Although I write on general trends and try not to predict the future, one has to admit
that we have never had a period when data is all over the place and the future is truly
murky.
US President Abraham Lincoln said 150 years ago: “The dogmas of the quiet past
are inadequate to the stormy present. The occasion is piled high with difficulty, and
we must rise with the occasion. As our case is new, so we must think anew, and act
anew.”
An uncertain future is nothing new. What is difficult to read are the five major global
forces that are disrupting almost everything, from our daily lives to geopolitics:
urbanisation, technology, demographics, globalization and climate change. We sense
that weather change and natural disasters are becoming more frequent and
unpredictable, but are not sure whether these signal something more ominous for the
long-term.
The real problem is that with information overload, we can’t sort out the signal from
the noise.
The stock market carries a lot of noise – short-term fluctuations due to no news or
bad news. Since companies and governments use public relation specialists to spin
news, one is never sure what is fact or fiction. The London Review of Books has just
carried an article by a respected journalist who claims that much of the official story in
the killing of Osama bin Laden was not the whole truth.
Is the Chinese stock market in a bubble and is it about to burst? As a former
securities regulator, I know how difficult it is for a government official to comment on
the market. If you say it’s too high and the market goes higher, those who believed
you would say that you caused them lost opportunities to make money. If the market
drops after you make that market warning, the losers claim that the government has
no business interfering in the market. This is a no win situation.
So all I could say was to repeat the four “Knows” – do you know what you are buying,
what risks you are taking, how much you can afford to lose, and finally, do you know
yourself?
The first question should be easy, but is very difficult because the Chinese stock
market has not behaved according to normal theory. Between 2007 and 2013, when
the Chinese economy was the fastest growing economy in the world, the A share
index dropped from 6,000 to a low of 1,800 in 2008 and lingered around 2,000 till
August 2014.
It then rebounded and in a matter of months, reached the current level of 4,300. This
happened despite the economy slowing to almost half the former speed, with worries
on a possible hard landing.
The market recovered because the retail investors are back in the game, punting not
just penny stocks but also highly speculative technology stocks. One real estate
company changed its name to a technology-sounding name and its shares went up.
Technology company stocks are defying valuation logic, because many of them do
not even make money or may never make money. Just because a handful may
become the next Apple or Tencent does not mean that every one of them will. In fact,
many of them are likely to fail.
Knowing the risks that you are taking is both a question of fact and your own financial
circumstances. When you buy a speculative stock, the risks are considerable and
you can both win big and lose big. When you buy a blue chip stock, which yields a
good dividend with less volatile prices behaviour, you should not gain much and
hopefully not lose that much.
The trouble is that with exceptionally low interest rates, it is difficult to judge valuation
according to conventional methods. How do you apply discounted cash flow valuation
based on near negative real interest rates to even bond prices? Even experienced
fund managers are having a tough time predicting bond and equity prices, because
central bank intervention through quantitative easing has changed the game.
The third question depends on your own financial circumstances. If you are a retiree
or have a lot of financial commitments, it would be dangerous to bet on speculative
stocks and lose almost everything. Worse, if you borrow to speculate, the upside is
higher, but so are the losses. Hence one must have a bottom line on how much you
can afford to lose.
The last question is an emotional issue of knowing oneself, which is most difficult. No
one can protect you from your own greed or stupidity. The most dangerous
investments are those in which you win initially and then you double up and the
market reverses.
Investment is a discipline on one’s own emotions. We will never be able to buy at the
lowest point and sell at the peak. The key is to control your own greed and take
profits when you win and cut losses when you know the market is against you.
In today’s game of computerised trading, a retail investor is trading against
professionals and computers.
You are not even sure whether the increased volume and liquidity is due to
professionals who understand the valuations more objectively or due to computers
buying and selling because of an algorithm that just picks stocks according to price
and volume signals. All you know as a retail investor is that when the price reverses,
it will do so very fast.
The market moves on valuation, momentum and conflicting sentiments of greed and
fear.
Valuation is tough to measure and momentum is crowd and computer driven. Hence,
whether you win or lose really depends on your own ability to control your own
emotions. If you made good profits and did not take them, then you have no one to
blame except yourself when the price changes.
Your guess is as good as mine where the market is going. My own rule is to trade on
the noise, but invest in the signal. What is the right signal is up to individuals to
assess. What goes up will come down, but enjoy the buoyancy whilse it lasts and
don't be too greedy.
Andrew Sheng is former chairman of the Hong Kong Securities and Futures
Commission.
A version of this article appeared in The Star Online, 23 May 2015
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