Why The Wrong question is being asked in Investing !

Forecasting or predicting the market movement

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

Even in every investment seminars, one may notice that the most question people like to ask 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 the Bank / O&G / property sector in the next few 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 natural sciences.

 An examination of the peculiar concepts of economics thinking, of the atmosphere of ideas of modern economic 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 winning 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 every circumstance. It is the hammer in search of a 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 the 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, maybe 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 a 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. The market is just
slightly undervalued from the regression point.  We definitely don’t know if we will have a 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.”.

The market can be in side-way (under-value ) for a 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 the current earning level?

Cheers!

Quote Of The Day :

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