|»5 Minute Wrap Up by Equitymaster|
On This Day - 11 NOVEMBER 2010
Have you made uncertainty your best friend yet!
In this issue:
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Allow us to explain in greater detail. You see, as per a famous blogger Barry Ritholtz, if you want to earn good returns from the markets, there has to be some degree of uncertainty involved. This is because it is only during times of uncertainty that a stock will tend to be mispriced. As per Ritholtz, uncertainty drives the market's price discovery mechanism. Without any uncertainty, who is going to take the opposite side of the trade?
We believe Ritholtz could well be right here. Whenever there has been an absolute certainty about something, markets have tended to take a completely opposite stance. Recall what happened in Jan 2008. Investors were almost certain that Sensex could go on to scale new highs and within no time, a bear market began. Similarly, in March 2009, investors were absolutely certain that there is no recovery in sight for the markets. But what transpired was completely different. We saw the biggest turnaround in recent times.
Thus, to conclude, it is uncertainty that drives markets and contrary to popular perception, absolute certainty about something could actually result in an unexpected disaster. Little wonder, Warren Buffett often likes to say that uncertainty is a friend of a long term buyer of values. Hence, the next time you try your hand at investing; it could help to see the extent of uncertainty or the lack of it prevailing in the market place. If investors are absolutely certain that markets are going to go higher, it is perhaps time to take a completely opposite view.
While inflation has not yet reached alarming levels, the upward trend indicates that the government is likely to announce an increase in interest rates quite soon. The country is also grappling with the risk of asset bubbles which further intensifies the need for interest rate hikes. The Chinese government had hiked its interest rates last month.
Besides lower production, what is leading to sky rocketing prices is the huge rise in speculation in these commodities. Just to put things in perspective, average daily turnover by value of spices futures on the National Commodity Exchange has almost doubled from a year earlier. And to make matters worse, since the markets lack depth, only a handful of wealth entities can sway the markets in their favour and hold other people at ransom. Clearly, an adverse demand supply situation has been made even more adverse by mindless speculation.
We agree that the growth prospects in the emerging nations are much better than those in the developed world. But the key here is the price that one should be willing to pay for this growth. At present, loose monetary policies by the US is driving money into emerging markets and is raising fears of asset bubbles forming there. Thus, while there could still be opportunity in US stocks, at the current levels one would have to tread cautiously while investing in emerging market stocks.
Roubini believes that a fixed exchange rate regime or a gold standard takes away from the central banks' ability to induce pro cyclical measures in an economy. According to him, in a gold standard, monetary policy instead of helping to bring about a recovery ends up making it worse.
Roubini could well be true. But the current system has its share of flaws as well. In the current system, the central bankers are just not aware of when to stop printing more money. Take the US Fed for instance. Its money printing efforts are showing no signs of stopping or even slowing up. And this is highly risky as well. Infact, more risky than perhaps the gold standard. The key then is to maybe, have an entirely new approach. However, what is it going to be like is anybody's guess.
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