinate leader is justified in modifying or even changing the task assigned to him as long as his action supports the manager's intent.

During the fast moving operations in the stock market, the orders were normally given verbally, either by telephone or, if possible, in person. Later, when the pace has slowed down somewhat, a written copy of these orders would be prepared for the department's diary. The more formal process of developing orders would be too much slow. The training referred earlier would ensure that everybody thought along the same general lines. This will go far in reducing the length of orders, since details do not have to be mentioned. The personnel also tends to get to know each other better when they work together long enough. The manager and the subordinate leaders start to understand each other during the operations. The better they know each other, the shorter and less detailed the orders can be. In Tobank and in Halkbank, the team usually allowed themselves only about 5 minutes in which to decide what to do in the next operation in the stock market. The manager would issue the daily order at 9 a.m. By 9.15 a.m., the order had been analyzed by the section's leaders and were translated into directives and transmitted to the personnel.

The staff must be small and we had that chance in the department of Tobank and Halkbank, compared to today's standards. The less there is, the less aggravation we have. I see this as essential to the proper exercise of the concept. The operational level should have only half a dozen of personnel and leaders and a minimum supporting personnel.

The decision process was quick, without much detail or staff analysis, although the underlying staff work was both competent and detailed. We were stretched to the breaking point but this practice helped to hold down the size of the staff and ensured continuity. The daily briefing with extensive number of staff did not exist. I would go with my papers to the manager, who is taking his morning coffee while trying to catch the air from the daily news on newspapers and television channels; I would deliver the verbal report quickly. There was no huge theater required.

During the period of heavy trading in the stock market, the manager had established a routine, of sorts. The manager spent the day dealing with the market. Late in the day, after conferring with his operation team, he made his decisions for the following day. He would go to the lower personnel and give personally the order for the next day. In this way, the subordinate leaders and personnel could begin to plan for the next day, although they knew that these orders had not yet been discussed with the headquarters in Ankara, and were therefore subject to change (it happened rarely). As he was closer to the market realities, he had a better feel of the situation and thus he was calling the right plays. Of course, he was not aware of the larger picture to the degree the headquarters in Ankara were. But close contact between him and the headquarters minimized the discrepancy, if it was ever practiced. Generally, the manager would be dealing with the daily market operations and thus see and feel the actual situation.I would brief him with the current situation within the market as well as the larger picture based on my contact with the headquarters in Ankara but the second rarely happened. This allowed the manager to compare the information about the portfolio's situation as he experienced it on the market with the one reported by myself. In this way, discrepancies could be identified and resolved; reality could be separated from fiction. He was also informed of the headquarters' situation, in particularly about the Director of the Capital Markets' intent. By keeping up with the overall situation through me, he could usually anticipate the next move. He was an extremely important asset to the headquarters who could count on him to have a very realistic picture of the market. Thus, the Director of the Capital Markets would place great weight on the manager's proposals, and usually accept them if they were in line with the headquarters' intent.

Today's securities departments and their staff often resemble a three-ring circus. Instead of using the new communications and data processing technologies to reduce the labor force, more personnel is required to keep the whole thing from collapsing. With more people, internal friction increases and it becomes harder to ensure that the right information gets to the right person.

The small size of the organization proved to be very effective. I served both as the orchestrator of the department's portfolio when a change had to be made and the department's contact with the headquarters in Ankara. I was the focal point of all the information coming from into the department from outside. I analyzed the information as well as the field reports and reported my analysis to the manager, keeping him abreast of the bigger picture. The manager did not spend much time with things outside the department, relying on me to tell him what he needed to know.

Important returns resulted by my adoption of unorthodox approach in dealing with the portfolio management. I knew that I was expected to show initiative in delivering a superior return. When a rare opportunity presented itself, I had the confidence to take advantage of it, knowing that this was precisely what my superiors expected from me. My guidance was the manager's intent.

Our need for detailed data must be tempered by what we really need to know in order to arrive at a quick, good decision, rather than what we would like to know in order to arrive at a lengthy, optimum decision. Operational staffs must be small so that information can be easily shared among a nucleus of personnel streamlined enough to advise the manager in making timely operational decisions.

In the operation orders, the managers often turn their concept into a lengthy diatribe on exactly how they envision the investment operation to be undertaken.  Short, very broad concepts are needed rather than detailed  minutes. Generally operations orders are far too detailed. Standard procedure, for example, belong in SOPs and not in operations orders. The manager must train his staff and subordinate leaders so that they don't need lengthy instructions. Quick, broad orders are needed to keep ahead of the events. The challenge is to combine the right style with the information processing power of the computer to achieve a management system where good decisions are made quickly and at the appropriate level.

MANEUVERS IN THE STOCK MARKET: THREE STOCK SELECTION METHODS

In order to obtain an investment result that will be above the average over a long period of time, there is a necessity of having a method of stock selection which incorporates two elements: (1) it must possess an objective or rational back-test; and (2) it must be different from the ones used by the vast majority of investors. My experience on this field leads me to consider three stock selection methods which meet them. They are different from each other and and each requires a different set of ability and psychology.

Blue chip companies

The market has a tendency to overvalue the stocks which have been exhibiting high growth whereas it undervalues the stocks that are out of favour due to adverse developments of a temporary nature. It constitutes one of the essential parts of the stock market dynamics and point to an investment approach which is relatively safe and promising.

The basic approach would be to concentrate upon the large companies undergoing an adverse period. The large companies have the resources in capital and in intellectual capacity to get out of the adverse situation and return to the normal earnings base; also, the market will most probably respond quickly to any improvement.

The idea of buying unpopular large companies on a group basis is quite simple. Nevertheless, when the individual companies are considered, another factor must be taken into consideration. During their good years, the companies have a tendency to sell at a high price and at a low P/E in the good years and the opposite in their bad years. In this case, the market has doubts over the perseverance of high profits in terms of valuation and the opposite when earnings are almost nil. Thus, one should start with a low P/E concept but must consider the issue together with qualitative and quantitative factors when constructing his portfolio.

Bargain companies

I define a bargain stock when it trades to less than its book value and thus is worth much more. In order to be definite on the matter, I may suggest that the stock is not a real bargain  unless the current price of the stock is less than 50% of the book value.

One can value the stock by estimating future earnings and then multiply them by a factor, whether inherent to the company itself or to the market. If the obtained value is well above the current price, the stock can be considered as a bargain issue.

At the bottom of the market, a large section of the stocks can be very attractive in terms of price, measured by such standards. The current earnings and immediate future may be grim but the average future conditions may indicate intrinsic values that are well above the current levels. The only thing that one needs in depressed markets is courage and application of some basic valuation techniques.

The excesses of the stock market's behavior both on individual basis and on market basis permits the existence of many bargain issues at practically all levels. Therefore, there are two major sources of undervaluation: (1) short term unfavorable results and (2) general neglect. Nevertheless, on a stand alone basis, these cannot be considered as reliable methods for sound investment.

One should look for some sort of stability in the earnings over the past years with a sufficient size and financial strength in order to meet unfavorable events. The best combination could be a large company trading at a big discount to its past price and average P/E. This method may disregard many golden opportunities but I prefer real-profits compared to probable profits.

Stock selling below liquidation value

Sometimes, the stocks have a terrible beating in the market and they sell at big discounts relative to their book value. In such instances, the liquidation of the business itself would produce abnormal profits. All that the investor has to do is to estimate the relative fire-sale value of the company's assets and deduct all prior obligations. If the balance is positive compared to the stock price, the investor has a good bargain.

My experience with this type of investment selection had been very good for several years. I can affirm without any hesitation that this stock selection method constitutes a very safe and profitable method of determining undervalued situations and thus exploit them.

ON QUANTITATIVE EASING: PROJECTIONS FOR THE YEAR 2014

In the light of our experience this year, there are two important determinants for the U.S. First, of course, is the U.S. Federal Reserve (Fed). If it does not start on December 17-18 on this year's last meeting, when and how severely it will begin to reduce the amount of bond purchases will be the primary determinant and it looks that it will start in the next quarter after the taking office of the new chairman. After that the Fed raised that possibility in May, the net capital inflow to developing countries decreased dramatically and therefore, the exchange rates and the interest rates spreads jumped. The reduction of net capital inflows decrease the rate of credit flow after a while. Consumption and investment spending are adversely affected; the growth rates are declining. Because it will lead to similar movements in 2014, the Fed's decision is very important.

The second determinant is whether the well known fight which has the risk of locking the fiscal policy of the United States will continue in 2014. The first test is in the first months of 2014: let's see what the Republicans and the Democrats are going to do. If the public sector is led to a shut-down of its system, the Fed's decision (if it does not start within this period of time) in terms of timing and/or severity may be affected: it may be postponed a few months and the purchase amount may be reduced further. The challenge of building a baseline scenario for 2014 has emerged while discussing the United States. We still have in store the uncertainties related to Europe.

There have been several positive developments related to Europe this year. First, several small steps have been taken towards the establishment of a common banking authority. Second, with the exception of Italy, the unit labor cost of the troubled countries is dropping. It has not reached yet the Germany's level  but there's an improvement which is considered as to be one of the biggest issues of the Euro zone. But nonetheless, Europe is growing slowly and the inflation is very low.

In that case, whether the European Central Bank (ECB) will or not loosen further the monetary policy is under discussion. What kind of path will the ECB follow depends on two factors: the first element is as to how the inflation will take shape in the coming months which leads to concerns such as "Is the scourge of deflation coming?" due to the fact that the inflation dropped below 1% during the previous two months. Secondly, of course, is the growth rate. If there isn't any development in this area and the inflation continues to remain below 1%, ECB may take steps for additional measures. It has the option between three tools that can be used together and which are not mutually exclusive: to reset to zero the monetary policy's interest rate which has been reduced to 0.25% during the course of this month. The banks will not accredit and give negative interest rate to the deposits held with ECB. Issuing more money by purchasing more bonds. The first one is the more likely. The second one is somehow doubtful. And the third one is a policy that could irritate Germany.

Consequently, I want to give an "early" basic scenario. "Early" because a significant part of the scenario depends on what the Fed is going to do. The Fed is meeting on December 17-18. In this meeting, there is a possibility that the "feared" decision is going to be reached. Even if it is not reached, its statements may change the expectations regarding the timing and the severity of the decision. If this is the case, then I will update my current scenario under the heading of "new base scenario". For the time being, my assumptions about the external conditions are as follows:

The Fed will gradually decrease the third quantitative easing during the course of the year and will reset it to zero. Even if it does not start it at the end of this year, it will begin in March. On the other hand, in accordance with what was previously announced, the monetary policy's interest rate will remain unchanged in 2014.

Uncertainties related to the fiscal policy in the U.S. will not be on the rise as compared to 2013. In different terms, the Republicans and the Democrats will continue their disputes in front of a scared world. But they will agree before the time is up. Meanwhile, the first test of the correctness of this assumption will take place in the first months of 2014.

Europe will not have a deflation and will recover, albeit very slowly: Europe is not expected to grow in 2013. By contrast, the IMF is predicting that it will grow by 1.3% in 2014. And the forecast for the Euro zone is at the level of 1%. On the other hand, the economic programs in force in the troubled countries will be continued. To put it differently, the questions of "Does the Euro zone crash?" will not come up. In this case, ECB will not undertake the monetary easing by purchasing bonds. There is a possibility to set to zero the monetary policy rate of 0.25%.

THE PRINCIPLES OF THE MANEUVERS IN THE STOCK MARKET

When I look for investment opportunities in the stock market, I look for cases of pessimism if not extreme. Each stock market crash provides me with a moment of great opportunity where the stock prices have dropped to such an extent that there is no more risk involved. This perspective pushes me to look for an opportunity to take advantage of the fear in the market and to look for ideas, under the condition to have sufficient cash at hand.

In most cases, I try to understand the nature of the problem with the price of the stock and the company itself and I put it into mathematical terms what these problems are. One of them is to determine the impact of the financial disaster upon the company and to quantify it. And then, I try to see if the problems have been reflected properly upon the stock price itself.

If you want to be a contrarian, you ought to do what other people are not going to do or will not dare to undertake. But one must not be a contrarian for the sake of being a contrarian. I always try to understand the issue and get some insights as to why people are not doing certain things and what are the elements that they do not take into consideration in terms of valuation.

When a stock has dropped significantly, just because it is cheap that one should invest into it right away has some reserves. Most of these drops are event driven and this requires an event driven analysis. When an event has impacted negatively upon a stock, one should look into it in order to see whether there's an opportunity. I can say that at least half of my investment ideas come from this understanding.

Any major financial crisis pushes down extensively the stock prices and thus creates an opportunity for me to buy a stock at a big discount. There isn't necessary a catalyst to turn around the stock and when a catalyst drives the prices down, I react to it by buying it. Frequently, the Turkish stock market had severe drops in the marketplace during the financial crisis, reaching more than 50% drops. All I had to do was to start to look for beaten stocks once the drop went further than 50%.

What I was trying to understand was what I was paying for the company and what was it doing. If it is a cement company, what is the value of the company in the marketplace, the enterprise value per produced cement unit? It is more interesting to me than just to look at the book value of the company or the earnings stream of it. I am trying to figure out what I am paying for this company per unit of whatever it does. And this in turn gives a better sense of "is it affordable?"

One must understand what it means to buy a company. It is not just the market value of the company but it also means assuming the liabilities in terms of balance sheet. Due to this, I do a lot of stock screenings. I look for problems that push down the stocks dramatically. Such stocks come to my screening because they have a lot of problems. Therefore, I do a number of screens in terms of valuation and attractiveness criterias such as a formula that I had developed to evaluate the private market value of the stocks.

I am very mindful of the famous phrase of Warren Buffett: "diversification is a protection against ignorance." I don't turn much the portfolio and in fact I avoid it as much as possible and accordingly, I hold 10 stocks at a time in the portfolio and my holding period is quite long, at least until the next extreme optimism in which case I sell the entire portfolio without a second thought.

One of the things that one must do as far as the investment style is concerned is to change the investment style over time. I maintain a list of stock selection methods but I must always have 10 different ways of looking at a stock. I do a lot of future earnings projections and discounting them to today's stock price and also, I look at the dividend streams over a long period of time. But had I kept doing the same thing that I had done 10 years ago, it wouldn't have worked. The dynamics in the marketplace change over time and consequently, I am constantly trying to improve what I am doing. When the market is offering me something, I have to identify what is cheap on the market. At some point, growth stocks might be cheap; in other times, value stocks might be cheap. Consequently, I have to find what is cheap in the market or what it is offering to me and I try to understand why it is cheap and what is the rationale behind that price. Flexibility in the investment approach is very important. And changing my investment approach according to what the market is accommodating to me is very important as well.

Over a long period of time. I have been trying to find a normalized earnings over a full business cycle. Many investors concentrate on what the company will do this quarter or next year but the more efficient part of the market is further out because people are not willing to look to that further out, they are not comfortable of holding securities that long. Thus, the shorter term is less efficient that the longer term; so, I concentrate on the longer term. I believe that the normal business cycle is five years. So I can figure out what a company can earn both in recession and in expansion periods over that five years period. Then I discount it back to the current stock price.

One part of my job is to manage risk. I want to know how much money I can lose in every single stock that I have invested and how much money I can make. I hold in the portfolio a certain number of names for the upside and I may be wrong a third of the time despite running the numbers on a constant fashion. For example, I may think that the bottom price is 10 but it may go to 8. Then the management sits with me around the table and discuss with me about it by saying that why I was wrong and is it temporary in terms of stock prices, etc (especially when I bought the Turkish Airlines at 800 TL (0.11 USD) in 1991 at 50% to its book value and in early 1993, the stock dropped to 400 TL (0.035 USD) at 20% to its book value before jumping to 24000 TL (0.40 USD) in 1995).

The most important thing for me when I am wrong is that I try to understand why I am wrong and I try to determine whether I am comfortable with that or not and whether the longer term thesis of the stock is still in place or not. When the price of a stock goes down and I don't understand why it went down, it will be wrong for me to maintain that position.

I believe that people are wasting time in thinking too much about the overall risk than the company's specific risk. And their asset allocation decisions based on risk trade totally ignore the company's specific valuations and this provides me with investment opportunities.