Monday, December 23, 1996
Predicting the Market
or
Maybe Elaine Just Needs The Money
by MF Runkle
A couple of weeks ago my wife got some sort of mass-mailed "private invitation" from Elaine What's-her-name. Elaine has "never been wrong" according to this invitation, and a market "crash" was coming. All we needed to do was subscribe for 400 some dollars to find out all the details. Well, I thought Elaine predicted an immediate crash a couple of months ago, and it didn't come. I would consider that being wrong, but, what the heck?
Since then, I've seen all sorts of market gurus predict what the stock market will do. There are those who predict its fall to a thousand something (which certainly could happen, say if nuclear war occurred), and there was some lady on CNBC last week who predicted the stock market would continue to go up. Of course I'd like to believe her. Anyway, I thought about this whole situation and decided to go over what affects the stock market. Maybe from there it's possible to predict its direction.
Well, here are a few things (you can probably think of more):
1. Corporate earnings -- these are affected by the economy, competition, and politics. Also, corporate management, labor agreements, weather (which can affect raw material prices), and maybe a few other things too.
2. Interest rates -- higher rates entice investors to pull money out of stocks and also hurt corporate earnings. They also make the economy go up or down. Interest rates are affected by the Federal Reserve Bank, how much the government borrows, and how much everybody is borrowing and lending. All of this is affected by the economy and politics.
3. Politics -- unstable world situations make investors jittery. Stable world situations makes investors optimistic. Also, politics determine how much governments spend and borrow. Some political events are catastrophic. Wars make the market go down; so do rapid changes in governments. Wars are started over economic conditions, ancient blood feuds, and plain old power lust. Governments change because of the economy, wars, political scandals, or anything else.
4. Valuations of stocks -- stocks in companies are worth only so much. How much? What people are willing to pay for them. How much is that? Well, I put several different formulas on a spreadsheet to see how much my investments are worth. I used Benjamin Graham's formula, the YPEG, the PEG, the DPEG. The end result? Wildly varying valuations. Sometimes it is obvious a company is over- or under-valued. Most of the time it's not too clear; if it were, the market would be much more efficient.
5. Investor sentiment -- how do people feel about the future? This is affected by the economy, politics, and corporate earnings, as well as such things as how good an investor feels on a certain day, which can be affected by anything, including the weather.
6. The economy -- everything affects the economy, interest rates, corporate profits,
overseas competition, and politics. Did I include the weather? Oh yeah, earthquakes too, remember the problems Japan had after the Kobe earthquake? The economy can affect politics, like Bush losing the re-election. It also leads to wars. Germany suffered hyper-inflation after World War I, which helped Adolf Hitler come to power. What he led Germany to do was one of the more horrible events in all of history.
7. Weather -- yes, weather. Bad weather can cause cocoa prices to rise, for example, which would hurt Hershey stock. An abundance of good weather can actually be a bad thing, creating a surplus of some commodities, hurting profits, lowering taxes, which of course can hurt governments. Weather affects shipping conditions. It affects people's moods. It can cause catastrophes, which can lead to political instability.
Of course, this is a very short list. What's even more interesting is that the seven items above feed off of each other. Some, like politics and weather, are real hard to put a finger on. Who would have predicted two years into President Clinton's first term that he was going to be re-elected so easily? Who would have predicted the Berlin Wall was going to go down way back in 1980? Who can predict how much snowfall we'll see in any given year? Predicting the economy is no easier. Too many things affect it. Since corporate profits feed off of the economy, which is affected by politics, can they be predicted with any real accuracy?
With all of the complexities that affect stock prices, how in the world do you predict what the stock market will do? In a few rare cases when things get really out of whack, you might be able to do so. Otherwise, I really don't see how you can hope to make accurate predictions. Even more hilarious is that so many gurus make their predictions on such simplistic notions as advance-decline lines on the New York Stock Exchange. Some, like Martin Zweig, really put an effort in nailing down different indicators to come up with a prediction. The question is, do they have the right indicators? Sometimes they might. Other times, who knows? In the end, it appears we have too much chaos and uncertainty (which are complex mathematical topics in themselves) to predict the stock market on a consistent basis. I can make this prediction though: if you don't send that 400 some-odd dollars to Elaine, you'll put it to much better use.