An academician recently suggested that the success of those who accurately identified and predicted the emergence and the impact of past bubbles had been a result of happenstance.
That's because allegedly, since it is human tendency to seek patterns even where there is none, which is known as clustering illusions, these patterns coincidentally played out favorably for those who made the seemingly prescient predictions.
The academic expert further claimed that bubbles signify as deviations from 'fundamentals'.
In other words, the bubble phenomenon has been largely blamed on irrational behavior or cognitive biases, in the perspective of the expert.
While we accede that cognitive biases have a major role to play in bubble cycles, we believe that irrational behavior is basically prompted by responses of the marketplace to the incentives shaped by displacements.
People just don't buy stocks or real estate out of mood or because today's horoscope column say so.
For whatever cognitive reasons for the transactional actions, they are facilitated by real forces such as easy access to credit, low interest rates and or other government policies that shape incentives such as subsidies, guarantees, distortive tax laws and etc...
Thus, while people can or will be herded into irrational behavior, such as impulsive buying, it takes money to drive up asset prices. And money functions like fuel that mobilizes a car-regardless of the intended destination of the driver [For all we know he can drive the vehicle off a cliff!].
And sound money based on real savings don't create nasty nationwide bubbles. That's because the ability to go on a speculative binge would be restricted or that the access to credit will be limited...in spite of one's irrationality.
On the other hand, credit expansion from money from thin air not only facilitate but magnifies such human frailty.
Besides, if bubbles are an outcome of people's irrationality and fundamentals are indeed the genuine basis to evaluate assets, then why is it that there has been no consensus or established formula on what defines as the winning fundamental metric for investing?
For instance, value investors differ from growth based investors. Moreover, even from the value standpoint, analysts have different approaches (e.g. Graham & Dodd and etc...). This would largely depend on the parameters (data points, reference points and disparate theories) used to interpret data and to arrive at value.
In short as with bubbles, the ambiguity of ascertaining the so-called scale of 'intrinsic' value of an asset largely depends on subjective appraisal.
This chart from Bespoke could be used as example.
The chart demonstrates the basic fundamental metric for analyzing global stocks. It shows of the Price Earning ratio PLUS GDP growth.
According to Bespoke (whose chart is shown above), ``In this regard, we have created "PEG" ratios for a number of countries using the P/E ratio of each country's main equity market index along with 2010 estimated GDP growth rates. Just as with stocks, the lower the country PEG, the more attractive. As shown, India has the best PEG out of the countries we analyzed. It has a P/E ratio of 26.19 and estimated 2010 GDP growth of 8%. While its P/E isn't as low as a lot of countries, its growth rate is very high. China ranks second with a PEG of 3.66. The US ranks in the middle of the pack with a P/E of 24.53 and estimated GDP growth of 2.6%. At the bottom of the list sits Switzerland, Italy, and the UK, while Australia, Japan, and Spain have negative PEGs due to either a negative P/E ratio or negative estimated GDP growth."
So in spite of the breathtaking 2009 run, the HIGH current PE ratios (left column) can be deflated by adding an input-GDP growth (mid column). For the others with low GDP the effects of overvaluation is apparently magnified. So an additional variable changes the entire assessment process.
Hence, as per the economic growth adjusted perspective, this would imply that many stocks markets from China down to Russia have yet ample room to climb (right column) without having to be labeled as bubble.
And conversely, nations with poor or relative lesser economic growth should underperform or become suspect to thriving bubbles (due to exorbitant PEG ratios), e.g. as Taiwan to UK, while those with negative PEGs as Australia, Japan and Spain would account for the worst!
I am not suggesting nor am I implying that this approach is the valid way to deal with the markets. In my view this would seem irrelevant, since policies have all been calibrated to bubble blowing dynamics.
My point is that people will anchor on anything that will reinforce their biases regardless of the instruments used.
And the story above will most likely change with additional inputs, such as expected inflation (see ADB chart), demographic trends, and etc.
Yet the more inputs, the less likely these models will reflect on the reality and the more likely these would reflect on the bias of the analyst.
Bottom line: If investor irrationality have allegedly been the primary factor to cause for bubble episodes, then in the same context, fundamental metrics are a function of cognitive dissonance from cognitive biases.
Investor irrationality aren't primarily the cause of bubble cycles. That's because markets reflect on the subjective appraisals of the incentive driven participants that are mostly likely shaped by government policies.
That's because allegedly, since it is human tendency to seek patterns even where there is none, which is known as clustering illusions, these patterns coincidentally played out favorably for those who made the seemingly prescient predictions.
The academic expert further claimed that bubbles signify as deviations from 'fundamentals'.
In other words, the bubble phenomenon has been largely blamed on irrational behavior or cognitive biases, in the perspective of the expert.
While we accede that cognitive biases have a major role to play in bubble cycles, we believe that irrational behavior is basically prompted by responses of the marketplace to the incentives shaped by displacements.
People just don't buy stocks or real estate out of mood or because today's horoscope column say so.
For whatever cognitive reasons for the transactional actions, they are facilitated by real forces such as easy access to credit, low interest rates and or other government policies that shape incentives such as subsidies, guarantees, distortive tax laws and etc...
Thus, while people can or will be herded into irrational behavior, such as impulsive buying, it takes money to drive up asset prices. And money functions like fuel that mobilizes a car-regardless of the intended destination of the driver [For all we know he can drive the vehicle off a cliff!].
And sound money based on real savings don't create nasty nationwide bubbles. That's because the ability to go on a speculative binge would be restricted or that the access to credit will be limited...in spite of one's irrationality.
On the other hand, credit expansion from money from thin air not only facilitate but magnifies such human frailty.
Besides, if bubbles are an outcome of people's irrationality and fundamentals are indeed the genuine basis to evaluate assets, then why is it that there has been no consensus or established formula on what defines as the winning fundamental metric for investing?
For instance, value investors differ from growth based investors. Moreover, even from the value standpoint, analysts have different approaches (e.g. Graham & Dodd and etc...). This would largely depend on the parameters (data points, reference points and disparate theories) used to interpret data and to arrive at value.
In short as with bubbles, the ambiguity of ascertaining the so-called scale of 'intrinsic' value of an asset largely depends on subjective appraisal.
This chart from Bespoke could be used as example.
The chart demonstrates the basic fundamental metric for analyzing global stocks. It shows of the Price Earning ratio PLUS GDP growth.
According to Bespoke (whose chart is shown above), ``In this regard, we have created "PEG" ratios for a number of countries using the P/E ratio of each country's main equity market index along with 2010 estimated GDP growth rates. Just as with stocks, the lower the country PEG, the more attractive. As shown, India has the best PEG out of the countries we analyzed. It has a P/E ratio of 26.19 and estimated 2010 GDP growth of 8%. While its P/E isn't as low as a lot of countries, its growth rate is very high. China ranks second with a PEG of 3.66. The US ranks in the middle of the pack with a P/E of 24.53 and estimated GDP growth of 2.6%. At the bottom of the list sits Switzerland, Italy, and the UK, while Australia, Japan, and Spain have negative PEGs due to either a negative P/E ratio or negative estimated GDP growth."
So in spite of the breathtaking 2009 run, the HIGH current PE ratios (left column) can be deflated by adding an input-GDP growth (mid column). For the others with low GDP the effects of overvaluation is apparently magnified. So an additional variable changes the entire assessment process.
Hence, as per the economic growth adjusted perspective, this would imply that many stocks markets from China down to Russia have yet ample room to climb (right column) without having to be labeled as bubble.
And conversely, nations with poor or relative lesser economic growth should underperform or become suspect to thriving bubbles (due to exorbitant PEG ratios), e.g. as Taiwan to UK, while those with negative PEGs as Australia, Japan and Spain would account for the worst!
I am not suggesting nor am I implying that this approach is the valid way to deal with the markets. In my view this would seem irrelevant, since policies have all been calibrated to bubble blowing dynamics.
My point is that people will anchor on anything that will reinforce their biases regardless of the instruments used.
And the story above will most likely change with additional inputs, such as expected inflation (see ADB chart), demographic trends, and etc.
Yet the more inputs, the less likely these models will reflect on the reality and the more likely these would reflect on the bias of the analyst.
Bottom line: If investor irrationality have allegedly been the primary factor to cause for bubble episodes, then in the same context, fundamental metrics are a function of cognitive dissonance from cognitive biases.
Investor irrationality aren't primarily the cause of bubble cycles. That's because markets reflect on the subjective appraisals of the incentive driven participants that are mostly likely shaped by government policies.
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