The Market is Very Smart

At barbecues, I often get asked about the latest hot stock pick, or what I think about this bank or that mining company as an investment. Aside from not viewing my works as merely being about investments, the truth is that what I think about these matters is largely irrelevant.

The market has a lot of information available to it, and makes use of all of that information when fixing the price for a particular security. The only way for one investor to have an advantage over another in purchasing an investment at a low price with prospects of windfall gains is for that investor to have information which the market doesn’t have. If you spend as much time with investment analysts as I do, you will mostly find that they share the same views about particular stocks, though their view may not necessarily be as strong as one another and therefore not always reflected in their recommended portfolios. It is very unusual to have one analyst recommend a particular stock as a strong “buy” when another is recommending a “sell”.

The impact of this, of course, is that if an analyst is recommending a “buy”, the price will go up and very often before you make the decision to buy. Similarly a “sell recommendation” will usually have the effect of placing downward pressure on prices.

So what does this mean? Well, investing is not punting, companies which generate profits, or are anticipated to generate profits will usually increase in value over the long term, and investing in them will bring rewards. In the DotCom bubble of the early noughties, companies which had never and were never likely to, generate profit were being traded at outrageous prices, with very little substance behind them. Many of these companies no longer exist. what looked like the latest hot tip suddenly feels a little cooler in this environment. There will from time to time be anomalies in pricing like this, but seeking to exploit them is very difficult, particularly in terms of pricing. The number of DotCom investors who wisely got out before the crash is very small, human nature is such that we don’t want to sell when markets are rising, only when they are falling, and by then it can often be too late

The shrewd investor doesn’t look for quick gains or seek to outsmart the market, after all the market has access to more information, and opinions, and interpretations than you will ever have. If your neighbour or Joe down the pub tells you he has “inside information” he almost certainly does not, and following his recommendations is as sensible as accepting his prediction of the next Melbourne Cup winner. If he did have inside information, why on earth would he be spreading it around, it is only going to impact on prices.

Philosophically, we don’t often recommend direct equities anyhow, there are far wiser and more experienced sharemarket investors in the world than us. We call these guys Fund Managers, it is their job to create portfolios which will maximise the likelihood of them achieving their mandated outcomes over the time horizon which they have set. We select these managers for our clients based on the clients’ needs and their tolerance for risk. Our assessment of each manager can only be made based on whether they have historically achieved what they have sought to do – no one has ever demonstrated a working crystal ball to me. These Fund Managers DO have information which is not available to me (though because of the size of institutional and managed portfolios it will have already been reflected in prices) so it makes sense to utilise their expertise.

So when we meet at our next barbecue, and my response to your question about specific stocks is “No Idea”, now you know why.