Why The Wrong question is being asked in Investing !


Forecasting or predicting the market movement



Sometimes I have been asked by friends on how will the market or certain stocks perform in coming months or what will be the direction of index moving towards in next year or so. 


<Image credit: factsanddetails.com>
Even in every investment seminars , one may notice that the most question people like to ask to those investment “ Gurus “ will be “ how do you think the prospect of STI index in 20XX ? or What do you think about the performance of Bank / O&G / property sector in coming months ?



The future, like any complex problem, has far too many variables to be predicted. Quantitative models, historical models, even psychic models have all been tried — and have all failed.

Bellow quoted from HBR : “The best prediction machines known to us are actually our own brains. Many people think of the brain as either a really powerful computer or just something too mysterious to explain. But it turns out that the brain is not mysterious, nor is it a computer; it is instead a damn good prediction machine. That is one of the reasons we do well at games like chess or baseball. 

While a human brain cannot calculate a mathematical equation as quickly as even the most basic calculator, it can easily determine where a ball in mid-flight will land — without calculating its precise trajectory or velocity, as a computer would do. Could you imagine trying to instantaneously calculate where a fly ball will land? Of course not. But I bet you could catch it.
Our brains are great at what they do because they make educated guesses — but that also makes us vulnerable to errors in judgment. Nowhere is this more pronounced than when we try to forecast the future.
The human brain is great at predictions but horrible at long-range forecasting. This is why we have no problem anticipating that the slithering stick on the ground might bite us (and can jump out of the way in a millisecond) but have so much trouble guessing where the snake will be the next time we go out into the yard (we almost always guess incorrectly and avoid the same spot). 
This is one of the reasons Nassim Taleb argues in The Black Swan that we are guilty of ascribing far too much predictability to the truly unpredictable. “


The real rub on Wall Street is that economic and financial forecasting models play on our biases. 


The Equilibrium Delusion :


In his book “ Forecast “ , the author Mark Buchanan , a former editor at Nature and New Scientist , highlighting that one thing was missing in today’s financial forecast and economic modelling .
“ Economic theory today is highly mathematical , and economist have often accused of having “physics envy!” , of using imposing mathematics to give their field the same prestige and apparent certainly as one finds in physics and in other nature sciences.

 An examination of the peculiar concepts of economics thinking , of the atmosphere of ideas of modern economics theory, which swayed many people to believe that the tumultuous history of economics and finance , a history of almost continual crises and disruption going back four hundred years , had somehow come to a miraculous end in our era because of the market’s self-regulating nature and tendency towards “equilibrium .” he writes.

He further elaborated that “ Yet the mathematical ideas used in economics are strangely primitive. In his address on wining the Nobel Prize in economics in 2004, Vermon Smith of Gorge Mason University noted that economic theory – for all it alleged mathematical sophistication – actually has only one model , which is adapted , contorted ,twisted , and tortured to fit to every circumstance . It is the hammer in search of nail.”


We will need to always remind ourselves that if someone, anyone, can provide you with the definitive answer to your investing questions on how the market or certain stocks will perform in near future, hate to disappoint you guys, but no one can do that for you.

So it turns out that the correct answer is, Sorry, you're asking the wrong question.”  The sooner investors accept that they don't have a clue about the future, the better off they will be.

What Investors should Ask Themselves Instead ?


Alternatively, may be the more proper question to be asked would be : “What will be the chances ( probability ) of winning the game at current market valuation ?”.

Below charts may give you some clues on what is the market valuation now .. but as disclaimer : this is not a call to buy or sell at current market level. 





From Regression line , it seems that we are still far from crisis level ( -2SD ) or even at -1SD of around 2475 point . Market are just slightly undervalue from regression point.  We definitely don’t know if we will have crisis in coming months but at least we know that we are not buying at much over-value at this level , one should have W.W.W in their mind ( War chest , Watch List , Wait patiently ).

Remember the best quote from Keynes : 

“The market can stay irrational longer than you can stay solvent.”.


Market can be in side-way (under-value ) for very long period of time, one should not expect the "mean reverting " is going to happen soon .






This is something strange and what puzzles me , valuation seems cheap base on PB but not so base on PE’s valuation.

Can someone please sheds some light on which valuation method should I use ? PB or PE ?
Should one believe that STI 's component is more on "asset play " or the price may have to drop more base on current earning level ?


Cheers !




“Volatility is a symptom that people have no idea of the underlying value.”  by Jeremy Grantham


Comments

  1. Hi STE
    In a falling market, P/B may not be so accurate as it is lagging, that is, many companies will take some time to mark the "book" to accurate market levels when it is constantly falling.
    Also, earnings is what drives the news, and correspondingly, what drives the share price in the short term.
    We see headlines like "company XXX hit record earnings..." but never "company XXX NAV rose to record highs..."
    TTI

    ReplyDelete
    Replies
    1. Hi TTI,
      Hahaha,,, that's very true, :) , earning is what drive the market and make headlines news !! One may learn on what previous STI blue chip Noble's story on what had happened to their asset value ,,
      Cheers !

      Delete
  2. Hi STE,

    I have the same thoughts as TTI. Though I would also believe that even when the book value is updated, the adjustment still wouldn't be as big as compared to P/E.

    A analogy would be a rental property. The dropped in rent during bad times normally is much larger than the drop in property prices (generally speaking).

    Regards,
    FFE

    ReplyDelete
    Replies
    1. Hi FFE,
      Thanks for the comments , yah ,, in normal case, company will not "markdown " the book as fast as dropped in earning ,, as TTI mentioned .. Good analogy as on "rental vs property price " .. :)
      Cheers !

      Delete
  3. Hi STE,

    Book value is an accounting term, the number is based on accounting rules to derive, the pro is it is less difficult to manipulate. However, the con is that this is not the actual or true value of the assets. It could be over valued or under valued depending on depreciation policy or if the underlying assets have grown in value over time or devalue over time and etc. Asset heavy vs asset light business, profitable vs loss making and etc will have a varied P/BV. For eg, a loss making, heavy asset, sunset business, will likely have a low P/BV. On the other hand, asset light, growth companies, good leadership (priced in stocks) will likely have a above 1.0 P/BV.

    On the other hand, earnings is real. However the p/e is just an indication on what market thinks on its shares price vs its current earnings. So if p/e is 10, it just means that based on its earnings reported, and if this earnings is constant, the company theoretical return is 10% a year or 10 years to get back original investment. But in real life, this is not the usual case. It is difficult to predict the next q earnings, let alone year after year. Nevertheless, it is an useful indicator when we compare competitors within the same industry.

    It is difficult but more rewarding to pick a low P/BV stocks, based on tests conducted using SG stocks. The result was about 2-3X more rewarding if I remembered correctly. On the other hand, it is also a lot more risky because low P/BV can be lose making companies, whereas low P/E companies are still profitable.

    Just my personal opinion on the indicators, is not a fast rule. Therefore, the so called methods, formulates sold by several bloggers, it is just some course on basic finance, nothing to scream about. If their methods work, they do not need to earn money through "teaching their methods". There are more money to be made in the capital market.

    ReplyDelete
    Replies
    1. Hi millionfaith ,
      Hahaha !! well said and thanks for the comments and detail explanation which is very true and valid !! 授教 , 授教!!Yah , somtimes , BV may not reflect the true value like case of " Noble " ,, and Book seldom be " markdown " like what TTI said ..
      Cheers !!

      Delete
    2. Hi STE,

      Yup, Noble is a good case. It does not have a P/E now because it is loss making. It is asset heavy, and coupled with loss making, the market does not thinks highly on its shares price. Therefore low shares price/high book value resulted in a very low P/BV, but do you dare to take the chance and 'hope' the business improve? It can be very rewarding if Noble turns around.

      STI components are mainly assets heavy companies, and this could be one of the reason the PB is -1SD vs PE. PE is a better indicator to have a feel if the market is cheap or expensive as it is a measure of its shares price against what it earns.

      Delete
    3. hi millionfaith,

      Yeeee... :< Noble ,, I dare not to touch as i'm a bit " kia shi " ,, haha
      Yup! do agree that STI is very much skew towards "asset play " in most of the counters ..good point!
      Cheers !

      Delete
  4. Would like to quote below comments from my friends Mr Raymond on my facebook page : just to share on the thoughts on this issues :

    Raymond Ng :PB low because of price is low but the BV has increase over the year.

    On the other hand PE close to mean level despite the price is low. This is due to poor earnings.

    The other indicator possible indicator is yield. High yield ~ cheap?
    //unquote//

    ReplyDelete

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