In this issue
Philippine Stock Exchange: The PUBLIC’s MILKING Cow???!!!
HOW HUMAN PSYCHOLOGY DRIVES the BUSINESS CYCLES
How to benefit from STOCK TIPS and stop blaming others!
NO REGRETS, I SHOULD HAVE….
Wake Me UP from MY Nightmares Please
First of all I’d like to greet all fathers a Happy Fathers day (Including my thoroughly missed Dad who now sits with St Peter.)! This issue is dedicated to all you fathers….and of course to the loving mothers in support of us.
``Ain't only three things to gambling: knowing the 60-40 end of a proposition, money management and knowing yourself.”- Walter Clyde Pearson Tennessee Poker champ
I watched in HORROR when a TV news documentary portrayed the stock market as some sort of variant strain of a “milking cow” for the public last Thursday.
The prime time news documentary highlighted a twist of fate by an “accidental” stock investor who happened to turn into a “millionaire” over a short period of time.
The featured “heroine” swaggered about her “garbage-to-gold” experience by having her 40,000 pesos investment converted into 1 million pesos or an amazing 2,400% return!
And after the initial success, she unabashedly declared herself to have been transformed into a “basura queen” (master of “penny” stocks or highly speculative issues), where her virtuoso performances has enabled her to luxuriate on a new lifestyle.
While of course, the show “feigned” to secure a “balanced” commentary from a high profile mainstream analyst, which ostensibly proved to be greatly inadequate (how does one explain a relatively complex dimension in a few seconds?), the media’s message has been inexorably predetermined; the stock market is today’s du jour source of easy money!
Because we frequently decry news reports as habitually attempting to simplify events in order to sell SENSATION to the public rather than objective reportage, the TV program obviously failed to point out major inconsistencies into the allegations of the featured protagonist.
While it is true that there are many issues that has performed superbly; similar to or even over the degree of the returns cited, and likewise it is true that our hotshot has had indubitably achieved her millions by surfing today’s rising tide, one significant source of inconsistency is her changeover from a chanced “passive” investor to a “momentum trader”.
She claims that it was years before when she placed 40,000 pesos into the market and suddenly “realized” that it had evolved into 1 million pesos, from which according her words, ``once a “basura” issue turned into “fundamentals”” (whatever that means).
Obviously it was the passive “buy and hold” approach which delivered to her such magnificent gains, yet upon the realization that she could reap a windfall from the market, adopted herself into a self declared “momentum” trader, ergo her self baptized “basura” queen.
Our experience is that momentum trading while pulsating and electrifying as the ticker goes, hardly delivers the meat, as timing the markets or securities fluctuations over the short-term is proven to be a futile exercise. Notice, in today’s trending market, most of what we’ve sold, in the assumption that it would go lower, we’d have to buy back higher.
Such conflicting behavior leads us to question on the validity of her claims. If she realized that her bonanzas came from a passive approach and NOT from timing the markets, it would be quite obvious that she’d chose the former path, right? Apparently not.
In short, our stockmarket ace has been nothing more than a fortuitous investor metamorphosed into a stock punter, buoyed by the rising tide, glorified and extolled by media. Is it a wonder why we Filipinos have been sooooo obsessed with the EASY money dependency culture?
Once again playing your skeptic, could it be instead the 40,000 pesos represented the residual value of a previous losing investment in the past which resulted to her initial passivity? And with confidence rediscovered by virtue of the stock’s recovery and attendant ego magnified by the recent astronomical gains, have turned our superstar into a chronic “exuberant and unrepentant” gambler?
What we understand is that media didn’t ask for evidence through confirmation receipts to back such claims but rather relied on personal declarations as a truism and as basis for their presentation. And as we know, it is the nature of people to brag about their victories (real or imaginary) and shun the ignominy of setbacks. In the words of Plato, ``Wise people talk because they have something to say; fools, because they have to say something."
Given the benefit of the doubt that we take such portrayal on face value, again we would like to point out of the emergent perils symptomatic of the cyclical transitions as manifested by burgeoning risk appetite, excessive optimism, overconfidence, euphoria and excitement, all of which are part and parcel of what shapes our economic, business and even financial markets cycle as shown in Figure 1.
Figure 1: Death Cross Trader: Human Psychology underpins the Financial Markets Cycle
Market cycles are mostly determined by human psychology where in the Philippine setting, the cycle has evidently evolved from a period of despondency in 2002 into today’s incipient manifestation of optimism.
Eventually, optimism will be replaced with widespread excitement and thrill until finally euphoria permeates, where everyone would think that the markets can do NO wrong.
As for our superstar, we believe that she is indeed serendipitous enough to capitalize from the fledging optimistic phase, despite her “euphoric” demeanor. However, once the euphoria spreads to the general public, much like a bush fire to a forest fire, greatly abetted by media then it would be a principal concern for us.
Yet, like in all cycles, a significant majority would end up losing MORE than their accumulated gains from the markets, as cyclical downturns will in most instances catch most investors off guard, aside from of course the added use of leverage in order to amplify their positions to maximize gains.
1997 should be a good reminder, where the Phisix fell from about 3,400 to nearly 1,000 or about 70% loss fueled by the Asian crisis. Legendary trader Jesse Livermore describes the human nature best in the face of stock market investing ``The stock market never really changes that much. What happened before will happen again and again and again."
As for media’s oversimplification this highly important quote from my favorite iconoclast Mr. Black Swan himself, Nassim Taleb in his latest book, Black Swan, The Impact of the Highly Improbable,
``The problem of overcausation does not lie with the journalist, but with the public. Nobody would pay one dollar to buy a series of abstract statistics reminiscent of a boring college lecture. We want to be told stories, and there is nothing wrong with that-except that we should check more thoroughly whether the story provides consequential distortions of reality (highlight mine).”
In other words, investors have to learn how to fend for themselves in winnowing and filtering the validity of data presented and its utility to the decision making process and understand media’s role in sensationalizing information. Borrowing the aphorism of sixth-century B.C. Chinese Philosopher Lao-tzu``He who conquers others is strong; he who conquers himself is mighty.”
HOW HUMAN PSYCHOLOGY DRIVES the BUSINESS CYCLES
As for human psychological phases transmitted into business/economic cycles, we observe similar curve patterns as shown in Figure 2.
Business cycles run under the overinvestment and underinvestment themes.
During an economic downturn or the contraction phase, market clearing forces the previous excess investment to be liquidated, hence are backed by psychological characteristics as the benign “anxiety” phase, working its way into a deeper “denial” phase then to a more desperate “fear” phase. In Wall Street, this stage is called as the “Descending on a ladder of hope” phase.
Eventually, the bullish stragglers “capitulate” and then turn despondent which lead towards a cyclical trough or a period of underinvestment.
On an economic expansion phase we see old investments recover from depression which results to extraordinary large profits.
The allure of large profits entices new investors to eventually hop in and provide for competition. As the gains become more entrenched and pervasive, the economic cycle or the “recovery phase” accelerates in momentum. Here we find positive human traits as hope and relief prevail over the economic landscape and the financial marketplace. In Wall Street this phase is known as “Climbing the Wall of Worries”.
As advances or progress get embedded, the self feeding cycle leads to prosperity, where optimism intensifies. At the height of such optimism investors would likely miscalculate the demand in the marketplace and overestimate on the perceived future gains which eventually results to investment excesses. And then cycle revolves.
I have shown you some examples of how the long cycles playout in the previous outlooks as in May 21 to May 25, 2007 Edition (see Profiting from Markets by Understanding How Cycles Determine Trends).
Of course, there are other major contributory factors to the economic or financial market cycles such as regulatory policies, technological advances, demographic trends and etc.
However, I find the monetary inputs from governments as one major influence factor. From the Austrian Economics point of view, business cycles are wrought by the interventions of the government in the marketplace by the use of monetary policies, which brings about distorted signals and induce entrepreneurs to miscalculate, thereby resulting to malinvestments or the boom bust cycle.
According to Mises.org’s Dan Mahoney, ``Time preference is the extent to which people value current consumption over future consumption. The key point of the Austrian business cycle theory is that interventions in the monetary system—and there is some debate over what form those interventions must take to set in motion the boom-bust process—create a mismatch between consumer time preferences and entrepreneurial judgments regarding those time preferences.(highlight mine)”
There is also the issue of excessive leverage in the financial system (again monetary induced but this time through the credit system) which eventually contributes to the boom bust dynamics.
As discussed in our March 5 to March 9, 2007 Edition see US Markets: Risks of Ponzi and Speculative Finance, Hyman Minsky’s Financial Instability Hypothesis enunciated on the evolving structure of the credit markets, first shaped by stability and ultimately gradating to one that destabilizes.
Mr. Minsky identifies the three income-debt relations for economic units as hedge financing, speculative financing and finally Ponzi financing. Where the credit structures are initially founded to fulfill all obligations (hedge) then progressing into payment on income accounts on interest only leaving out the principal (speculative) to a more severe form of debt structure by pyramiding where both principal and or interest cannot be complied with by cash operations but instead rely borrowing to finance the outstanding liabilities (Ponzi).
Subsequently, Ponzi schemes signify an offshoot to overinvestments and collapse by its own weight.
How to benefit from STOCK TIPS and stop blaming others!
Yes today’s optimism has unassailably filtered into the general public. In fact, I have received many queries from different quarters over the different avenues (coming from those who knows or have an inkling on what I do).
And many investors perceive today’s market as astonishingly almost “risk free”. How circumstances have changed, radically from 5 years ago.
Nevertheless in most instances, I am asked of WHAT particular issue to bankroll them. In fact, some of my encounters include expectations of incredible outsized returns, even prior to last Thursday’s TV documentary, which had been picked up from their social circles.
When I try to explain that investing entails risks and opportunities management, which highly depends on their risk profile, their expectations on returns and time preference, I usually get a cold shoulder. Instead, I am thought to be self-indulgent.
How difficult it is for the public to understand that investors operate on risk-reward trade off. That trying to predict markets over the short term is tantamount to horse racing. To quote Dr. Marc Faber, ``Concerning the timing, I am the first one to admit that to press a button and say this is the low and press it again and say this is the peak, is very difficult. I am not sure if anyone has successfully managed to do that. I always look at what is the risk and what is the reward of an investment.”
Again, as an analyst-trader/investor we work on the crude probabilities of the market’s directional flow and act accordingly to its cyclical progression. We are not in the works to predict the future as clairvoyants.
While we may have our predilections over (investment themes as published in our outlook) some issues, we don’t know and can’t predict on which issues will be tomorrow’s darlings. Yet, this is what is expected of us; to deliver tomorrow’s returns. In today’s market, select companies have reached BILLIONS in market capitalizations which does NOT even have a million pesos worth of assets! If markets are a mystery, so be it. We won’t be lulled into taking inordinate risks.
Our predisposition has been mainly to position on our investment themes and wait for their maturity and anticipate the cyclical if not secular (long term) transitions rather than trying to second guess who tomorrow’s favorites are.
It is in the same tradition, Edwin Lefévre writing in behalf for Jesse Livermore in the must read Reminiscences of a Stock Operator warned that people do not want to think or work but only wish to be “spoon-fed” or given stock tips.
For instance, if I give you a tip and since your entry position has been directed by me, then it should follow that your exit position should likewise be based upon my tip to ensure the efficacy of my “tips”. In short, since your position depends on me, such “tip based” trade serves to measure the tipster’s or my accuracy in determining the trade’s outcome. That should be the protocol.
Yet, when we get tips that end up with bad results we usually engage in finger pointing. Why? Because we usually don’t follow this route, we end up heeding the tip but usually become unaware of our exit points. Even if a tip does accurately move according to the direction of the tipster’s advice, but since the exit position had not been determined, then the burden of success of the trade has essentially shifted from the tip giver to the tip receiver. And when the security or the markets in general move against your positions, the inability to establish exit points parlay to losses, from which we tend to blame the tipster. Is this fair? Obviously not.
Why? Such is known as a psychological delusion called Transference, which according to Author Robert Ringer (emphasis mine),
``the act of looking to others, or to “uncontrollable” circumstances, for the source of one’s problems. When you insist that something is not your fault, what you are unwittingly saying is that you cannot change your situation because you have no control over it…
``Even when you suffer as a result of someone else’s bad behavior, you do yourself no favor by blaming your pain on that person. There is a difference between engaging in transference (blame) and trying to analyze the reason you incurred the problem.
``There is always a reason for a bad consequence, but a reason is far different from an excuse. An excuse is nothing but a clever way to escape accountability. The fact that someone was dishonest with you could be a legitimate reason why you were harmed, but it is not a valid excuse for abusing your own Machine.”
Since most in the investing public have either been dismissive or ignorant of the dynamics that stockmarkets operate under human psychology as its main driver, one of our reasons in not giving out specific stock tips, aside from abiding by Jesse Livermore’s rule, is for our investors to pay heed to the lessons of cognitive illusions.
Any tips that you desire to heed should include an entry as well as an exit point, to lay the burden on your tipster. Otherwise we are ACCOUNTABLE for our actions and NO ONE else!!!
NO REGRETS, I SHOULD HAVE….
Further, in relation to cognitive biases, you should be familiar with these very common phrases:
I should have bought at the bottom; I would have gained a remarkable….
I should have sold at the top, I would have bought myself some brand NEW….
If I held onto this issue I would have been a ….
If I shifted to this issue I would have gained more than…
One of the reasons why the investors are hesitant to act on making important decisions is the fear of regrets. And those fears as encapsulated above are specific examples. It is known as the REGRET THEORY, where according to changingminds.org (highlights mine),
``People know that when they make a decision they will feel regret if they make the wrong decision. They thus take this anticipated regret into account when they decide. This is probably what makes them loss-averse.
``When thinking ahead, they may experience anticipatory regret, as they realize that they may regret in the future. This can be a powerful dissuader or create a specific motivation to do one thing in order to avoid something else.’
Again, it should be emphasized that the essence of investing is about anticipating returns as a trade off in relation to risk based on one’s risk profile, returns expectations and time frame preference. All other aspects naturally become subordinate to these.
Let’s make an example; stock XYZ in 2002 was worth 1 peso at its low and fortunately enough we were able to acquire them at 3 pesos in 2004. Today, stock XYZ is worth 8 pesos. What do we do now?
Let us assume that 5 years in the future the stockmarket peaks and by then stock XYZ will be worth 40 pesos. Then, in the next 5 years the falling market will drag stock XYZ back to the 5 pesos level.
Easy to say, since by virtue of fait accompli allows one to know where to exit, simply is because the past is unchangeable.
However, given today’s predicament, where the secular/cyclical climax has yet to be determined…what does an investor have to do? Cheer prices up to 40, then “deny-until-death” that prices have been in decline and finally revert to its near long low at 5 pesos?
Such would mean reaching the top and the bottom without taking ANY action, prompted by the fear of opportunity loss. In the end, all that cheering and sulking will end you up with a probability of net loss due to inflation. So what good does inactivity or directionless trade/investing make?
Let us further assume that stock ABC in 2002 was worth 1 peso. And that today it is worth only 2 pesos, far from the returns provided for by XYZ. However at the peak of the market cycle stock ABC will end up at 70 pesos per share higher than XYZ only to fall back to 3 pesos at the trough of the cycle 10 years from now, which is lower than XYZ.
Again under the present circumstances, what does an investor do? Maintain position and ignore or effect a switch? At what instance does one decide to take a shift?
These questions are difficult to answer because the future is unknown. We can only make our estimated guess of the market’s future whereabouts and act on contrived possibilities and their respective probabilities.
In essence, prices are relative; it will not always go up neither will it go always down unless under certain exceptions-fundamentals take it to the bin (e.g. insolvency) or to heavens (revolutionary discovery).
However, the general trend determines the price path, as we previously argued which is etched by the secularity/cyclicality of the financial markets and/or economy. Regrets on taking action will only compound to one’s miseries. Nor would we like to live in fantasy land.
The key point for an investor is to have specific goals and contingent plans to work with and apply action triggers under conditions operating under perceived possibilities.
Wake Me UP from MY Nightmares Please
Going back to the elements of horrors which affected me as impelled by the TV news documentary:
1. Bubble Risks.
If media barrages the public with constantly misleading depiction of the stockmarket, we could likely see an emergent bubble in the near future as the clueless throngs will dash into the market to gamble, ala China. Think of maids, drivers or janitors joining the mad rush to speculate on the markets.
This would either bring an abrupt end to the present cycle or create huge price swings or gyrations, enough to send us to the ICU.
2. Security Risks.
Criminal elements could target the industry mainstays, associated professionals and participants or investors known to have reaped a windfall and officials in publicly listed firms.
3. Political Risks.
Self righteous political personalities including their conduits could utilize the pretext of mounting inequality to slap legislative actions against the financial markets industry, such as levy additional taxes, impose capital controls, curb investor rights and access to financial markets in the name of wealth redistribution.
Wake me up from my nightmare please.
Figure 5: Jack Crooks: Milestone Low Yen on Huge Open Interest Level
