After reading ‘A Random Walk Down Wall Street’ A book by Burton G.Malkiel my belief in Fundamental Analysis and Technical Analysis was a bit challenged. The book rubbishes the two methods that have for long been trusted by financial analysts as ways of predicting stock price movements in favour of Efficient Market Hypothesis. His argument being stock prices already reflect the information financial analysts labour to collect and analyse.
Simply put – all that analysis is futile.
Even though I still cherish Fundamental analysis and Technical Analysis, I find some level of truth in Burton’s book – it’s hard to beat the markets. But does his argument hold in bull and bear markets?
For instance, I like to compare market Volatility to the Ocean activity that is the rising and falling of waves. Random and full of rage. A result of various factors that build up overtime. In the stock market, these rises and falls are normally referred to as bull and bear markets respectively and, as I’ve come to realise, if we’re to use the ocean activity comparison; the knowledge you derive from analysis is what helps you manage amidst the turbulence, or randomness if you like.
Bear markets
A drop of between 15%-20% in share prices that normally lasts over three months is characterized as a bear market. One of the worst bear market runs at the NSE was experienced in 2011 and saw stock market investors collectively lose around KES 200 billion in just ten months. It was attributed to high inflation, high interest rates and ripple effect of a troubled Euro zone.
Most bear markets normally have immediate short term effects that build up to pave way for sometimes financially tragic effects that last for long periods. The first instance is normally the upset of demand for stocks due to reducing prices which triggers panic selling that guarantees further fall in prices. Immense losses follow and in the long run the low prices prevail as investors stay away from the market out of fear.Mostly,stocks in bear markets are undervalued regardless whether the companies have strong fundamentals or not.
However, markets are prone to bouncing back from bear runs. Therefore, opportunities to make money in bear markets cannot be ruled out.For instance adopting Value investing as a strategy can provide a good entry into a bear market albeit it’s a long term approach strategy. The Idea here is to take advantage of the undervalued stocks with strong fundamentals before the advent of a bull run when their demand will be on the high. Normally,fundamental analysis would prove helpful as you try to establish a stock’s intrinsic value. Without which your Value Investing would be meaningless.
Bull markets
While a bear market is mainly driven by fear and panic bull markets on the other hand are as a result of increased investor confidence or general optimism in the markets. It could be due to an economic boom or low interest rates. The result is normally a 15%-20% increase in share prices over prolonged periods of not less than two months otherwise it’s just a bull trend.
Share prices in bull markets rise because demand is more than supply,therefore bullish investors would normally end up paying more for a stock in hope that they will gain from it’s continued rise. The common danger in bull markets is that stocks end up being overvalued giving way for a bubble.
Savvy investors love to take long positions in bull markets. That is the buying of stock in anticipation that it will continue to rise in value. Quite a commendable position but of what use is a long position in a bubble that is about to go burst? Without Detailed analysis you won’t be able to establish clear entry and exits from your position hence attracting loses.
Maybe Burton was right,It is a random walk. Since there’s money involved here,wouldn’t the walk be more worthwhile or profitable with some bit of guidance in way of a map which in this case is analysis, hence removing any element of randomness from it?