The global stock market: A trader’s viewpoint

Like any other risky decision, investment in stock market, especially long-term, is guaranteed to go through lots of turbulence. It is about time several myths, which are believed like a folklore, need to be revisited and revalued their usefulness. Read on for an in-depth insight… 

Dr Bobby Srinivasan

Conventional wisdom keeps reminding us that those who teach do not practice and those who practice receive very little practical value for academic sermons. To support this, Warren Buffett, the legendary investor made a famous comment and I quote “If I had listened to my professor, I will be sitting with a tin can at the end of the street begging for alms”. George Soros, legendary currency trader, similarly quipped that currency markets have their own behaviour, which is not going to change corrected to meet our egos and pockets to fill, rather the investor accept the market behaviour as norm and act accordingly.
Here are some of the myths and the author’s experience.

Myth 1: Market is efficient and price discovery happens because of its efficiency.
This is not true. Most of the participants are either poorly informed or under a delusion that in the long run the price discovery will take place.

Example: The Japanese Nikkei index was 38,500 in September 1989 and after 21 years, it is around 9100. Basically the market has wiped out the total wealth of an investor if time value is also considered in valuation. The efficient market theory did not definitely predict the future prices of Nikkei. At that time, Japanese industries were considered to have the highest productivity and best quality control in the world.

Myth 2: Market participants are rational. Average investor is supposed to have considered all the relevant information before he bought a stock.

This is not true. While he / she may have considered all the historical facts he / she is not in a position to correctly project the future price movement. Lots of information remain latent and hidden due to lack of transparency. A serious problem surfaces wiping out the values of stocks.

Example: In 2008, US stock market meltdown, no investor could predict that such solid companies as the AIG, Lehman Brothers, Citibank and Bank of America will suddenly become on the verge of bankruptcy. Those who survived were because of the US government TARP programme.

For example, a rational investor who was counting on an expected earnings of $7 per share of Lehman Brothers would have given zero probability to its going bankrupt which it did.

Myth 3: The company is too big to fail.
This is false. But for Obama’s Tarp (Toxic asset rescue plan) plan, which involved spending $875 billion of taxpayers’ money, very many large number of US companies would have hit the dust. So without support all those companies big or small but with risky assets would have floundered.

Myth 4: What is good (bad) for General Motors (GM) is good (bad) for the US.
This is true. GM is heading progressively towards bankruptcy and so is the uncontrolled US government budget debt. According to statistics, the US government debt is fast approaching 14 trillion dollars and is almost neck to neck with their annual GDP.

Myth 5: In the long run, the stock market will reward the investor a return superior return as compared to other asset classes.

This is far from truth. Look at the data:
In the US the DJI in 1999 touched a high of 14512
Today in September 2010, it is around 10000
11 years with approx negative 45% return. A savings account would have done better than that.
In Japan in 1989, the Nikkei index touched a high of 38512 and now in 2010, it is trading around 9000.
This is a 21 year period and the Japanese investor is completely devastated.

Myth 6: The so called experts who is supposed to have knowledge and comprehension about the overall economic performance of a country are well equipped to deal with any crisis.

The myth is very hard to verify. Goldman Sachs has been accused of misleading the investors to buy when it was selling for its corporate account. Until Ramalinga Raju revealed the truth about the true financial situation of Satyam, the entire investment world believed in their balance sheets. At best we can say that the experts will have knowledge in hindsight about what really took place which an average investor may not have.

Myth 7: The stock exchange regulators are the real watchdogs of the conducting the day to day operations of the stock market.

If you believe this you are taking unnecessary risks. Transparency and governance are textbook terminologies and have no meaning in the market place. The examples of Enron, WorldCom are classic examples of how the exchange regulators failed to protect an average investor.

Myth 8: If a so called good stock is at its all time low it is bound to recover.

This is not true. Even giant companies such as Essar Steel (now not listed) had seen its share trading above Rs.250 per share was delisted at around Rs.48. However good companies such as Infosys which dropped from Rs.2700 to Rs.1100 is now fully recovered.

Myth 9: The market fully reflects all the information and the stock is correctly priced at any point in time.

This has never been true. As long as the human emotions play a role of greed and fear the price will never to accurate. For example, ICICI Bank share which went to around Rs.1400 before the melt down of 2008 dropped to around Rs.270 before it made its way back currently to around Rs.950. Seeing that the prices are moving up, people stand in line to pick up the stock at any price throwing away their rationality and judgement. Similarly when a stock is heading south, the investor rushes to exit with fear and uncertainly. Buffet says that the best time to buy is when the panic drives down the price of a good stock to ridiculous level. For your reference, during the boom years, the share of NDT Docomo PE ratio touched 1000 and the research analyst justified it. Yahoo stock traded at $500 a share during boom time only to crash to $5 a share a few years later.

Myth 10: All players have equal chance of making money in the stock market.

This again is not true. People who are knowledgeable and insider connection outperform others. They are not necessarily insider traders but have a fairly accurate understanding of what is going in within the industry. The recent case is of an individual investor who made billions of dollars during the sub prime crisis. He later explained as to how he made use of the publicly available information to take advantage of the situation.

Finally, there are lots of myths developed over time. What we are using is in hindsight. Like any other risky decision, investment in stock market especially long term is guaranteed to go through lots of turbulence. We academicians select that period of data to prove our hypothesis which will not be universally true. The investor has to use these results and conclusions with some reservation and use their own judgement in selecting the stock. There is a saying “fools rush in when angels fear to tread” and investing in stock market is no exception. The final word is caveat emptor (buyers beware).

Dr Bobby Srinivasan is President, IFMR, Chennai