Sunday, October 08, 2006

Defining "Investing" and the correlationship of Interest rate and Stock prices (Part two)

What had happened in the 17 years starting from 1982? A thing that didn't happen was comparable corporate growth in GDP: In this second 17-year period, GDP less than quintupled. But interest rates began their descent, profits began to climb - not steadily but nonetheless with real power. Then by the late 1990s, the after-tax profits as a percentage of GDP were running close to 6%, which is on the upper part of the "normalcy" band historically. And at the end of 1998, long-term government interest rates had made their way down to that 5%.
With these dramatic changes to the two fundamentals that matter most to investors explain much of the more than tenfold increase in stock prices, though not all - if you recall that the Dow went from 875 in 1981 to 9181 in 1998. What was causing this was also human and market psychology. As always, when a bull market is underway and once you reach the point where everyone had made money no matter what system or method he or she followed, a crowd is attracted into the game that is responding not to the fundamentals - that is interest rates and profits - but simply to the fact that it seems a mistake to be out of the equity markets. In effect, these market participants drive the market prices way over the price which fundamentals allow by having the "I can't miss the party" factor.
In a bull market, everybody's expectation is always too rosy. This kind of phenomena will always exist just like how investor will behave in a bear market where they are overly pessimistic. In a bull market, businesses are mostly valued at a multiple many times over its probable earnings. This can be due to the overly rosy picture painted by Wall Street. In valuing a business, investors must practice logic and realism of achievable earnings. You cannot expect to forever realize an annual gain that is more than the actual gain of profit in a business, though in the interim you can achieve purely because of the rosy paintings but ultimately, the actual results will prove it. The inescapable fact is that the value of an asset, whatever its character, cannot over the long term grow faster than its earnings do.
An investor must always be aware that any future returns are always affected and tied to the valuations that you give today.

2 comments:

Anonymous said...

Bershire,
I am interested to know what news/commentaries you monitor in relation to what constitutes triggers for you to initiate your investigation into stocks. In other words, what are your idea generation triggers for evaluating stocks for value?
Do you have prefered markets - Nasdaq, Commodities, STI, Hangseng, ??
Regards

Berkshire said...

Hi Renxin,

Frankly, I try to do most studies on my own, searching for news reported by people who follows value investing.

I do not have a preferred market although at the moment I find the US market pretty interesting. I like the way the annual reports are reported, Singapore still have a long way to catch up in terms of how much informations are given, especially the part written by the Chairman.

As for value in stocks, I think in all markets, we can find some, the only difference is I find US business much more durable in terms of survivorability say 10 years down the road.

The downside in US stocks is the exchange rate where I think the only direction is downwards for the long run, no one knows when but it will happens unless the trade deficit is curbed.

By the way, I do not have any special ingredients in the way of investments. The only special ingredient is the ideas of Benjamin Graham, Warren Buffett and Charlie Munger. Of course, one must be able to make sense of those ideas to practice in a correct way.