Crazy days
Posted on November 14, 2006 by Richard Beddard
Filed Under Investing |
Most weeks I turn to the same investment book to get an update on what the markets should be doing. Why it should be ‘The UK Stock Market Almanac‘ puzzles me as the markets are of very little relevance to my investment style, which is relentlessly bottom-up: concerned exclusively with businesses and valuations and not at all with the short-term flights of fancy of market traders.
The Almanac’s third edition (2007) is published today and if its US namesake, ‘The Stock Trader’s Almanac’, is anything to go by it’s well on its way to becoming an institution (it was first published in 1967).
Being Almanacs, both books contain calendars. I don’t particularly need one, but the UK Almanac’s calendar is better than most. For a start, each week gets an A5 page, which means you’ve got space to write. Secondly, it’s hard-bound and lies flat when it’s open. And finally it contains information investors may find useful: the expected dates for company results; key dates (be they the Bank of England’s Monetary Policy Committee meetings or the Japanese Grand Prix); and the degree to which each trading day is, historically speaking, an up day or a down day.
As an investor, I couldn’t care less. I really couldn’t. Both Almanacs are devoted to calculating calendar effects: the best and worst days, and months to invest on. Apparently you’re much more likely to make a profit in April than June. Statistically it’s better to buy as winter approaches, and sell as summer approaches. Some traders swear by calendar effects, believing among other things that a gloomy mood hangs over the City in November because the days are getting shorter. Chris Dillow, an Investors Chronicle columnist and blogger, describes himself as a great believer in seasonal investing, selling in May, as the old wives’ tale commands, and buying back on or near Halloween. No doubt he’d find much to agree with in the Almanac, but it doesn’t explain why I turn to it.
That I attribute to the Dilbert effect. The many owners of cube-shaped page-a-day Dilbert calendars will know what I mean. No matter what idiot plan your diabolical boss has you working on, no matter what impossible situation he’s about to put you in, it’s comforting to tear off a new sheet and be reminded by the cartoon that the joke’s really on him.
The Almanac has more graphs than laughs, though it’s assertion that investors in the UK market should cheer on Australia in the Ashes is surely laughable (over the last 106 years the UK market has performed 365% better when Australia has held the Ashes than when England has). But it’s a weekly reminder for the lonely investor that it’s not him, but the stockmarket that’s crazy. And that irrationality is what gives him the opportunity to make money.
It celebrates the failure of the Efficient Market Theory (also known as the Random Walk) which comes in many flavours. At its most extreme, it states that short-term changes in the stockmarket cannot be predicted. Consequently attempts to beat the market, or take the advice of so-called professionals are no more likely to succeed than blind luck. According to the EMT, stock picking is a game of chance. As Professor Burton Malkiel famously declared in his bestselling defence of the theory, you might as well employ a blindfolded monkey to throw darts at a newspaper’s financial pages.
Investors are defined by their ambition and the effort they are willing to put into investing. There are those that try to beat the market by finding anomalies - situations where the odds are skewed in their favour and can be exploited for profit. The effects listed in the Almanac’s calendar are one example. Shares on low price earnings ratios, growth companies (also analysed in the Almanac) and trends that persist are others. Then there are those investors who hold up their hands and capitulate to the random walk, happy to ride on the rising tide that, history tells us, characterises most equity markets over the long term.
Such investors can make their bed with an index tracker and lie in it. Stockpickers and market-timers sleep less easily, knowing that it’s not fate guarding their wealth, but their own decisions. In moments of weakness, the Almanac is an ally, gently reminding them that anomalies do exist and the joke is on the market.
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3 Responses to “Crazy days”
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Thanks. An excellent article.
It is patently apparent that the markets are often driven by investor emotions (primarily greed/fear) and not efficient market theory (although this explains why markets always spring back to their correct levels over time).
You can practically feel the upwards drive after a few days of inexplicable falling.
I am sure that there are many people who would say that the last couple of days of poor FTSE performance is down to some factor or other. However, an equal number of people do not know this and are just trying to follow the trend. Therefore, to say that the value of a stock reflects the sum of all knowledge about it (as EMT states) is simply not true.
I think it’s common knowledge now, at least among seasoned investors, that over 70% of fund managers don’t beat the index. What is less often commented on is that even those that do beat the index in any one year display no consistency of performance in terms of their likelihood of repeating this feat in the next.
A study of fund managers beating the index on a consistent basis would be bleak reading and drive many investors into the arms ofthe tracker funds.
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