Market Fluctuation

1
Market Fluctuation

• Price Fluctuation
• The Value of Uncertainty
• The Way of Timing
• The Way of Pricing

2
Fluctuation and Extreme Movement

• Price volatility and Earnings volatility
• Bull and bear markets 1949-1961 and 1990-2000
  bulls
• --Without bear markets to take stock prices back
  down, anyone waiting to buy low will feel
  completely left behind, and all too often will
  end up abandoning any former caution and jumping
  in with both feet
• --The longer a bull market lasts, the more
  severely investors, who no longer believe bear
  markets are even possible, will be afflicted with
  amnesia

3
Extreme Movement

• Point of inflection breakthrough
• Mass psychology booms and crashes
• The historical review of booms and crashes
• Tulip bulb
• Automobile
• Aviation
• Internet (Telecommunication)
• Biotech

4
What Causes Price Fluctuation?

• Expectation on future prospects
• The driving force behind the demand curve and the
  supply curve
• Price itself, market sentiment, fundamentals, and
  leverage effects
• Stock price itself and earnings
• Bond price itself and interest rates
• Currency exchange rates and economic growth
• Real estate real estate price and inflation
• Commodities price itself and macroeconomic
  factors

5
The Value of Uncertainty

• The charming child v.s. the sleepy aged
• Pricing uncertainty using binominal trees
• A simple example
• Consider a firm that is trying to decide to
  invest a machine factory and
• the factory can be built instantly at 1600
  and
• will produce one machine per year forever
  with zero operating cost.

6
The Value of Uncertainty

• Currently, the price of a machine is 200, but
  next year the price will change.
• With 50 of probability, it will rise to
  300, and with 50 of probability, it will fall
  to 100.
• The price will then remain at this new level
  forever.
• Assume that the firm should discount future
  cash flows using the risk-free rates of 10.
• Should the firm invest the machine?
• If yes, should it invest now or should it wait
  for one year?

7
Calculation of Uncertainty Value

• The expected net present value of investing now
• The expected net present value of investing later
  (wait for one year to get more information)

8
Calculation of Uncertainty Value

• The expected net present value of investing now
• The expected net present value of investing later
• The value of the option to defer (wait),
• suggesting that the value of the right
• that we have to invest one year later rather
  than right now is 173.
• It is better to wait for one year than to invest
  right now

9
The Way of Timing

• Speculators anticipate the action of the stock
  market
• Speculators buy and hold when the future course
  is deemed to be upward and sell and refrain
  buying when the future course is deemed to be
  downward
• If an investor places his emphasis on timing, in
  the sense of forecasting, he will end up as a
  speculator and with a speculators financial
  results

10
The Way of Timing

• The stock brokers and the investment services
  seem wedded to the principle that investors and
  speculators should devote careful attention to
  market forecasts
• Investors have been persuaded that they should
  form some opinion of the future course of the
  stock market and that brokerage or service
  forecast is at least more dependable than their
  own.

11
Speculators Timing Psychology

• Timing is of great psychological importance to
  the speculator because he wants to make his
  profit in a hurry, since the idea of waiting one
  or two years before his stock moves up is
  repugnant to him
• However, a waiting period is of no consequence to
  the investor, who enjoys an advantage only if by
  waiting he succeeds in buying later at a
  sufficiently lower price to offset his loss of
  dividend income

12
Speculators Timing Psychology

• Why can any typical or average investor
  anticipate market movements more successfully
  than the general public, of which he is himself a
  part?
• For who will buy when the general public, at a
  given signal, rushes to sell out at a profit (or
  a loss)?
• The positive trading psychology of buying past
  winners and short selling past losers

13
The Timing Signals

• Trading volume relative to price movement
• Advancing stocks relative to declining stocks
• Margin trade relative to short selling
• Insider trading activities
• Trading activities of institutional investors
• Stock repurchase activities
• Initial public offerings (IPO)
• Stock seasoned issuance

14
The Timing Signals

• Mass media signals
• Price relative to earnings
• Cash dividends relative to price
• Book value relative to price
• Government intervention
• Derivative trading activities

15
The Way of Pricing

• Investors buy stocks when they are quoted below
  their fair (intrinsic) value and sell when they
  rise above such value
• Make sure that you do not pay too much for your
  stocks when you buy
• Make tactical asset allocation when the levels of
  stock prices appear more or less attractive by
  value standard

16
Discrepancy between Value and Price

• Mr. Market
• - Mass psychology
• - Fear and greed
• Calculate a firms fair (intrinsic) value
• - Expected future cash flows
• - Estimated risk discounted rate
• - Probabilistic decision making
• - Mood of Mr. Market

17
The Role of Security Selection

• In efficient markets, active portfolio
  management, like market timing, tends to detract
  from aggregate investment performance.
• In the context of relative performance to the
  market index return, security selection
  constitutes a zero-sum game.
• In the aggregate, active investors will lose by
  the amount it costs to play the game in the form
  of transaction costs, fees, and market impact.

18
Effective Security Selection

• Value-oriented strategies in inefficient markets
• Value can be purchased by identifying assets
  trading below fair value, or created by bringing
  unusual skills to improve corporate operations
• Value investors operate with a margin of safety
  unavailable to less conservative investors
• Thinly-traded, illiquid, neglected, and
  small-size private equity