The Star Global Malaysians Forum - Posted: 19 February 2007 at 2:18pm


I was spending my whole day, watching economic/market oriented - VCDs/DVDs, reading some books and magazines, researching the internet to find good 'historical' articles for my reference. All these efforts have led me towards a bunch of interesting reminders about 'when things go wrong'. Among others :

a) 1929 - Stock market crash. - Briefly -

The stock market crash ushered in the Great Depression. Causes :

Abstract

Capital - tools to produce things of value out of raw materials e.g. Buildings and machines. A factory is a building with machines for making valued goods. Later capital was represented by stocks. A corporation owned capital. Ownership of the corporation in turn took the form of shares of stock. Each share of stock represented a proportionate share of the corporation. The stocks were bought and sold on stock exchanges i.e. NYSE located on Wall Street in Manhattan.

1920 - 1929 - a long boom took stock prices to peaks never before seen - stocks more than quadrupled in value. Many investors became convinced that stocks were a sure thing and borrowed heavily to invest more money in the market. 1929 - the bubble burst and stocks started down an even more precipitous cliff. In 1932 and 1933, they hit bottom, down about 80% from their highs in the late 1920s. This had sharp effects on the economy. Demand for goods declined because people felt poor because of their losses in the stock market. New investment could not be financed through the sale of stock, because no one would buy the new stock. Also, it has created chaos in the banking system as banks recovering loans made to investors whose holdings were now worth little or nothing at all. Worse, many banks had themselves invested depositors' money in the stockmarket. When word spread that banks' assets contained huge uncollectable loans and almost worthless stock certificates, depositors rushed to withdraw their savings. Unable to raise fresh funds from the Federal Reserve System, banks began failing by the hundreds in 1932 and 1933. Franklin D. Roosevelt became president in March 1933, the US banking system had largely ceased to function. Depositors had seen $140 billion disappeared when their banks failed. Businesses could not get credit for inventory. Checks could not be used for payments because no one knew which checks were worthless and which were sound. Roosevelt closed all the banks in the United States for three days - a "bank holiday." Some banks were then cautiously re-opened with strict limits on withdrawals. Eventually, confidence returned to the system and banks were able to perform their economic function again. To prevent similar disasters, the federal government set up the Federal Deposit Insurance Corporation, which eliminated the rationale for bank "runs" - to get one's money before the bank "runs out." Backed by the FDIC, the bank could fail and go out of business, but then the government would reimburse depositors. Another crucial mechanism insulated commercial banks from stock market panics by banning banks from investing depositors' money in stocks.

b) Black Monday 1987

Black Monday is the name given to Monday, October, 19, 1987., when the DJIA fell dramatically, and on which similar enormous drops occurred across the world. By the end of October, stock markets in Hong Kong had fallen 45.8%, Australia 41.8%, the UK 26.4%, the US 22.68%, and Canada 22.5%. (The terms Black Monday and Black Tuesday are also applied to October 28 and 29, 1929, which occurred after Black Thursday on October 24, which started the Stock Market Crash of 1929)

A certain degree of mystery is associated with the 1987 crash. Many have noted that no major news or events occurred prior to the Monday of the crash, the decline seeming to have come from nowhere. Important assumptions concerning human rationality, the efficient market hypothesis, and economic equilibrium were brought into question by the event. Debate as to the cause of the crash still continues many years after the event, with no firm conclusions reached.

In the wake of the crash, markets around the world were put on restricted trading primarily because sorting out the orders that had come in was beyond the computer technology of the time. This also gave the Feds and other central banks time to pump liquidity into the system to prevent a further downdraft. While pessimism reigned, the market bottomed on October 20, leading some to label Black Monday a "selling climax", where the excess value was squeezed out of the system.

Causes

In 1986, US economy began shifting from a rapidly growing recovery to a slower growing expansion, which resulted in a "soft landing" as the economy slowed and inflation dropped. As 1987 wore on, it seemed that recessionary fears were not warranted and that boom times would continue. The stock market advanced significantly, peaking in August 1987. There were a series of volatile days that caused widespread nervousness leading up to the crash, with the market ultimately sliding downward. In late August some observers warned that technical analysis indicated the market was now in a cyclical "bear" mode. However, this view was not widely subscribed to even as the market traded wildly. Potential causes for the decline include program trading, overvaluation illiquidity & market psychology.These theories might explain why the crash occurred on October 19 and not some other day, why it fell so far and fast, and why it was international in nature and not unique to American markets.

The most popular explanation for the 1987 crash was selling by program traders. Program trading is the use of computers to engage in arbitrage & portfolio insurance strategies. Through the 1970s and early 1980s, computers were becoming more important on Wall Street. They allowed instantaneous execution of orders to buy or sell large batches of stocks & futures. After the crash, many blamed program trading strategies for blindly selling stocks as markets fell, exacerbating the decline. Some economists theorized the speculative boom leading up to October was caused by program trading, while others argued that the crash was a return to normalcy. Either way, program trading ended up taking the majority of the blame in the public eye for the 1987 stock market crash. Economist Richard Roll believes that the international nature of the stock market decline contradicts the argument that program trading was to blame. Program trading strategies were used primarily in the United States, Roll writes. If program trading caused the decline, why would markets where program trading was not prevalent, such as Australia and Hong Kong, have declined as well? Although these markets might have been reacting to excessive program trading in the United States, Roll points to observations that would indicate otherwise. The crash began on October 19 in Hong Kong, spread west to Europe, and hit the United States only after Hong Kong and other markets had already declined by a significant margin.

Another common theory states that the crash was a result of a dispute in monetary policy between the G-7 industrialized nations, in which the United States, wanting to prop up the dollar and restrict inflation, tightened policy faster than the Europeans. The crash, in this view, was caused when the dollar-backed Hong Kong stock exchange collapsed, and this caused a crisis in confidence. Jude Wanniski stated that the crash happened because of the breakup of the Louvre Accord, a monetary pact between the US, Japan, and West Germany to keep currencies stable. Just prior to the crash, Alan Greespan had said that the dollar would be devalued.

Another theory is that the Great Storm of 1987, which happened on the Friday before the crash, helped contribute to it. In 1987 there was no Internet trading, and brokers had to physically get to work in the City of London in order to do their deals. On Friday, October 16, many routes into London were closed and consequently many traders were unable to reach their offices in order to close their positions at the end of the week. This made many people nervous on both sides of the Atlantic and there were certainly some traders who believed at the time that this acted as the trigger for the panic selling which took place on Black Monday. Panic selling in London and New York, the biggest stock markets in the world, then affected other markets around the world, creating a global stock market crash.

Yet another theory for the 1987 crash was the random placement of sell orders in a sufficiently small time interval as to cause a sudden decline in the indices, leading to a cascade effect of further sell orders. In the days preceding the actual Black Monday crash the markets began to sell off, beginning with a sudden 5% selloff on Wednesday, three days before the actual crash. Prior to that Wednesday, the trend for the Nasdaq/DJIA was stable, and undergoing what could be interpreted as a normal correction. If one were to zoom in on Wednesday one would notice normal trading activity and then an abrupt 1% intra-day drop. This drop could have been triggered by randomly placed sell orders that happened to all trigger at once. Although the odds of this happening are very slim, there is a probability that sufficient random sell orders placed by institutions, insiders, and the like will trigger a cascade effect should enough sell orders be placed in a small enough time interval.

The initial small 1% selloff caused by the 'clumped' random sell orders may have prompted trend traders to liquidate their positions, resulting in a larger decline that simply fed on itself like a domino effect, ultimately leading to the 26% crash of Black Monday.

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Others were 1998 Currency Devaluation, Post 9/11 Market Effects etc.

These 'dark' events serve as great reminders for us to be extra careful of rosy events.

The question now : "What lessons have we learned?"

The Star Global Malaysians Forum - Posted: 24 February 2007 at 6:52pm

brooklyn_3p3 wrote:

Hello. I was wondering, how effective is it to set a sell limit on a stock, by that I mean, telling your broker that if the stock reaches a certain level they should sell it? I always wanted to know how to make money in the stock market - without the agonizing stress and uncertainty. Please tell me how is that possible.

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Nik Zafri's Response

Here's an interesting article that you should be reading. I've taken part of it from the original source

1. As time goes by. If you're going to invest in stocks, keep in mind a trend is just a trend. In short, don't overreact by trying to time the market. While past performance is not a predictor of future returns, historical data shows holding stocks for the long run really cuts the risk. According to a recent study by Chicago stock research firm Ibbotson Associates, for all three-year holding periods since 1946, stock returns were positive 93 percent of the time, based on the S&P 500 Index.

Take this hypothetical illustration: If you invested $1,000 every year for the past 34 years and reinvested all dividends in the S&P 500 Index, your $34,000 investment would have earned $325,771 if, with the worst timing imaginable, you had invested at the market high of the year. Of course, if you had perfect timing, investing your $1,000 at the market low, you would have earned $365,880. The difference between the extremes? A mere 12 percent; that's less than 1 percent annually. As a long-term investor, you avoid the aggravation of trying to get out at the top and in at the bottom of the market's cycles.

2. The bears wore red; the bulls wore blue. As a rule, the blue-chip stocks of large, well-
established multinational companies are less risky than the stocks of small, little known, single-product firms. When the markets drop, investors often see a "flight to quality," with money going where investors feel safest: the stocks of big companies. No stock, large or small, guarantees investor protection, but large companies are less prone to sudden plunges and are often the first to rebound when the markets begin to turn up again.

3. Don't be misinformed. Get your research from a reliable source--crystal balls and fishing buddies don't count. In-depth research involves the big picture, including political, economic and demographic factors as well as specifics of individual companies.

Technical analysis--using charts and computer programs to identify price trends--provides other information to help you make informed decisions. Base your research on facts, not feelings, hunches or tips.

4. Round up some unusual suspects. Smart investors use overall asset allocation to ensure their portfolios include different classes of securities, such as stocks, bonds and cash. In addition, no stock portfolio should consist of just one or two companies. Diversification means building a multistock portfolio, including domestic and foreign holdings, blue-chip and OTC (over-the-counter) shares, as well as companies in different industries.

5. The start of a beautiful friendship. If you're a risk-ready investor, you keep your eye on several traditional measures of investment value, including price-to-earnings (P/E) ratios, price-to-sales ratios and book values. All other things being equal, a stock selling for 60 times earnings is riskier than a stock selling for 10 times earnings. Growth stocks come from companies experiencing accelerated earnings growth; they often sell at high P/Es because investors expect that higher earnings will result in higher share prices. Value stocks are generally shares of long-established companies, often those familiar as household names with predictable long-term earnings growth rates. As you build a diversified portfolio, emphasize both value and growth stocks to protect it from excessive risk.

6. Play it again, Sam. Ups and downs in the market make you queasy, but you still have a financial goal you'd like to reach? Dollar cost averaging is a simple strategy used by investors to add to their holdings by investing a fixed amount of money at set intervals, such as every month or every quarter. This strategy doesn't assure a profit or protect against a loss in the case of a market meltdown, but it can help smooth out the effects of stock price fluctuations. Best of all, you can start with a small initial investment and make additional small, periodic investments in managed accounts.

The principle is simple: When the price of shares is lower, your investment dollars will buy more shares. When the price is higher, you'll buy fewer shares, but the prices of the shares you bought when prices were lower will have increased. The key here is sticking with the program.

Over the long term, assuming that stock prices continue to rise, the average cost of shares purchased through a dollar cost averaging plan will usually be lower than the shares' average price. How? Say you plan to invest $500 quarterly. If you make a purchase at $10 per share, for example, your $500 investment gets you 50 shares. If the share price rises to $20 during the ensuing quarter, your next purchase gets you 25 shares. After two quarters, your hypothetical purchases would total 75 shares bought at $15 each but with a lower average cost of $13.33 per share.

Because this strategy involves periodic investments, consider your financial ability and willingness to continue buying through periods of high and low prices.

7. I came for the stop orders. A stop order is an order to buy or sell a security at the market price once the security has traded at what is known as the stop price. If you're worried about market declines, consider putting protective sell stop orders in place. A stop order to sell is always set below the current market price and is usually designed to protect a profit or limit the loss on a security that you hold at a higher price. It works like this: Say you bought a stock at $40 per share, and now its price has increased to $60 per share. A sell stop at $50 means if your shares decline to $50, your order could possibly lock in a $10 profit, not including commissions.

While this may sound like an easy strategy, there is, naturally, more to it. The risk is that this type of stop order may be executed several points below the stop price because of market orders placed before it. These market orders could radically change your order's execution price. To be more certain of the price at which your order will go off, consider a stop-limit order. This kind of stop order becomes a sell order only when the specific stop price is reached. Unfortunately, the stop-limit order carries the risk of missing the market altogether since the specific price may never occur. In our above example, say you set a sell stop-limit order of $50, which is reached but delayed because of market orders ahead of it. If these market orders cause the stock price to fall below the $50 stop-limit, your stock will not get sold and you'll still own it at whatever price it reaches.

Setting stop orders is tricky business because sell orders can be triggered by temporary volatility. Cautious investors move stop orders up as stock prices rise, but the trick is to avoid setting them too close or too far from the price of the stock in question. Consult your financial advisor for more information on how best to use stop orders.

Volatile markets are the ones that separate the investors from the speculators, those who panic from those who profit. Whatever kind of investing you decide to do, make sure you and your portfolio are risk-ready

The Star Global Malaysians Forum - Posted: 09 March 2007 at 4:30pm

Back to economics basics - The Superbull. Take into account :

a) Consumer Price Index & Inflation,
b) The volatility global crude oil price (may turn the Superbull and to a Deep Bear),
c) Bluechips - carefully/systematically plan anything to do with abroad investment,(also never forget the RM)
d) Anyone know if there are still 'safe stocks' (bear-proof)? If so, will the risk increase or decrease in owning such stocks in large numbers?
e) Closely monitor NASDAQ/DOW - gaining or not gaining? (weight)
f) WAR-WAR-WAR...no more WAR!
g) Always be reminded of the 1990s
h) Politics
i) Buying Power, Selling Pressure and Profit Taking

The superbull is real but the current volatile correction should now serve as a reminder for everyone to 'review investment plans'

Where else can I find my superbull?

Yesterday, someone told me - 'Commodities'? I said - "Huh? What investment or economics books have you been reading? "

Reply : "Yes, it's a bit conventional but it may hold the answer. Up to you Nik to take my word for granted or otherwise - remember, you brought up the subjects of improving internal mechanisms of any business entity - e.g. supply and demand, quality & productivity, find better ways of doing/improving marketing/branding and sales, improved governance, tips/rumours/data/information screening & analysis?

I didn't give any response but asked him again..."Any other 'superbullish' tips? He stood up, called the waiter, paid the bill, shake my hands and said "Mutual Funds"

and guess what, momentarily before he left, he said some 'ouching' phrases to me "And Nik, cut the craps about the 'psychological sentiment' - I know you mean well, You're an analyst - not a fortune teller" (and left with that 'unforgettable cynical smile')

Gosh...I was stunned...(the guy has been reading GMN)

Ok..my advise - it's time for us to correct our past inaccuracy, prepare a better plan when buying or selling - remember, if the superbull come charging in later (which I'm counting on it - I can almost hear the 'snorts'), all of us would be lucky...trust me!