The speed and flow of information through the share market is not an issue that most of us think about very much. Nowadays, we just assume that the news and stock prices on our computer screen are live, or pretty close to it. The same goes for order processing. If your broker takes longer than a few seconds to record your bid or offer, you wonder what the problem is.
Yet in other ways, investors act like we’re still living in the 1870s, waiting for the London metal prices to arrive via the Darwin telegraph. For instance, most people are comfortable with the idea that they can make profitable trades by analysing historical price charts, or by performing ratio analysis on a company’s past financial statements.
This is particularly surprising given the financial dramas at Enron, WorldCom, Global Crossing, Tyco, Adelphia, HIH, OneTel and Harris Scarfe. While the media and regulatory focus in these cases has understandably been on shortcomings in corporate governance, the wider issue is the shortfall in information. And that’s what really matters in terms of investment research.
Don’t give me statistics, give me information!
Unfortunately, many people confuse new information with new analysis. Generating a stock chart on your computer is not new information. Adding a moving average to the chart is not new information. Comparing the 100-day and 200-day moving averages, subtracting the oscillation index and multiplying by the high-low differential is not new information. It’s probably not even new analysis. Yet most technical analysts (chartists) miss this distinction, blaming their mixed trading success on peripheral things like the number of days in their moving average, the software they use, their level of experience, or some perceived inadequacy in their trading psychology.
Fundamental analysts often make the same kinds of mistakes. Although they tend to think their work is more intellectually rigorous than charting, the two approaches are more similar than dissimilar. Both involve slicing and dicing publicly-available historical information to forecast the future. Torturing the data might make it confess but academic studies suggest that it wont help you achieve above-average returns in the long run.
So does this mean that all financial analysis is useless? Not at all. Just that when you use an ‘analysis-only’ approach, your winners and losers will tend to cancel out over time and you’ll probably end up with below-average returns once trading costs are taken into account. If that’s the case, there’s a strong case for saving money on research and buying an index fund.
How am I supposed to get new information?
You often hear parents advising their children to run their own race. Don’t worry about what other kids are doing, just focus on what you’re doing. The same adage applies when investing. Many small investors come to grief by trying to follow or guess what the smart money is doing instead of using their own firsthand knowledge.
In particular, they don’t take advantage of their knowledge as consumers. You might not have thought about it explicitly but you probably know more about consumer spending than most economists or analysts. For a start, you know what you like. And you know what you buy. With a little effort, you could probably make a list of the products, retailers, suppliers and shopping centres that seem to be popular or have impressed you. If you’re involved with a business, you’ll be able to put figures on many of the things that financial analysts look at, such as prices, sales and costs.
All this is valuable information. According to US experts, most people can generate two or three investment leads a year by examining these kinds of trends. For example, how many times have you driven past retail stores like Bunnings Warehouse or Harvey Norman and thought: that place is always crowded, or those shops are popping up everywhere? If you were alert, you could have used this knowledge as a prompt to check out Wesfarmers and Harvey Norman shares.
Likewise, how many times have you heard that the share price of a particular stock plunged after the company issued a profit warning? How does this happen? Maybe the downgrade was a surprise for fund managers and analysts but a lot of customers, suppliers and contractors must have known or guessed what was happening well beforehand. Finding new information might sound difficult but it can be straightforward once you know where to look. The trick is to notice opportunities when they arise.
Of course, this approach is not always foolproof. If you bought One.Tel shares because you liked their cheap call prices, you wouldn’t be too happy right now. But more often than not, you will improve your investment returns by supplementing an analysis of the publicly-available data with your own private information.
The helicopter view
While company research is perhaps the most obvious area to apply your own knowledge and experience, it’s certainly not the only one. If you look carefully, you can probably find market information which is equally valuable. This might also allow you to avoid some of the company-specific risks outlined above.
When economists try to forecast GDP, they spend countless minutes looking at past relationships, extrapolating trends and estimating variables. But what is GDP really measuring? It essentially summarises what you bought, what you earned, and what your business did. For this reason, many consumers and businesses will have a better idea of what’s happening in the economy than economists and financial analysts.
One of the surprising things about professional analysts is how little firsthand knowledge they have of business and consumer trends. Most rely exclusively on other people fortheir information, especially government statistical agencies, the media and securities exchanges. Collecting your own information is considered too hard, too time-consuming and too expensive. And hey, if the government is collecting figures on employment, inflation and business conditions, why reinvent the wheel? Despite this reliance on historical public information, most are convinced that they can ‘out-analyse’ everyone else.
This presents a number of opportunities. If you’re a business owner, you should be alert for trends on prices, employment and the level of sales. Not just in your own firm, but others in the neighbourhood or industry as well. The chances are that you will notice signs of a pickup in the economy or the beginnings of a downturn much sooner than analysts who rely on government-provided information.
Similarly, consumers should keep an eye out for general trends when buying goods and services. Do prices seem to be going up? Are businesses in your area closing down? Are people in your firm or neighbourhood being sacked? Are you becoming worried about your finances? If you’re feeling more pessimistic or optimistic about the economy, others probably are too.
If US studies are any guide, the most important business indicator to watch is jobs growth. On a scale of one-to-ten, it rates about ten.
Next in importance is the trend in wholesale prices (about 8 out of 10), followed by retail prices, retail sales, business orders, and business and consumer confidence (all around 6 out of 10). With a bit of basic detective work, literally thousands of business people and consumers will be able to tell what’s happening in the economy before economists and analysts figure things out.
One other point is also worth noting. Government statistics are generally collected on a monthly or quarterly basis and listed companies usually report half-yearly. For most professional analysts, this means there are long dry spells before new information arrives. People who deal with customers everyday, and firms that conduct more regular surveys, will often be much quicker to spot new trends.
In fact, exploiting this information lull is probably easier in Australia than most other developed countries. Take inflation as an example. There are only two countries in the 30-member OECD who don’t manage to produce a monthly consumer price index. Guess who they are? The Oceania twins: Australia and New Zealand. We’re strong performers on GDP as well. Although the US has 287 million people and is 27 times bigger than the Australian economy, it publishes GDP figures about one month after the end of each quarter. Australia takes twice as long to release its GDP statistics.
What really counts
Financial markets are generally very efficient at processing information. To have any serious chance of achieving above-average returns, you need new information and you need it faster than other market participants. No matter how smart you think you are, raking over historical information using charts or spreadsheets is unlikely to give you an investment edge. It’s new information that counts, not new analysis.
Luckily, obtaining new information is within the grasp of most people.
By: Andrew Quinn, Director