For weeks before the earnings’ season began, the entire media, especially the television media, has been peddling the view how the market direction will be set by the nature of corporate earnings. This piece of insight is usually followed by the assurance that since corporate earnings will be good… blah, blah, blah and since the P/E is 14 or 18 or 12 (depending on the earnings of 2008 or 2009)… expect the market to be on an up trend or be firm (pick an adjective of your choice).
Well, corporate results are great. Infosys announced a 50% jump in profit. Sensex hit almost 11,000. And what happened? It lost 1000 points thereafter. The mood suddenly turned sombre. There was consternation all around. The prediction of corporate performance was right but that of stock price was wrong. Surprisingly, there is no correlation. Soon thereafter, dire predictions of a bear market resurfaced. The Sensex rose 900 points. Surprise again.
If you have read earlier pieces of Earning Curve, you would not be surprised. Earning Curve, among other things, is a myth-buster and just two issues back we pointed out that changes in short-term prices are not linked to earnings. We also pointed out in the last issue that what you think is a long term, may really be an extended period of short term in nature. Irrational market behaviour that “should” end quickly, can go on for a long time.
There are millions of examples around us to prove that short-term market movements are random and are often irrational. Could it be that trying to impose our sense of rationality on market movements, to seek cause and effect (earnings will be better and therefore stock prices will go up), is itself irrational but self-serving? After all, a 24-hour TV channel, a 24-page newspaper or a stock broking network with hundreds of branches putting through thousands of transactions everyday can hardly be run by openly admitting to such short-term irrationality. What would they live on?
Indeed, just imagine switching on your TV sets in the morning and finding that your favourite 20-something anchor asking your broker, “What will the market do today?”, and getting the following response: “I am sorry I don’t know. In fact, I have kept a count of all my opinions made here and I find that I was right 50% of the time. But within that too, on many occasions, I was right about the outcome, not about the reasons behind the outcome”. Or imagine, the younger anchor interviewing his older colleague, about where the market is headed and getting a reply that “we have not been able to establish a correlation between stock prices and myriad nuggets of opinions we collect all through the day.”
But then, admissions such as these will take away the basic reason for their existence. After all, a broker cannot tell a client anything but the precise reason behind the movement of a stock or the market as a whole. And if business media admits that it may be thrilling and engaging to dissect the myriad factors behind changes in short-term prices, although having little predictive value, then what would they do? After all, they have acres of newsprint and hours and hours of airtime to fill.
This is all the more glaring at market turning points. Since prices very often change much before fundamentals do, we get misled by a consistent fall in prices when corporate results are good, or firm prices when the results are still bad. So, next time you eagerly look for market opinions at the end of the day or the next morning, know that while it may be interesting to be aware of the chatter, it is irrelevant to what the market will do subsequently.
