Are we out of the woods ?
Well, it’s been a long while since my last post. I must say the year has kept me quite busy. Global markets are extremely encouraging & investor confidence is improving by the minute. However, all this begs the question “Are we out of the woods ?”.
In my daily dealings with my investors, it’s becoming more & more common to hear them welcoming the current market rally but at the same time fearful that all this joy may be shortlived. I get queried as to why the markets are rallying but global economic data still looks dismal. Why the disparity between the two ? With many countries still facing economic challenges, shouldn’t it mean that the markets will eventually come down & that this rally cannot be real ?
In the course of my involvement in the financial industry, I’ve come to learn that the market & the economy move in slightly different cycles. The chart below illustrates their relationship:
Original source : Matt Blackman, The EquiTrend Weekly Market Watch
As you can see, the Market is forward-looking & moves ahead of the Economic Cycle. Back in late 2007 when the economy was still growing, markets were actually already hitting the top. Most countries only acknowledged their economic situation sometime in the 2nd-half of 2008 during which time the markets had already dropped very significantly. With this in mind, most people are of the opinion that the economy will stabilise & probably start looking better towards the end of 2009 or early 2010. Therefore, it’s expected that the markets will start moving up now in anticipation of the economic recovery.
Does it mean that the worst is over & markets will move up dramatically from here on ? I believe that the worst is behind us but markets will still be volatile as investors take stock of how they want to position themselves. Any new or unexpected bad news on the horizon may still shake the markets & drive it down again. However, the current outlook seems optimistic that the uptrend will continue (albeit hinging on a few key news & data coming up).
Should we take position in the equity markets ? My take is yes. This is an excellent time to start taking position but with a long term objective. The beating the markets took last year has put them into very undervalued situations & their upward potential is good. Caution is still advised but the positive prospects look much brighter now.
In the end, does this mean we’re out of the woods already ? Being the moderate person that I am, I would have to say maybe not yet. However, the wood is less dense now & the path ahead is clearer. Even if we’re not out of the woods now, I believe we will be very soon.
The Prospect Theory
The Prospect Theory was developed by Daniel Kahneman, a professor at Princeton University’s Department of Psychology, and Amos Tversky in 1979. What’s interesting about this Theory is that it describes how people make choices in situations where they have decide between alternatives that involve risk, e.g. in financial situations. Kahneman was awarded the Nobel Prize in Economics in 2002 for this economic model. Unfortunately, Amos Tversky had passed away before then.
A simple understanding of this Theory can be surmised from the following simple examples.
Scenario 1
Option 1
75% chance of winning $1000 and
25% chance of getting nothing.Option 2
Getting $700 for sure.
Scenario 2
Option 3
75% chance of losing $1000 and
25% chance of losing nothing.Option 4
Losing $700 for sure.
According to the Theory, in Scenario 1 most investors will select Option 2 even though Option 1 can probably offer $50 more (based on the probabilities). Also, in Scenario 2 most investors will opt for Option 3 although they know that they can probably lose less in Option 4. In an attempt to test this Theory, I conducted it with my family & friends and it came as no surprise when their answers matched the Theory’s model perfectly. It has been proven that investors tend to be risk-averse when there is “upside uncertainty” and be risk-seeking when it comes to “downside uncertainty”. Generally speaking, when the gains are uncertain investors will opt for gains that are certain (Scenario 1) but if the losses are uncertain then investors become more aggressive and takes on more risk (Scenario 2). Continue…
Quantitative easing explained
sourced from www.FT.com
By Chris Giles, Cynthia O’Murchu, Steve Bernard and Jeremy Lemer
Published: February 5 2009 20:35 | Last updated: February 6 2009 13:40
As the world suffers its worst recession since the Second World War, policy makers are searching for the best tools to limit the downturn. Central banks have rapidly lowered interest rates in order to reduce the cost of borrowing. The hope is to stimulate spending in the economy now.
So far, it has been to no avail. Confidence disappeared from banks, companies and households in the autumn of 2008 and unemployment is rising fast in 2009. Without an obvious source of fresh demand, central banks are moving to open the way to more unorthodox approaches to address the crisis.
One of those is quantitative easing. Our interactive feature explains how quantitative easing works and how this policy may stimulate the economy.
How fast can you double your investment ?
As more people look towards investments to grow their long-term savings, a common thought on investor’s mind would be “when will my investment double ?”. A well known method to calculate this is using The Rule Of 72. Basically, the formula is as below:
With this equation, one can estimate how many years it will take to double one’s investment based on a known annualised rate of return. On the other hand, if we have a fixed timeframe to double our investment then we can calculate the required annual rate of return to achieve it. This method of calculation is based on the compound interest factor and is assumed that no money is taken out or added into the investment throughout the period.
For example:
With an annual rate of return of 12%, it would take roughly 6 years for the investment to double. If we wanted to double our investment within 8 years then we’ll need an annual rate of return of about 9%. Continue…
Fear & Greed. The deadly duo.
During my years in the Mutual Fund industry, I’ve been fortunate enough to be able to experience the 2 sides of the financial markets cycle. 2007 was a phenomenal year for global markets with many reaching historical highs. Investors buzzed with excitement as most everyone tried to cash in on the buoyant market sentiment then but what a drastic turnaround a year can be. In 2008, markets crashed from giddy heights to frightening lows & investors rushed out of the markets in panic.
We’re into a new year now. Will 2009 bring the smiles back to our faces or will it prolong our frowns instead ? No one is certain but what we can be sure of is that the cycle will repeat and the markets will continue to bring us highs & lows. In the investment world many factors are uncertain & that’s why we need risk management but there are also certain constants. We know that markets always move in a cycle. It cannot be moving up or down indefinitely. We also know that the two most common investor emotions will always be there, FEAR & GREED. Continue…
Welcome
Thank you for dropping by. It's my pleasure to be able to share my views, observations, knowledge about financial concepts, investments & personal development here. Your feedback/comment is greatly valued, so do drop a line or two on how you would like this place to improve. Also, feel free to sign in the Guestbook to be kept updated on new developments.
Happy reading !
Recent Comments