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How the stock market fools you

Aug 22, 2015

In this issue:
» Situation worsens for global steel sector
» Crude oil dives further, nears 2009 lows
» ..and more!


00:00
Let's start with a question. What do two-year stock market returns of 164%, 157%, and 145% have in common?

Think about it.

Aside from being great returns, they're tricks.

The stock market loves to play tricks on you...to tease you...to excite you...to excite so much, in fact, that you take a big chunk of your hard earned money and jump into the markets head first.

From the vantage (or rather disadvantage) point of May 2006, November 2007, and November 2010, you'd see those great two-year BSE Sensex returns I mentioned and probably couldn't help but feel excited.

Not surprisingly, these were times when it seemed everybody thought the stock market was the place to be and that making money would be a cinch.

But that's why it's a trick! At the precise time you should be most cautious, the market wants you to be most excited.

The market can trick you in many ways, but the easiest way is to wave mouth watering recent gains like 164%, 157%, and 145%.

Yes, they're excellent, highly attractive returns. But they're a deception...a snare...a delusion.

So how does the trick work?

From one angle, the generous stock market might look like it will continue to deliver these juicy returns. But all these big short-term returns actually do is raise prices to unreasonably high levels - levels much higher than the underlying businesses are worth.

Investors fall head over heels with the market just when prices are at their most unprofitable.

As simple and obvious as this is in hindsight, investors fall for this age-old trick every time. So the market keeps playing it.

What can you do to avoid such folly?

It's quite simple actually.

Whether you're looking at the entire market or an individual stock, never judge the attractiveness of a stock by looking at the returns it has delivered over the recent past.

Instead, try and get a gauge on what the underlying business is reasonably worth. If it is selling for a good price in relation to its worth, it's an attractive investment. If not, avoid it. It's as simple as that.

Have you ever fallen for the stock market's tricks? Let us know your comments or share your views in the Equitymaster Club.

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02:44
 Chart of the day
Among major commodities on a downtrend, two that deserve special mention are oil and steel. And while India being a net importer of oil stands to benefit from the former, the same cannot be said for steel.

While some of the oil companies have gained due to cut down in fuel subsidy, there is no such consolation for steel producers. And this is well reflected in their stock price performance. The S&P BSE Metal index is down 32% in the year till date versus just 1% decline in the Sensex. Of this, around 17% decline has been over the last one month.

The major global steel producers have reported a fall in steel production. China is leading the losses with around 4.6% YoY loss in the first five months. Consequently, the industry's capacity utilization has also tanked in the month of July.

Things get worse for steel producers

There is nothing to indicate a reversal in the trend any time soon. As an article in Livemint suggests, a declining production in China does not even translate to reduced import pressure for Indian steel makers. With demand in China slackening, the thrust on exports is likely to continue. Worse still for Indian steel makers, the imported steel is cheaper than Indian steel. The steel industry has now turned to government for help and has sought higher import duties. But that's a long drawn process. For Indian steel companies, especially for the ones with high debt on balance sheets, there seems to be little hope in the near term.

03:25
And in this scenario where commodity prices have nosedived, oil has not been spared either. As reported in the Economic Times, oil prices dipped below the US$ 40 a barrel mark for the first time since the 2009 global financial crisis. The reasons for this fall are twofold. One is the increase in the US shale gas production. This is something we have seen since the past many months infact. The rise in shale oil production had led to a supply glut in the global market. And Saudi Arabia chose not to curtail production either. All of which led to the meltdown in oil prices. This is on the supply side.

On the demand side, things are not looking too good either. And that is because of China. Indeed, China is the world's second biggest consumer of oil. The Chinese economy has been slowing down for many months. And this only became all the more apparent through the release of the factory data. It showed that China's factory sector shrank at its fastest pace in almost six and a half years in August. Basically, demand has waned in China. Taking a call on oil prices is always a challenging task given so many variables that influence it. But for the time being, a combination of oil oversupply and tepid demand only means that prices could remain low in the medium term.

04:20
Global markets witnessed a mega correction this week due to multiple factors. Investors panicked as concerns about China's economic growth became widespread. Fears about the US Fed raising interest rates next month also contributed to the fall. Due the huge correction in commodity prices, the currencies of commodity exporting nations have also come under severe pressure.

The US markets suffered its biggest one day fall since 2011 on Friday. The volatility index (VIX) saw the sharpest week on week jump ever recorded as over US$ 1 trillion of investor wealth was eroded. Wall Street has remained buoyant thus far amid negligible growth in corporate profits. However, investors are now showing willingness to exit over heated stocks.

European markets were hammered this week. The crisis in Greece re-ignited with the government resigning and fresh election being called. All key European indices were down between 5% and 8% this week.

The Indian markets held up reasonably well this week. Global investors have not yet abandoned India in the way they have fled other emerging markets. However, we believe volatility will continue to remain high in the near future.

Performance during the week ended 21 August, 2015
Data source: Yahoo Finance

04:55
 weekend investing mantra
"You do things when the opportunities come along. I've had periods in my life when I've had a bundle of ideas come along, and I've had long dry spells. If I get an idea next week, I'll do something. If not, I won't do a damn thing." - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Rahul Shah (Research Analyst).

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1 Responses to "How the stock market fools you"

GHHOLA

Aug 22, 2015

Greed for jar joru and jamin-that is wealth,property and women is inherent.This question is like asking, "who does not drink water?" The madness of equity tend to make rational into an irrational , rich into a pauper.Gullibles are driven and allured by bulk of the so called stock market experts who do not know what is market but recommend to the readers/ audience/viewers as if they are" dharamraj " of market and can dictate to the market direction.Flip side is that NDA has lost control of its map if it ever had.This has happened owing to Modi,s over dependence on trioka who are scheming to clips wings of peoples/authority who so thinks out of the box which is generally not in sync with the philosophy of RSS think tank.Case in point Maggi being draged to NCDRF, renaming NITI without any clearly defined objective,re-tweaking role of RBI governor to clip independence of its Governor who ensured that Indian economy remains cocooned from ill effect of upheavals globally. But Jaitley and Modi are in a hurry to leave their own footprint where they would be giving a stench for days to come

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