Analyzing Price Moves Fundamentally is The Most Difficult Thing.....

In Stock Market.....Lack of Understanding is a Great Boon !!!

Analyzing asset price movement on fundamental basis is the most difficult thing to do. It creates illusion of not only able to understand value of assets but also ability to forecast its future value. Ascribing fundamental reason to asset price movement is like unlocking a lock with a help of a key (from bunch of keys), if a key unlocks a lock then we think that is the only key which can open the lock. In Reality, 50% of keys from the bunch could open the lock. This is precisely how things work with fundamental analysis. There could be end of number of reasons for movement in asset price but we tend pick only those reason/s which fit at particular point in time and same reason/s are then used to extrapolate to understand future price movement. Best part is, if in future those reasoning doesn't work then FUNDAMENTALS HAVE CHANGED. Though it is accepted that fundamental price drivers change all the time, effort is always to understand things on fundamental basis. By the time underlying reasons are discovered most of the price move is over.
The idea to stress above is to drive the point that "effort should be understand the nature of price move and not to understand nature of so called reasons of price move"


Paradox of Fundamental Understanding....

1) When everybody understands fundamental reason behind a price move, price move is always over...in other words ignorance (lack of understanding) and price moves are positively co-related. 

a) 1996-1999 Tech Stocks run....
In famous speech on Dec 5, 1996, Alan Greenspan coined the term "Irrational Exuberance" to ascribe price movement of Nasdaq then (though he didn't directly relate it to Nasdaq). Nasdaq was having one of the best runs since 1991. Lack of understanding of price move and phrase  "Irrational Exuberance" was coined. Nasdaq move was just about accelerate when this phrase was coined.  Right at the time, when index was about to peak in 1999-00, same guy became visionary and talked about new economy and structural shifts in economy...

b) 2009-2013 US Stock Market Run.....
Quoting same guy (the great maestro Alan Greenspan) in October 2009 from Bloomberg

Former Federal Reserve Chairman Alan Greenspan said he sees the U.S. economy slowing next year as the surge in stocks comes to an end.

“The odds are that we flatten out, even though earnings are doing very well,” Greenspan said in an interview with Bloomberg Television, referring to the equity market. That flattening out will probably “put some sort of dull face” on the economy in 2010, he added.

 Greenspan said he expects the economy to grow at a 3 percent to 4 percent annual pace in the next sixth months before slowing down. As a result, unemployment isn’t likely to decline much from last month’s 9.7 percent rate, he said. Even so, he doesn’t expect the economy to relapse into recession next year.

2009 was as young as financial experts brains in terms of leg of bull market that began in 2009....PRICES HAVE LONG WAY TO GO WHEN THINGS AREN'T CLEAR....

Fast forward March 2013.....Maestro again appears on CNBC (After 4 years of bull market that began in March 2009)...As expected he is as confident as he was about new economy in 1999....

Former Federal Reserve Chairman Alan Greenspan said that even with record-high stock prices, investors don't need to worry about "irrational exuberance" this time.

In fact, his current view is that stocks are still "significantly undervalued."

"Irrational exuberance is the last term I would use to characterize what is going on at the moment," Greenspan said on CNBC Friday morning. Asked about the recent bull market, he responded, "It's still got a ways to go as far as I can see."

Greenspan said the current stock run is due to reduced fears that the European sovereign debt crisis would crash economies around the world. He also seemed to dismiss the idea that the Federal Reserve's asset purchase program is responsible for driving stocks higher. (looks like old man wakes up only when QE is on....and has not seen what stock market does when QE is not around)

Greenspan believes Fed's QE is not driving stock market higher....!!!

CLARITY AND CONFIDENCE ABOUT FUTURE IS BIGGEST HURDLE TO STOCK MARKET ADVANCE...

c) Gold Price Run till July-Sep 2011...Pls refer to previous blog on Gold dated 10th March, 2013....Gold move was extremely well understood right at peak..in July-Sep 2011...this was after 10-11 years of straight annual gains...

I can go on and on citing examples of various asset class and how fundamental understanding of crowd always lag price moves.

2) Opinions and biases invariably gets into fundamental understanding....accepting the way things are is often not accepted.....

Another flaw in anchoring fundamental understanding for price move is opinions and biases invariably gets involved. US stock market had one of the best bull market since March 2009 bottom and this bull market could also be one of the most hated bull market. This purely due to the fact that it was driven by factors which were not conventional or experienced in past. Moral Grounds were raised about money printing exercise being done by most central banks. Disconnect between economy and stock market continues to baffle most if not all "rational" participants. Most Hedge Funds continue to under perform S&P for 5th Year in a row. Again, one can go on and on about strange nature of bull market since 2009. It could be termed as "bull market in price and bear market in understanding of price move". Bottom line is price kept on going up while understanding of price move kept on going down...till recently that is. AS WE HEAR MORE AND MORE ABOUT PERMANENCE OF THE MOVE....THIS BULL MARKET WILL EXPERIENCE SHARP TURBULENCE....MAESTRO HAS ALREADY INITIATED THE PROCESS....

3) Fundamental factors driving asset prices could be combination of many factors...many beyond comprehension....

 Various Factors Driving Bull Market in US and other markets
a) US Fed's QE's
b) Compression of Credit Spreads (direct result of QE)
c) Improving Economy
d) Record High Profit Margins and Cash with Corporate
e) Unlimited "money printing" by most central banks
f) Forced risk taking environment created by central banks, etc.....
Reason for bull market could any one or combination of many factors cited above and beyond.....Hence, knowing them is hardly of any help because same reasons could fail to explain price moves in future....but then explanations like "this time is different" and "fundamentals have changed" is always there. 


4) Fundamental Analysis is the area where role of luck is least appreciated or in other words role of skill is over appreciated....
Since drivers of asset prices based on fundamentals are far too many and changes far too often....role of luck is likely to be least understood....if right key is plugged at right time one can be genius and same genius will look fool when lock changes....