Sunday, July 30, 2006

Is history relevant? 1 comments

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If one holds the belief that the market is efficient, which means that all past historical data (weak-form efficiency) or even present fundamentals and future expectations (semi-strong and strong form efficiency) are priced into the stock, then he may question what is the point of studying the history of the market and of the stock?

There is a saying that history is philosophy teaching by example, and also warning. That, in a nutshell, summarises why history is relevant. After all, what is experience but a collection of painful experiences from one's personal history? A study of history allows us access to a collection of other people's experiences across a large expanse of space and time. Of course, the amount of understanding from these historical experiences that one can internalise within oneself will be less than if he goes through it himself, but certainly the relevance will always be there.

That is a top-level argument for the value of history in not just the stock market, but almost everywhere else in contemporary society. I'll try to relate some of the relevance of market history to the investor's market understanding. First off will be that a knowledge of market ups and downs in the past allows the investor to have a perspective of how drastic market swings can be, totally disproportionate with actual GDP growth or contraction which are typically single-digit. From manias such as the South Sea bubble and the dot-com boom to panics such as the the Great Depression and the Asian financial crisis, one gets a perspective of the extremes of the markets that are a result of human psychology. The technology and products can change, but the human traits of greed and fear are always dormant. An understanding of history imparts another facet to the old adages "let the profits run" and "never try to pick the bottom". To the extent that it helps to temper one's understanding and appetite for risk, an understanding of history is useful; however it is important not to let such knowledge paralyse one into inaction (see "Is too much knowledge a good thing?").

The same goes for understanding of the fundamentals of an industry --- history is a crucial piece of the jigsaw in consolidating one's understanding. An industry can appear very "hot" at the moment but observing its evolution and cyclicality (or lack of it) over a long period of time gives one a better understanding of its risks and possible trigger factors. Obviously oil and gas stocks, or even commodities in general, are the hot asset classes of today; yet so they were in the 1970s before prices collapsed over the next twenty years and the related stocks fell into a deep swoon, with subsequent underinvestment that has again led to a demand-supply imbalance triggering a boom today all over again. It has been said that the most reliable recurring series in finance is the reversion to the mean of profit margins; industry history provides a guide to what that mean should be.

Now for a stock's past trading history and in fact the idea for this article was triggered by a comment from a Shareinvestor forumer with regard to a writeup on Ipco's past history: "Pointless talk about history" he says, since the organisation has restructured and things are different. Without arguing from the point of technical analysts whose fortunes lie in reading the past price-volume history of the stock, I tend to see companies as adaptive organisations with a corporate DNA to themselves --- similar to humans (after all, these companies are run by human beings). Even if controlling shareholders or management have changed, the industry exposure, industry contacts, the intangible corporate culture, attitudes to risk, and probably most of all its reputation will form part of the historical baggage/legacy that will remain. In fact, I would think this historical baggage can be divided into two parts: company fundamentals and market perception. Restructuring might remove one or the other, but seldom both. The market can be rather unforgiving in this way (fool me once, shame on you; fool me twice, shame on me ---- and the market certainly does not want to look like a fool). Another facet to this is that the typical players behind the stock will tend to impart the same kind of characteristics to the stock --- speculative or otherwise. The same players always return to their favourite stocks, which might have been market darlings in their heyday, to the effect that these traders believe they might be getting a bargain now. The trading characteristics of a stock in the past give a clue to its future characteristics. (Personally, I do not use such historical price trends to pick my stocks, but I do use them to sieve out certain "avoid-at-all-costs" stocks.)

So, is history relevant? It is probably one of the most relevant aspects to study and understand, in my view, whether it's historical market trends, historical industry trends or company/stock history. It tempers expectations and improves understanding of risk factors involved, while giving a more comprehensive idea of fair valuation (through comparative valuation over time, and not just with current peers' share prices). In short, it is crucial in understanding the potential-risk-valuation triumvirate.





History will repeat.

2/09/2014 10:35 AM  

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