Factors to Consider to enjoy high return on investment (3)

In the past two weeks we covered key technical aspects related to investment in shares and their influence in the level of returns (both dividend and capital gain) as well as the performance of listed shares. We covered factors such as demand and supply; we discussed how these two market forces affects prices of listed shares. We further discussed how economic variables such Gross Domestic Price (GDP), inflation, interest rates, exchange rate, the state of current account and capital accounts, etc — and how these variables impacts the fundamental and sentimental performance of companies listed in the stock market. We also covered how company news results into the increase or decrease in share prices.
Today, we will delve not on technical aspects like we have done in the past two weeks — but we will focus our attention into the concept of market psychology and how, in addition to the technical analysis, it does inform our investment decision making. Later in our today’s article we will see how factors such as market cycles also affect market prices, and hence investment returns for investors in the stock market.
It is important to note from the onset that a good combination of both the technical tools and psychological factors can make a significant difference between a good investor and a great investor — we do not intend to say either technical aspect or psychological aspects, that one is better than the other. In actual fact, it is fair to say that when technical tools are used judiciously, their value in the process of investment can not be overstated. And every time, you, as an investor — apply a tool of technical analysis, you are (probably unknowingly) calculating a consensus of psychological — bullishness or bearishness — among all market participants. What it is, therefore is that the principles of market psychology underlie each and every technical analysis, so a good understanding of mob-psychology or crowd behaviour is crucial to your understanding of the fundamentals of particular technical indicators. Read on:
During our investment experience and processes, we probably have heard the efficient markets theory — basically, the theory of efficient markets are based on the assumption that rational people enter transactions with the intent to maximize gains and minimize losses. While this theory is sound, most investors are not the purely rational robots that efficient markets rely upon. Instead, emotions and other psychological factors often cloud our decision-making and prevent us and rational human beings from acting in a rational manner.

Knowing we can never conquer our inherent emotional and psychological biases, we should seek to understand the range of emotions we may experience as investors and how it affects our interactions with the stock market. A common market psychology cycle exists that shines light on how emotions evolve and the effect they have on our decisions. By understanding the stages of this cycle, we can tame the emotional roller coaster.
Market psychology is the overall sentiment or feeling that the market is experiencing at any particular time; greed, fear, optimism, hope, excitement, thrill, euphoria, anxiety, fear, desperation, panic, relief and other such related circumstances are all factors that contribute to the market’s overall investing mentality or sentiment. While conventional financial theory describes situations in which all the players in the market behave rationally, this theory do not account for the emotional aspect of the market that can sometimes lead to unexpected outcomes that can’t be predicted by simply looking at the fundamentals of the economy, the stock market or the underlying company.
Technical, analysts normally use trends, patterns and other indicators to assess the market’s current psychological state in order to predict whether the market is heading in an upward or downward direction
Market sentiment
Market sentiment refers to the psychology of market participants, individually and collectively. It represents the general prevailing attitude of investors as to anticipated price development in a market. This attitude is the accumulation of a variety of fundamental and technical factors, including price history, economic reports, seasonal factors, and national and world events.
Market sentiment is perhaps the most challenging category because we know it matters critically, but we are only beginning to understand it. Market sentiment is often subjective, biased, and obstinate. For example, you can make a solid judgment about a share’s future growth prospects, and the future may even confirm your projections, but in the meantime the market may simply decide to dwell on a single piece of news that keeps the share artificially high or low. And you can sometimes wait a long time in the hope that other investors will notice the fundamentals.
Market sentiment is monitored with a variety of technical and statistical methods such as the number of advancing versus declining stocks and new highs versus new lows comparisons. A large share of overall movement of an individual stock has been attributed to market sentiment. In the last decade, investors are also known to measure market sentiment through the use of news analytics, which include sentiment analysis on textual stories about companies and sectors.
Emotions and perceptions
Share prices can change because of perceptions, greed, hype, euphoria, anxiety, desperation, panic and fear. Sometimes the stock market can be seen as the sum of the emotions of its human entrepreneurs and investors, subject to the arbitrary human whims and flights of fancy.
According to a Wall Street saying, only two influences are at work on the stock market – fear and greed. Most of the time they are in equilibrium, with greed only staying dominant long enough to produce the long-term trend depicted on a share market graph. The 1999 – 2000 technology boom was a good example of greed taking over. The Internet, and anything connected with it, became the spice of the moment and the technology companies shares skyrocketed in price. When it all got too much in Q2 of 2000 on the Nasdaq Stock Market – we probably recall what happened in the market place.
Bullish & Bearish
This is the other side of hype and momentum of the market. If investors are hopeful, they are thrilled and excited to the almost a euphoria status about the market and the economy at large — we expect upward price movement in the stock market, the sentiment is said to be bullish. On the contrary, if the market sentiment is bearish, most investors expect downward price movement. When a bear market sets in; fear, anxiety, panic, desperation takes share prices downward, to a long, bitter winter of discontent. During a recession nobody wants to buy shares. Only in hindsight do people realise that it was the best time to buy shares.
Seasons
“To every thing there is a season, and a time to every thing, and a season for every activity under heaven”, says the author of the Book of Ecclesiastes in the Bible. The writer of Ecclesiastes, the most wise person on Earth, King Solomon, could have been talking about the stock market as well!
Most stock markets show a distinct seasonal pattern. It has a regular seasonal correction at the end of the financial year. This is normally followed by a major seasonal rallies i.e. beginning of the tax year, periodical financial reporting seasons, dividends announcements, quarterly Monetary Policy Committee (MPC) announcements by central banks, etc. These makes the stock market to more likely rise and fall in certain months than in others. Portfolio and fund managers tend to withdraw from the markets at the end of each tax year to balance their holdings. They start spending again at the beginning of the subsequent tax year.
Market cycles
Besides psychological factors that determine market prices and rates of return on share investments, there is a totally different concept to consider and that is the market cycle. Stock market cycles are the long-term price patterns of the stock market. It is very important for investors to know where the market is in its cycle at the time when they will be investing, particularly if they are entering the market for the first time.
Two key types of models that have been developed to help you to understand at what stage of the cycle the market is in are macroeconomic models and intuitive market models. For either type of model, the two most important factors in determining the market cycle will be the interest rates and monetary policy. To determine whether interest rates are favorable for share market investment, it is necessary to calculate their ‘real’ level (which is the current ninety-day bank bill rate, minus underlying inflation).
Along with macro-economic models, the other way to identify and predict market cycles is intuitive market models. Intuitive market models are imprecise and rely on subjective inputs from the investor – for example, where you think you are in the market cycle. Although they are partially based on economic conditions, they are mainly based on an intuitive understanding of how markets work.

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Factors to Consider to enjoy high return on investment (2)

In the last week’s article we learned that there are several factors that influence the level of return (dividends and capital gain) for investors in companies that are listed in the stock market. We indicated that demand and supply of shares of a company impacts into share prices, we further detailed factors that impact the demand and supply of shares of listed companies — we mentioned these factors as: earnings (or profitability) of the underlying company; profits (or loss) warnings that listed companies are periodically required to issue to the public, prior to the end of their reporting period; impacts of research reports by securities analysts; factors related to financial reporting seasons and the level of liquidity of the the stock market in general and for the specific company’s shares in particular.
In the article, we indicated that company’s share value, its levels of returns as well as price reflects investors’ perception on its earnings flow. If the stock market detects something about a company that may harm its earnings flow, the company’s share price falls. If the stock market hears good news about the company’s earnings, its share price rises — such information may be relating to its core operations or otherwise. Why? because share prices change based on sellers and buyers constant review of companies’ earnings prospects. We said there are mainly two factors that determine a change in share prices – future expectations of earnings and the price to earnings (P/E ratio) multiples. Both of these factors depend on an evaluation by buyers and sellers as they learn more about listed companies.
Having detailed how demand and supply of shares impact its share price and returns to investors, this article, focuses onto economic variables [such as the economic growth outlook (as measures by the Gross Domestic Product – GDP), the level of inflation, interest rates and exchange rate] and how these variables impacts the investment return for the investors in the companies that are listed in the stock market.
before we dwell into that — we need to understand that, apart from fundamental performance-related factors, investors (especially sophisticated retail and institutional investors) are also looking at other market information, including economic news and political events that can cause share prices to rise or fall. In the short term, the share price is also affected by intangible factors such as hype and word-of-mouth (gossip), which then feeds into speculative activities for some investors.
It is important at this stage, that we also note the Dar es Salaam Stock Exchange (DSE) listed companies’ performance, like in other stock markets, are influenced by the happenings, events and performance of other markets and economies. If there is a substantial fall in other major markets activities, Tanzanian share prices are likely to be under pressure as well mainly because markets and economies are integrated. Currently, foreign investors participation in our market is about 70 percent of the total DSE investing and trading activities — hence, what happens to these investors (fundamentally or sentimentally) impacts into the share prices and consequently the levels of investment returns to investors.
Back to the economic variables — the stock market performance depends on the economy and its economic activities. Economic conditions and its outlook directly (or indirectly) affects companies’ earnings prospects, therefore news on either of the economic variables has an important influence on the stock market and companies listed into it. Economic statistics that affect the share market are:
Official interest rate, dictated by the financial markets and the central bank;
Inflation rate or the rate of increase in consumer prices;
Rate of growth of economic activities in the economy (as measured by the Gross Domestic Product – GDP);
Exchange rate, or how the local currency (Tanzania shilling) fairs against other currencies; as well as
The health of other key economies in the region or major trading partners.
Interest rates and inflation
Interest rates affect companies’ earnings directly because their debt repayment costs rise and fall with rate changes. Interest rates determine how much it costs the company to borrow or upon lending what the company receive borrowers of the company money. High interest rates increase a company’s financing costs, this literary means taking money directly from what would have been investors profit to pay to the the company’s lenders/bankers.
Rising interest rates affect the level of economic activity and consumer spending. On the other hand, a rise in interest rates also increases the attractiveness of fixed interest investments relative to shares. Alterations to interest rates are part of monetary policy, a weapon that central banks wields from time to time in relation to setting economic direction of the country and its economic activities. Like any other central bank, the Bank of Tanzania lifts interest rates to choke off any stirring of inflation as a result of bubbling economic activity, the opposite is also true.
During a period of tight liquidity, interest rates rise, increasing production costs. Conversely, interest rates fall when there is ample liquidity. People have more purchasing power, which is positive for business expansion and share investment.
Inflation, on the other hand simply refers to how much the prices of the goods and services that one buys go up by each period. One of the reasons that people invest in the share market is to try and beat inflation. And for those invested in DSE listed companies’ shares, beating inflation has been the case for the past few years – where returns on investment (i.e. dividends + capital gains) have consistently exceeded the rate of inflation.
The stock market in some cases dislikes inflation: inflation pushes up costs for companies quicker than it can pass them on to customers, as a result, it adversely affecting their earnings. Conversely, when a central bank believes that economic growth needs to be stimulated or an economic decline reversed, it will cut interest rates.
In most cases, low inflation has had a strong inverse correlation with valuations (low inflation drives high multiples, and high inflation drives low multiples). Deflation, on the other hand, is generally bad for investors in shares because it signifies a loss in pricing power for companies.
The exchange rate
Also, a company that exports or imports products or services, or has revenue receipts or payments in other currencies, is affected by the exchange rate between the local currency (Tanzanian shilling) versus foreign currencies. Some of the DSE listed companies i.e. manufacturing companies, or companies in the logistics and transportation businesses, or even banks are affected by the current deprecation of the Shilling. Periodically, local companies that are subsidiaries of multinational entities as well as companies with major foreign currencies operations are required to value their assets and convert into the reporting currencies — in doing they either report valuation gains or valuation losses — such accounting gains or losses impacts into investors’ profitability and earnings, hence impacting their returns.
If I may explain this a little further — we may need to note that high or low levels of the local currency relative to foreign currencies can be either beneficial or harmful — it depends, for example in the case of the high Shilling in relation to the foreign currency, i.e. the USD, may be beneficial as certain companies in some sectors of the economy benefits from this by making both local exports as well as import-replacement industries more competitive. This is particularly good for local producers and businesses who sell their products in USD, but take their profits and report their earnings in Shillings. What is important for an investors is that while considering investment or divestment — one need to understand what is the core business of the company and how is it being affected for the change in exchange rates.
The GDP
Gross Domestic Product (GDP) is the value of all goods and services produced in the economy. When GDP decreases, the economy shrinks and companies’ earnings fall; when GDP increases, the economy expands and companies’ earnings rises, other factors being constant. Therefore, an investor needs to understand the state of the economic growth and its future outlook when making investment. One would also need to know which sectors contributes (and will continue to contribute) more into the GDP and whether the company that one has invested or is considering to invest into falls within those sectors.
The health of other key economies
As I have indicated above, foreign investors, both strategic and portfolio based, accounts for more than 70 percent of the DSE trading and investment activities. Based on this statistic, the health of other [key] economies have an impact into the prices performance and therefore returns to investors. In the short term, when bad economic news causes a fall in external stock markets, the DSE and its listed companies, also comes under pressure, like what we have experienced in these recent days — countries and economies depend on each other on matters of trade, investment, geo-politics aspects, geo-economics aspects, etc; therefore markets and economies are easily directly (or indirectly) affecting each other; Tanzanian is not a exceptional in this phenomenon.