For future refrence, 3Q 2009

Logs from the old site…

Trying to apply logic

My foremost predicament these days is the fact that I – along with everybody else – am in no way able to predict the market. The uncertainty at the moment is ever so big. I see it this way: stock markets around the world have been recovering in recent months after the collapse but economic indicators suggest that there hasn’t been any real recovery and some even suggest that the negative numbers are only not as negative as they have been. But if we presume that the stock market is a leading indicator of economic performance we could say that the signs of confidence returning to the financial markets means that the real recovery is about to turn the bend. Another argument is that the stock market increases of the recent month’s aren’t based on any fundamental economic recovery and that the recent spike in stock prices is caused by investors looking at the stock market as a leading indicator of economic performance and therefore hyping each other up as a consequence. But thinking about the direction of the market and trying to time it is a short term problem. I define myself as an investor as opposed to speculator. Therefore the logical thing to do is to look at the underlying economics of my investing prospects (companies, funds, currencies etc.) in order to find equities selling at a discount. The margin of safety should lower risk in the long term.

A shock or a shift?

This moves us to the following predicament. Stock prices represent future value of a company. I use the presumption that historic earnings and earnings growth indicate likely future earnings and earnings growth. But the state of the world economy at the moment is a far from equilibrium situation, if I may lend the words of George Soros. On his blog doomish economist Jóhannes Björn says:

‘People have priced stocks way to high because they think that the trail of events of the last decades will repeat itself and that private consumption will increase dramatically soon as it did after the previous economic recessions after the world wars. The market has still not realized that we are experiencing in a totally different economic system.’

Either we are experiencing the biggest economic shock since the great depression or we might even see a burst of a super bubble and the birth of a new economic reality. Nassim Taleb, for instance, thinks that the economies of the world will need to deleverage. How would that happen and how would it affect equity markets? What about the risk of hyperinflation caused by the excessive printing of money to save the financial system, the US debt burden or even climate change? I have no answers for these questions but they are questions that I keep in mind these days for how can I use past performance as a matter of fitness if the environment has had a dramatic change?

Application

The past year has sharpened my views on investing:

  1. The equity premium puzzle is a reason to become involved in stocks.
  2. An important note concerning the EP puzzle is that it looks at indexes but individual stocks live and die. The most important objective in investing is surviving. By using the value investing discipline, looking at financially healthy stocks that hold some sort of competitive advantage in their market and are trading for a fair price, in the long run I will decrease the risk of a blow up.
  3. The use of the economic assumption of ‘perfect knowledge’ is totally opposed to the Popperian methodology and in fact useless in real life.

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