Thursday, October 20, 2005

Reasons for a market collapse 3 comments

(P.S: Sorry for any disturbances the advertisements above may have caused you)
The talking point these few days must be the continuous market collapse that culminated in a market meltdown of >65 points in the STI and a similar ~3-4% drop in the Sesdaq on Wednesday. That had analysts scrambling for reasons to explain the market correction, with some attributing it to the larger than expected rise in US producer prices (ie. higher inflation), the continued Fed commitment to raising interest rates, the loss of interest in local property stocks which have been overly priced upwards, the unexpected drop in Singapore's manufacturing industry performance, the impact of high oil prices finally sinking in etc.

Actually, is it useful to find reasons to explain the collapse after it has happened? Hindsight is always 20/20. The abovementioned reasons have been plastered all over the papers for several weeks, or even months now, and yet the market had been chugging along nicely with this burden of adverse news. So what additional piece of bad news had triggered the collapse?

The fact is that one should not look at the additional grain of sand that causes the whole sandcastle to collapse, but rather he should look at the existing precarious structure of the sandcastle itself. The market, in particular the STI and the property stocks, had been on an upward trajectory these few months and always looked ripe for profit-taking. It is dangerous to attempt market timing in a momentum-driven market, for the reason that price momentum tends to take on a life of its own. Yet, this momentum can stop when one least expects it, even in the absence of any immediate news catalyst.

An approach that makes more sense would be to understand the present state of the market (optimism or pessimism or realism), take the position that the efficient market is likely to eliminate price momentum in the short to medium term, and studiously avoid such key beneficiaries of the momentum so far (eg. property stocks recently). Although there are reasons for the price rise (usually short-term news flows such as release of Orchard Road parcels, overwhelming sales at condominum launches) the market usually has priced in these news, and then some ie. it also prices in rising optimism. Hence the efficient market does mainfest itself in response to short-term news flows, but perhaps excessively. At the same time, the long-term rationale for such optimism will be priced in ultimately, and that is where a correction eventually sets in. Many people know not to catch a falling knife, but perhaps it will be useful to also remember the effects of gravity as well in stock trading: the higher something goes, the faster it will drop (higher distance-> more time to accelerate downwards).

Of course, this is easier said than done, since during the price surge one cannot really tell if fundamentals or price momentum is at play; usually both. That is why it is so important to have a good long-term grasp of the industry in question, and that is why obtaining a historical perspective and business perspective is so important to the investor.




Anonymous Anonymous said...

Liberal Blogosphere on George Bush & His Band of Crooked Cronies
I live on the outskirts of one of the most conservative areas in the US ... Bush said this morning that he would focus on the nation's business instead of paying attention to the background chatter and noise caused by multiple investigations and criminal inquiries of the GOP and White House.
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bye bye - thanks for having this blog!

10/21/2005 4:55 PM  
Anonymous Anonymous said...

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11/11/2005 2:08 PM  

Interesting stuff.

12/11/2012 4:14 PM  

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