HERE we are a month and a half into 2015 with the Philippine Stock Exchange Composite Index up about 7.5 percent, and we are still trying to figure out if that increase is justified. That does not even address what may or may not happen in the future. The year is still young.
So how can we assess the stock market and determine of the current and perhaps even if future price increases are reasonable and if there is some sort of ‘legitimate reason’ for going higher.
For more than 100 years during this age of the ‘modern’ stock market, people have been trying to figure out what makes a stock market move either up or down.
Sensibly, a company’s corporate value and profit outlook should probably be of primary importance. But we know that factor, no matter how good it looks, can be washed away in a moment if the stock market in general turns sour. We think of stock prices as first reflecting corporate value. But then we know that “a rising tides floats all boats and the typhoon sinks all boats”.
In all the stock market crashes, the share price of good companies that continued to have rising profits also went down considerably.
Maybe then we should look only at the broad market and then examine more closely individual ‘good’ companies. However, there are certainly times when the market is going higher and the price of ‘good’ companies underperforms the broad market.
Suppose we just forget about the stock market and the individual companies and look only at the macroeconomic situation. Companies make more money when the economy is good or at least they should. The problem here is that studies have shown that a nation’s stock market tends to perform better when the economy is good but not necessarily great.
Then you have situations like Venezuela where the economy has all but collapsed and the stock market goes higher and higher. But isn’t rampant inflation a reason why the Venezuela stock market is going up? Sure, but other countries are experiencing deflation and their markets are rising.
Shouldn’t the relationship of corporate value to stock price be the key? That is the way we want to measure ‘expensive’ and ‘cheap’ prices. But even that standard varies from year to year, decade to decade, and market to other markets.
Now do you understand why there are thousands of expert books on stock market investing?
Even most of the old and wise sayings about the market fall short when examined closely. “Stock prices go higher because there are more buyers than sellers”. That is only partly true. Stock prices go higher because buyers, regardless of the number, are willing to pay a higher price than the lowest price sellers are willing to sell at. If it had only to do with numbers, then buyers would just buy at whatever price sellers were willing to take until there were no more sellers. And actually, that is also what happens sometimes.
Some analysts like to look at investor psychology to understand why prices increase and this also makes sense. If people are standing on a street corner looking up at the sky, other people will stop and do the same thing. This is herd mentality. With the local stock market up so much in the past few years, more people are investing and more money in the market means higher prices. Expect, the problem with that idea is that are not that many more investors in the PSE than there were several years ago. Stock prices may or may not go up if corporate value increases. Prices may go up or down even if the economy is good or bad. Stock prices are determined by investors’ participation but not always.
Money flow, alternative investment yields, and investor psychology and outlook are also good ways to forecast stock market behavior. But these factors do not predict market action consistently over time.
There are some consistencies in every theory of why prices move but there are always exceptions and it’s the exceptions that disprove every theory at least a little. But there is not enough consistency over a long time to say, “The stock market is going up because….” and conversely about going down. More importantly, it is almost impossible to accurately say, “The stock market is going higher in future because…”
We expect to be able to predict the future of the stock market the same way weather forecasters do. Take a set of parameters and then draw accurate conclusions. Simply, we can’t.
E-mail me at mangun@gmail.com. Visit my web site at www.mangunonmarkets.com. Follow me on Twitter
@mangunonmarkets. PSE stock-market information and technical analysis tools provided by the COL Financial Group Inc.