Saturday, November 08, 2008

Predicting the Market Bottom - An Exercise in Futility ?

With the recent unprecedented volatility dogging the stock markets around the globe, and with the economic crisis fully under-way, more and more people have been congregating together to ask the mother of all stock market questions - where will the market bottom be ? To expand this question a little, it's actually a little more complex, being divided into events like "where will the bottom be", "when will it happen", "will there be another bottom" and the no-brainer "have we already missed the bottom and the boat has left" ?

Interestingly, there are no lack of experts and market analysts making predictions on the stock market, as they have been doing for the past few decades. The funny thing is that when retail investors jump in to offer their "psychic" views on what's going to be happen, then it gets truly hilarious. Everyone knows that market bottoms cannot be timed, yet people persist in trying. There is something perverse about human beings that likes to make simple things complex; and this is about one of the most complex things one can ever attempt to achieve. As mentioned, the stock market is a complex adaptive system, which means that there are a myriad of factors which determine how prices move on any given day, and thus far there is no predictable pattern for these random movements. Yet, almost everyone loves to chip in to try to predict what's going to happen next, and where the market is going to go. It's becoming a national pastime, akin to a game show, where people try to outdo and outsmart one another to be the first to "guess" the right answer. It strikes me as being silly and a waste of effort. Why ? Read on.....

The point of investing is to ensure one gets a fair return on his investment in sound companies over time. The purpose of a stock market is for companies to float their shares so as to raise funds for business expansion. Most people seem to have forgotten the two golden rules above, which is why the stock market has turned into a game, a contest and to some, a sort of battleground to test their wits and dexterity. I must emphasize that my view of the stock market is one whereby I can park my money in shares belonging to a good company which can grow steadily over the years, and eventually my stake in the company will be worth more by virtue of its business growth. This represents a way for the retail investor to grow his money in a slow and steady way. The problem is that many people are impatient for quick gains and thus engage in the speculative "game" of market timing, which ultimately results in futility as their efforts to discern patterns in stock prices usually end in failure.

Trying to pick a bottom in the stock market is the same as trying to guess when the top is here (in a bull market) so that you will know when to sell out all your shares and stay in 100% cash. There are a few flaws to this logic which many people do not notice:-

1) Assuming the bottom is coming (i.e. not here yet), how can one devise a way to properly anticipate this and be able time it exactly so that one can purchase shares at the bottom ?

2) Assuming the bottom has already past, many people will still be waiting for the bottom to arrive so that they can buy at lower prices; while the stock market may just march onwards and leave them in the cold;

3) The bottom for the stock index may not always signal a bottom for individual stock prices; so one who tracks the index closely looking for a bottom may fail to capture appropriate opportunities in individual securities as he too focused on the forest to notice the trees;

4) "Hindsight Investing", the bane of market timers, always results in one thinking that he will know exactly when to sell out and exactly when to buy back. I need not say too much more about this as I have often mentioned how silly a concept hindsight investing is.

5) Pattern-seeking human beings will always discern patterns in past data, clearly because they are available and not because they form any part of a larger picture of what's going to occur in the future. Correlation is not equal to causation; and what caused a market bottom in previous cycles may not always lead to one in the current cycle, as each economic crisis is different. So people who postulate based on past data are simply trying to anchor their expectations of the future based on information which may not be representative of what's currently going on.

The conclusion to all this rambling is that market timing is simply an exercise in futility, and my advice to readers would be to conveniently ignore the bunch of forecasters and analysts out there who are forever trying to predict the bottom. Time can be spent more constructively on sieving out good bargains in terms of corporate valuations in the current bearish environment instead of reading tons of commentaries by "experts" and "gurus" who think they know better. Thinking indepedently is one of the traits of a successful investor, but at the same time, be open to opinions about your companies which are objective and may be of value to your assessment of a company's potential.


BlackCat said...

Hi MusicWhiz,

I feel it is a misconception that market timers *predict* the market. They *follow* the market. Market timing is really nothing more than a type of trend following. In essence, you pay a price in missing the absolute bottom, as well as being 'shaken out' (with small, but real, losses) often.... In exchange you are kept out of the occasional, but brutal bear market that will occur several times (or more?) in our lifetimes.

One can make money many ways in the market, some people may incorporate an element of 'market timing', others don't have to.

I actually feel sorry for those people on TV whose job it is to answer stupid questions like 'what is your target for the STI in 3 mnths?'. They all *know* it is just a guess, but are forced to answer the inane questions. This reinforces the general notion to the public that that 'professional' stock market people in suits somehow have an idea of where the market will be at some time in the future.

At the moment, of course I've got no idea where the bottom will be... But if good stocks fall to levels I saw in 01/02 (a few did last month - eg: boustead at 40c would fit this category), I am comfortable to buy and hold. Otherwise I need another strategy....


JIM L said...

Hi Musicwhiz,

Thanks for your nice overview again as usual which I follow half a year ago.

I have Ezra stock, and can I know what will happen if Ezra delisted from the STI?

Read from a forumer that he got it from paper that Ezra might be considering delisted from the STI.

Will i lose all my holding of Ezra?


Anonymous said...

prior to delisting, EZRA will send you one more chance to sell them at the offer price.

If you take up, then you had just sold your share to them.

If you don't take up, then you become of of their private investor.

Anonymous said...

"value" investment is market timing too.

imagine you gotten your favourite business that you wanted to hold forever.

The margin of safety is not there yet, what do you do?
You wait patiently till margin of safety is reached eg. 75% of NTA.

Guess what, after your initiate purchase, the price of the share drop further.
Says everything on the stock is unchange but the global stock market panic.
So, when it reach 50% of NTA (aka better Margin of safety), you search your pocket and found some additional funding and you buy even more of the stock at 50% NTA.

and of course, the price continue to drop and you continue to buy as the margin of safety become better and better.

Of course, in this case, you did not time the market, you just buy based on the MOS.


Jim L said...

IF I become private investor, how is my stock price being affected? Will I be getting dividend yearly?

HOw do I profit from becoming private investor?

ghchua said...

Hi anonymous,

Value investing is not market timing. In your example, one can always purchase another stock if the margin of safety is not available for the stock in question. (i.e. 75% of NTA)

One can purchase any value stock, regardless of market conditions.

Anonymous said...

hi MW,

Say today you are given SGD 100k to invest in SG stocks, can I have you view on the 10 counters that you would buy/invest.

Thanks alot.


Brendan Lee said...

I dont agree pal.

I have been advising my readers to hold cash and trade forex instead.

If investors have followed my advice, they will not be sitting on 50% - 70% losses now.

Anonymous said...

You are right on the definition of "MARKET" timing.

I'll make a correction, I'm actually refers to "security" timing.

"Security" timing is very important when buying a business.

Because, the low can be lower and you should demand better MOS before you put in our hard earn money.

Ricky said...

Hey pal, neither do i. Not everyone is able to do well in forex. In fact, most active investment instruments requires their OWN due diligence and strict discipline.

There are many vehicles to increase wealth, everyone should find out what they're best at and not just blindly follow any advice.

patrick ho said...

Hi musicwhiz,
nice article about market timing and bottoming. makes me think about the markets being a leading indicator of how the economy will fare...might be accurate to a certain extent, but markets tend to overshoot on sentiment i feel and it might not necessarily be an accurate indicator after all. anyhow, timing will ultimately be futile, typically happens during times of indifference;)

musicwhiz said...

Hi Blackcat,

I don't really agree about following the trend. Market timers do try to predict the markets with consistency, even though most of them fail to do so. One can argue that as long as you get it right more often than wrong, you can make money. But sadly, they are forgetting about frictional costs of transacting so often !

Of course the experts can make money in all situations, but not many people are so skilled. :)

Market commentators are supposed to sound intelligent even when they have no idea what's going to happen 1 day, 1 week or 1 month down the road. Not many are as honest as Warren Buffett who flatly declares he does not know what the market will do in the short-term !


musicwhiz said...


When you own a share of the company, you own part of the company. Whether it is listed or not, you are still part owner of that company.

Of course, being listed gives you the chance to sell the shares to another person more easily and creates a ready market for the shares.

And don't worry, I don't think Ezra plans to delist any time soon.


musicwhiz said...

Hi Anonymous and GHCHUA,

Thanks, yes value investing is NOT market timing, they are 2 very different concepts.

Buying at a discount to NTA does offer some measure of safety, unless that NTA erodes quickly or is unsustainable ! Same goes for buying based on PER, are earnings going to remain consistent ?

One can always find value in all conditions; it's just that bear markets make it so much easier that's all.


musicwhiz said...

Hi Faris,

I would buy more of the companies I own, particularly Ezra, Boustead, Tat Hong and China Fishery as I know their businesses well and have confidence in their long-term prospects.


musicwhiz said...

Hi Brendan Lee,

I would strongly advise you to take your advertising elsewhere. If you wish to talk about currency trading, this comments box is NOT the place for you.

Thanks, in future such comments will be deleted without hesitation.


musicwhiz said...

Hi Patrick Ho,

Yes markets tend to be forward looking, so I'd rather just buy based on value than try to time the market. Eventually value will rise to the surface and leave the slag behind. :)