4 Market Lessons from This Rocky Period

The last 9 months have been really incredible. The best way to learn about monetary policy, central banking and stock markets is to be in a financial crisis like today's. So here are my key takeaways:

1) Markets can be manipulated. Witness the fall of Bear Sterns and the volatility in Lehman's stock price. Bear Sterns was brought down by feverish rumor mongering. If it can happen in a liquid stock like Bear Sterns, there is also truth to allegations that the 1997-98 East Asian crises was caused/exacerbated by hedge funds. That is not to say there weren't real issues, but the decisive blow could have come through manipulation.

2) 5-year financial models that linearly extrapolate the last 3 years of data are useless. In 1997, could anyone have predicted the East Asian crises and then the tech bubble? In 2002, could anyone have predicted a 5-year global bull run? If one cannot predict such defining macro trends, how can one really do a "bottoms up, company specific analysis"?

Any such analysis assumes stable macro trends. Except for some defensive companies (FMCG, healthcare etc), almost everything else is impacted by macro trends, most importantly interest rates and currencies. While financial models do help understand a company better (especially if there are one-offs, tax rate changes etc), one should be careful in not getting too bogged down.

3) Speculation is possible. I disagree with those avowed value investors who think speculators are gambling and will lose money in the long run. Sorry. You are wrong. The definitiveness with which you claim that traders are gamblers reminds me of my MBA school's insistence that markets are efficient. They clearly aren't. Otherwise Bear Stearns wouldn't have gone belly up in 24 hours. Value investing is great, and so is speculation.

4) It pays to be a contrarian. Nobody in emerging markets predicted in January that markets were going to crash. But they did. Similarly, if confronted with the fact that UBS had a $19bn write down, a logical person would have said that markets would go down Tuesday. They didn't. Media commentary tries to justify retrospectively why certain things happened. It is useless. The simplest answer to why markets went up yesterday is... they went up.

I guess what Warren Buffett says is true: Markets are efficient, but not all the time. And we are living in such a time.

Comments

[Bylo-:]

A liquid stock like Bear Sterns? Yea, they were so liquid they only needed $10B+ to stay afloat!

2008 Apr 04 08:40 AM

[westwest888:]

I think the market was efficient when it came to Bear Stearns. As soon as it became clear Bear wasn't going to make it, they took the stock down toward $0. The market is inefficient when it comes to the rest of the banks because of asymmetrical information. Read: the banks know they are insolvent but will play the con for as long as possible, aided and abetted by the Federal Reserve. LEH, MER - put a big goose egg next to them also. Hint: they will go from good to zero in about 24 hours.

2008 Apr 04 12:19 PM

[Indexor:]

Which begs the question - why would anybody in their right mind follow fundamental analysis of companies and rely on such data, including earnings "estimates" to invest money? That is reckless thinking in our current manipulated markets. Wall Street is becoming clogged by spoiled little children known as shareholder "activists." Stir in the removal of the uptick rule and out-of-control hedge funds. And sadly, the total and complete failure of the SEC to even understand so many of the financial products that have hit the markets in the past ten years, especially in the fixed-income markets, and nothing more than a total disaster is now waiting to blowup. And where is the "regulation" (using the term very loosly) by the CFTC????

In a world of $50 Billion Warren Buffetts adding $10 Billion in a year, Billion dollar Wall Street CEO bonuses and $150 million "severance packages" not to mention the Clintons recent revelation of their $100 million "payday," the question remains: How are you going to get yours? If you're still thinking about "efficient markets" I'm sure somebody has a nice bridge they would like to sell you today, toll booths included.

2008 Apr 05 02:01 PM