My dad, who has a bigger porfolio (not necessarily more diverse though) told me once to predict what most common investors were up to, basically their sentiments, and then make decisions based on what might not be a herd instinct. I had never really gotten hold on the point he was trying to make, but an article in The Business Times on 10 June clarified some doubts that I had.
This article is called 'Myths that stand in the way of investors' by Shane Oliver. The 11 myths he has stated make much sense, and provides me much needed insight into equity and sentiments.
Myth #1 High unemployment will prevent an economic recovery
As interest rate falls, the boost to household discretionary income from lower mortage bills, tax cuts or stimulus payments will offset the fear of unemployment for the bulk still employed, and consumption will then pick up from there. As we all know, consumption boosts output and derived demand. One good point to note here is that share markets normally lead economic recoveries, and a peak in unemployment comes a long time after shares have bottomed.
Myth #2 Business won't invest when capacity utilisation is low
Cap utilisation is low in a recession simply because consumer and business spending (investment) is weak. With a pick up in demand, profits go up and drives a increase in business investment which leads to increase in capacity utilisation. An increase in demand maybe in the later part of the year may lead to increased investment although production plants may still be idle.
Myth #3 Corporate CEOs, being close to the ground, should provide a good guide to where the economy is going
It is pretty interesting how some papers and financial annuals publish 'insider movements', on the various purchases and sales of the big shots in the company, and in previous books I've read, following closely insider movements might be a good way of learning which way a company is going. According to Oliver, these people are often overwhelmingly influenced by their own sales figures and have no particular lead on the future. This does not mean though, that their comments are worthless, but should be seen as telling us where we are rather than where we are heading. This is right, for one can never base our decisions on the actions of a few, whose investing goals might be significantly different from us, not to mention the massive amounts of capital we lack.
Myth #4 The economic cycle is suspended
I have always been a firm believer of business cycles, because simply what goes up will eventually come down and vice versa. It is just simply the mechanisms of business interest and consumer sentiments working the demand and supply, which determines the peaks and troughs. Oliver states that 'new eras of prosperity' and 'continued tough times' are common talk when the extremes of both states of the economy are reached. However, history has shown us otherwise. This has also been one of my pillars of confidence behind some of my more risky investment decisions.
Myth #5 Crowd support for a particular investment indicates a good thing
It's a 'safety in numbers' concept that investors have in mind when they put their money in an equity that everyone else has their capital in. This approach is a trap. The reason being, if everyone is bullish about a certain stock, there will be no one left to buy when there is more good news, but there is plenty to sell if some bad news hit. 'Investors' who do this usually base a lot on sentiments rather the actual value of a stock, and I feel this might be the reason how big players manipulate a counter, using market sentiment and media exposure of certain equities, and pull the plug when the time comes. Another reason why sentiment is never a good basis of choice to invest.
Myth #6 Recent past returns are a guide to the future
The difficulty in processing information, short memories and wishful thinking, recent poor returns are assumed to continue and vice versa for strong returns. This, combined with the problem of 'safety in numbers' will result in investors getting into the markets at the wrong times: buying high and selling low.
I shall continue with the rest of the myths in my next posting, probably in the evening after the SGX closes and before the US market starts business.
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