Tuesday, March 20, 2007

Current Investing Insights

Consensus Estimates - If there are 20 research reports, or index predictions by experts, the general view is to take the average of all predictions and take that as the consensus. Consensus information is an overused thing when it comes to investments. It is very one-dimensional and blocks out a lot of useful information but still, reporters and the media will jump on earnings results and compare it vis-a-vis to consensus estimates.

If I have 20 experts predicting where the Dow Jones index will be come end-December 2007; and say the consensus is 13,000: I wouldn't be very interested in reading those in the middle of the pack but rather I would be very keen to get hold of the two extreme predictions. Say the person who predicted 16,000 and the other who predicted 9,000 because they are bound to be very convinced by certain factors/scenarios which caused them to make those predictions. It is up to us to assess the viability of their arguments but its refreshing to read up on people willing to stick their necks out - they are usually braver and smarter, and not afraid to be wrong. Though the extremes may not be correct all the time or even most of the time, it is very useful to understand why they favour certain factors. It could very well lead us to make better strategy or investment conclusions.

Rate Cuts - Rate Cuts 101 says that a rate cut will mean stocks rising in price, ceteris paribus. But does history validates that theory? This is an especially critical aspect now as the Fed is HIGHLY PROBABLE to start easing rates for the rest of the year. William Hester of the respected Hussman Funds noted that since 1955 there have been 11 periods where the Fed have lowered rates at least once after raising them multiple times. Following the first interest rate cut, the S&P 500 has advanced at annualized rates of 23.9% over the following 6 months, 18.3% over the following 12 months, and 18.7% over the following 18 months. However, that is not the full picture. The impact is vastly different depending on the valuations of the markets' then. One should read his cutting report here:

During periods where the S&P 500 price-to-peak-earnings multiple was less than 15, an initial rate cut was followed by annualized S&P 500 returns of 43.2% over 6 months, 26.1% over 12 months, and 25.4% over 18 months. In contrast, rich valuations have produced far more tepid returns. When the S&P 500 price-to-peak-earnings ratio has been above 17, the market's annualized return following the initial rate cut was a dismal –2.3% over the following 6 months, 5.9% over the following 12 months, and 6.2% over the following 18 months.

My assessment is whether the present markets' valuations are expensive. I think its in between, and not as expensive as most would think. Remember the previous blogs on liquidity, and demand & supply of scrips. Still, the first cut would not do much, its the second rate cut that would work wonders. At the end of the day, the data shows that a rate cut is better than none at all.

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