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Bourse Basics

For now, the topics listed below are discussed. On occasions, they are also further articulated in the monthly newspaper, The Cosepp Financial Analyst
Prerequisites
Asset Allocation 
Audit Risk  
Behavioural Finance 
Booms And Busts  
Bourses... yesterday, today, and tomorrow 
Challenge v. Problem  
Confidence 
Distorting Statistics 
Dividends 
Equity Markets... what drives them 
Market Manipulation 
Optimism Junkies 
Share Price 
Strategies 
Wishful Dreamers 

Prerequisites.    It is assumed that the reader has an average education with some knowledge about financial mathematics, and is also able to bear in mind or dismiss the possible relevance of certain financial philosophies, some of which are outlined on this website's, things to think.  All this within the constraints imposed by law and by one's Religion. 

Asset Allocation.   Fund Managers usually have a natural inclination to talk about asset allocation and asset classes, with good reasons. At the core of their concerns is the question of what to do with all the money they are supposed to manage on behalf of their investors. In selecting a suitable home for all or part of these funds, they invariably endeavour to balance expected yields against perceived risks. These expectations and perceptions of course change over time, and some do the balancing act better than others.

Traditionally, the usual targets of their funds lie in the following broad asset classes:
(a) property;
(b) shares;
(c) bonds; and
(d) cash or cash equivalents.

There are fund managers that concentrate solely on any one of the above asset classes, and there are others that take in all classes and may occasionally even dabble in paintings, antique furniture, coins, commodities, and derivative products such as options and futures. Hedge funds, an esoteric name for adventurous fund managers, are in special category of their own, and their styles may aptly be aligned more with gambling than with investing.

Asset allocation, then, entails, as a first step, deciding how much of the total portfolio cake to devote to each of the various asset classes mentioned above. But even within each of these asset classes themselves, there are also sub classes as well, that need to be considered. So, the exercise of dividing up the portfolio cake is not as straight forward as may seem to appear, at first sight.

Regrettably, except for the generally accepted need to diversify one's investments, there's basically no clear conceptual guideline on how much of the total portfolio cake ought to be devoted to each asset class. At the end of the day, it really boils down to the subjective preferences of the individual people involved within the fund manager itself.

Audit Risk.   A new risk has emerged in sharemarket analysis, namely, audit risk. This is the risk that the published financial statements of a public company, despite being audited, may nonetheless be false or misleading or unreliable or undecipherable.

Already in the United States, in the wake of the failure of Enron, Worldcom, and of other similar companies, reservations have been expressed in general about the reported profits and financial positions of US public companies.

Behavioural Finance.   In recent years, a new field of study has emerged in sharemarket analysis, namely, the study of the psychological quirks of share traders and investors. 

These quirks, now labelled as behavioural finance, have of course been around for years, for as long as bourses have existed, but the psychologists have now moved in, attempting to explain sharemarket behaviour according to their own methods of understanding and analysis. There are many books around on this subject, so these analyses need not be replicated here.

It is debatable, however, whether or not a thorough understanding of all these quirks, and of the psychologists' own interpretation of them, can lead to greater success on the bourses. It is also debatable whether or not the particular investors or traders concerned, having these quirks, govern the market to any significant extent, if at all. As is often the case, success is usually all about who was right and who was lucky.

Booms And Busts.   If you live long enough, you'll eventually find that every boom is followed by a bust, and every bust by a boom.

The problem with accepting this apparent truism in its entirety is that life is plainly just not long enough. A mighty long time can elapse between drinks.

So why do we have booms and busts? Good question, eh? These cycles often baffle even the most seasoned players.

Numerous theories abound, in answer to the question. The best answers are those given with the benefit of hindsight, which even blind Freddie can adduce. Of course, anyone can be clever and wise after the event. The trick is to be so beforehand.

My own theory about booms and busts is that interest rates and confidence about the future play big, predominant parts. For example, low interest rates and positive confidence tend to lead to a revival of the bourse, whereas either high interest rates or negative confidence can easy deflate it. The logic is fairly straight forward. Both economic parameters affect the future profitability of companies, and hence their net present values, which transcribe to their share prices at any point in time.

Bourses... yesterday, today, and tomorrow.   Bourses can probably never be the same again, as they were in the past.

Why? Because of terrorist fears re-emerging, time and time again. These issues never really existed prior to 11 September 2001, when terrorists attacked the United States. As a result of all the events that took place then, and of other events that followed therefrom, the world and the bourses will probably never be the same again. Never before, throughout history, has there ever been the opportunity for just a few individuals to cause so much damage to so many in so little time as now, with the use of today's lethal weapons.

We will all just have to get used to, and carry on, living with terrorism as being part and parcel of our daily lives, "to be alert and (pretend) not to be alarmed," as the current government propaganda machine would have us do and believe. Such a state of affairs is unpalatable, no doubt, but there is no escaping from this truth and realism. The people, the bourses, and the market players will in time necessarily factor all these issues into life and the markets, and things will inevitably carry on forward. Is there another alternative?

Challenge v. Problem.   Once upon a time, the meaning attributable to "problem" was clear cut. Until, that is, the spin doctors moved in. Spin doctors want everything to appear good and right and positive and optimistic. They avoid negativity, and all its variants, like the plague. Spin doctoring itself, though, has become a plague.

In certain financial circles, the word, "problem," has been eliminated entirely and, in its place, "challenge," has been substituted, in order to camouflage some unpalatable truth, or simply to distract attention from the real issues. Saying that there's a challenge, rather than a problem, seems to sound a lot better, doesn't it?  It appears a lot more positive, even if it may be untrue.

For those who value the correct usage of language, rather than spin doctoring, a problem refers to a difficulty requiring a solution, whereas a challenge refers to a call to fight.

Confidence.   In economic and related business matters, confidence is everything. Its absence corrodes.

Whenever confidence is based mainly on worthless hype, it usually vanishes like mist upon the sun shining out. The general public is much too well informed, and intelligent, to discern fact from fiction. But try telling that to the pollies, many of whom are either oblivious to this realism altogether, or simply couldn't give a damn but pretend otherwise.

Nothing gets a pollie back to realism than an impending election. But that's when his own precious little livelihood is on the line, not his constituents'. A person once said, that, a recession occurs when someone else loses his job; but a depression occurs when you lose your own job.

But beware of optimism junkies.

Distorting Statistics.   If an economic number is much too high and looks bad, most economic or political vandals will try to make it look good, by expressing it as a ratio of a much larger number, such as the Gross Domestic Product (GDP), or the population of a country. This technique also pleases the journalists, enabling them to write many flashy words for their newspapers.

For example, if the foreign debt is much too high, then the usual technique in order to make it look good, is to express it as a percentage of the GDP. Or, if the expenses incurred by a government funded television broadcaster are much too high, then the usual practice is to express the expenses as a percentage of the whole population, on a per person basis.

Pretty nifty, eh? Such techniques work every time, in fooling the public, in treating them as mugs.

Dividends.   Once upon a time, the dividends being paid by a company were taken as a guide about its ongoing health and prosperity, provided such dividends flowed on naturally from such good favourable results..

Then along came all the dopey dotcom bombs who argued otherwise. Most of these companies never ever paid any dividends at all, and most of them, needless to say, went out, belly up, a clustered event that became generally known as the tech wreck.

I say, however, that the dividends being paid by a company are still a good guide about its ongoing health and prosperity. But this apparent truism can nonetheless also be a trap. For example, a company might just decide, for whatever reason, to jack up current dividends, which would probably result in its share price rising as well. Those in the know would then be able to sell their shares into a firm market and then be able to buy back in again at a lower price when the dividends get cut in the not too distant future due to "unforeseen circumstances."

A company not paying dividends, on the other hand, needs more than the usual amount of scrutiny in order to assess its merits. Take the examples of the dotcom bombs and other high tech wrecks. They were paying no dividends, they were incurring huge regular losses, and they failed. And many gullible investors lost plenty.

Equity Markets... what drives them.   Current economics literature postulates that equity markets are driven, at any point in time, by present sentiment about the future.

If that sentiment is optimistic, then equity prices rise; whereas if it's pessimistic, then they fall. This is pretty basic ordinary economics logic.

Of course, what generally makes for optimistic sentiment is positive expectations about the future profitability of companies, as a first building block. But, whereas, generally speaking, optimism is engendered by economic growth and a stable credit market, a perceived or actual collapse of either can trigger a collapse in equity prices.

In order words, generally speaking, both economic growth and a stable credit market are necessary prerequisites for a rising sharemarket; but a collapse in either of these two parameters can trigger a collapse in equity prices. Two of them to go up, but any one of them to go down.

Market Manipulation.   From time to time, but in secret of course, equity markets can be manipulated, not by small players such as you and me, but by rather large ones that usually involve either respected big financial institutions, or obscure "others" with very deep pockets.

On occasions, though, even these big fish can get their act going horribly wrong and lose heaps of money, as happened in the cases of Baring Brothers, a once renowned old establishment English bank, and of Long Term Capital, an American hedge fund that sported at least two Nobel laureates in Economics. Both of these entitles took, not calculated risks as one must do in these games, but sheer gambling forays and so came to grief because the markets moved against them unexpectedly, against the positions they took in the markets. They gambled, and lost their money, much like at a roulette wheel.

Manipulation of equity markets, or market manipulation as the game is ordinarily referred to, is usually secret, rather sophisticated, and normally hard to detect, except by exceptional seasoned players. One example of such market manipulation involves the use of indices (or futures) and actual market trades.

In this particular example of manipulation, an equity player would first acquire a huge long (buy) position in a particular sharemarket index (or futures contract). Then he would start buying the individual shares entailed in the particular index, thereby driving up the prices of the shares involved and, as a consequence, the price of the index (or futures contract) already acquired previously at a lower price.

Once this exercise has yielded a good profit, the transactions are usually reversed, normally the next day, or very soon afterwards.

So, the next day, or very soon afterwards, the equity player would then sell the previous long (buy) position in the sharemarket index (or futures contract) at a huge profit, and also concurrently buy a huge short (sell) position in the same particular sharemarket index (or futures contract). Then the shares entailed in the particular sharemarket index, once previously bought, are now sold off, thereby driving down the prices of the shares involved and, as a consequence, the price of the index (or futures contract), which is subsequently later sold again at a huge profit.

In this way, the particular equity player profits from the transactions on the way up, as well as on the way down.

Pretty nifty, eh? Nice if you can get it.

This clever little earner, this simple market manipulation technique or concept, is nearly as old as the sharemarket itself, except to the extent that it has been further refined and extended in recent years to exploit and encompass the new playthings of the bourse, namely, futures and options. But not too many people can really understand them, though some people pretend to do so. Their use is now in vogue again as a result of the legalising of the short selling of shares, a practice that undoubtedly destabilises financial markets especially in times of low sentiment when they have the greatest need to be stabilised. Short selling increases the oscillations of share price movements, and really tests those who may not have the nerves of steel to be market players, who would need to ride out such oscillations.

Short selling of shares in Australia, and in many other countries, used to be illegal, for very good reasons. To prevent sharemarket oscillations and manipulations as outlined above, and to avert or diminish or prevent chaos and instability in financial markets. In addition, people are hardly likely to continue investing in such markets if they believe them to be crooked or manipulated or unfair.

As previously mentioned elsewhere, in these times, world financial markets have long taken on the role of a giant casino, of a huge glorified gambling den. Today's financial markets are probably the most unstable they've ever been throughout history, due largely to the variety of new trading instruments, advanced rapid communications, super fast computers, and deregulated bank lending. Most of the protective practices put in place in the aftermath of the 1929-33 Great Crash and Depression have almost all been repealed, no doubt at the instigation of super big market players, such as hedge funds which always seem to be at the centre of big market turmoils. These practices should not have been repealed as they served the useful purpose of maintaining stability in the event of a disruption. History will now probably repeat itself, not if, but when.

Anyhow, who said that, "life wasn't meant to be nice and easy ?"

Probably someone who was fabulously wealthy, I suppose. It is mostly those who are loaded with plenty of money who say that money is unimportant. Boy, I wish I could say that money in unimportant.

Optimism Junkies.   Most walks in life spawn minorities, one of whom are optimism junkies. These are the people who, on being splashed on the face with mud, will utter, enthusiastically, "oh, wonderful, goody...  free face massage." Or, upon viewing an earthquake and devastation, exclaim, "oh what a marvellous landscaping opportunity." Most of the rest are those who are exceeding adept at crop dusting with bovine fertiliser, or who have prodigious amounts of space between their ears. Or who simply lie.

The best way to proceed is always from a knowledge of the existing truth, whatever that truth may be, either positive, negative, or whatever. In security analysis, this is absolutely fundamental. A decision, to have the best change of achieving a desired outcome, ought to be based on the existing truth, on the actual facts, not on lies or deceptions or distortions. Sometimes, though, sheer luck may override everything, but this is generally the unknowable exception.

But I do concede, though, that there are some people around who would rather prefer not know the unpalatable truth. These are generally the abject losers. That's why, metaphorically speaking, they sometimes decry or shoot down the messenger.

Share Price.   Traditional economics postulates that the price of any product at any time is determined in accordance with the law of demand and supply. This law states that, if the demand for a product exceeds its supply, then its price will rise. And if the demand for a product is less than its supply, then its price will fall.

A share in a company (or stock, as is more often used in financial literature), is a "product," and it is therefore likewise determined in accordance with this law, even though a great number of factors are usually involved in determining its demand and supply at any given point in time, and over time. 

All these numerous factors, though, can generally be grouped into two categories, namely, stock factors and market factors.

All these factors, then, interacting and intermingling altogether, whether rational or otherwise, determine the demand for, and supply of, the shares of a particular company (stock) at any point in time, and the market price naturally results from all this interaction, continuously, during trading days, on the Bourse.

It should always be borne in mind that it is the total amount of money, i.e. the weight of money, that is involved in this process of price determination, and not the number of participants on both sides of the exchange. An individual player, though, with plenty of money at his disposal, can easily dominate the market for a particular stock, sending its price in whatever direction he chooses, irrespective of what the actual prospects for the stock may be. This does indeed occur from time to time.

Strategies.   There aren't too many bourse strategies around to choose from. There are just the traditional two, namely, either to buy and trade, or to buy and hold. The problem of picking the right stocks is common to both strategies. Spin doctors and optimism junkies would probably denote all this as being a challenge.

Buying and trading shares involve good stock picking skills, as well as good entry and exit timing. Here, one needs to be pretty agile in identifying changing trends and other imperfections in the markets. Then one has actually got to be able to deal oneself into such situations. This dealing in, is not always easy, or possible, to accomplish. An opportunity may be identified but, because of various factors, one may not be able to take advantage of it. Then there is the added risk that, once in, such market imperfections may remain imperfect for quite a long time.

Buying and holding shares, just sitting on them, letting time alone do the work automatically for you, as some investment gurus from time to time advocate, involve the implicit belief that the stocks selected are on a long term upward trend. Their mantra is, "time in." The problem with this strategy is that life is just much too short and finite.

So which strategy do we choose? There are many difficulties involved, some obvious and some not so, as already intimated.

The choice of a strategy will depend, not only on the current conditions in the economy and the attendant difficulties, but also on our current expectations of what those conditions are likely to be in the next 3-24 months or so. These conditions will, of course, be affected by political, social, and other factors, including, now, terrorist fears. Prior to the 11 September 2001 terrorist attacks on America, terrorist fears weren't really considered in security analyses. But they are now. And they have a debilitating effect on equity markets.

In times of harmony and of steady economic growth, the correct strategy might be buying and holding shares, provided one can pick the correct stocks to benefit from this scenario.

In times of disharmony and of uncertain economic growth, the correct strategy might be buying and trading, or even perhaps exiting the markets altogether. The actual decision will depend on the expertise and skills of the individual player concerned.

Each strategy involves buying low, and selling higher. But it's rather surprising how many people do the reverse, and then bemoan the fact that they've lose money in the equity markets.

Not easy, eh?

Now, I've read somewhere, someone saying, that life wasn't meant to be easy. And if it's never ever been easy before, it has certainly become a lot harder now, with today's modern financial markets having taken on the role of being quasi giant casinos.

Financial market have become so volatile, so uncertain, and so manipulated, that unique money making strategies are pretty hard to follow. Bolts out of the blue do come out occasionally, as history has shown, time and time again. And who could possibly have predicted the events of 11 September 2001 in the United States, that sent equity prices around the world spiralling downwards at that time?

The Share Trader doesn't follow any set unique strategy. All he's doing is attempting to achieve the aim of trying to make the most money in the shortest possible time frame. That means he's always on the look out for opportunities, and necessarily has to, as a consequence, read widely and analyse deeply.

Now here, then, are two obvious clues... reading widely and analysing deeply. It's not sufficient merely to read widely. One also has to analyse deeply, to think about what one has read, and then to come up with some sort of a valid conclusion and with a plan of action (or inaction). All this sounds rather like an easy to follow technique, then, doesn't it? And yet, such a technique is not that much different to what went on at school, now isn't it?

"Do your work! ..." the teacher would say. I guess such a similar directive should also apply to those who wish to operate in the equity markets.

Wishful Dreamers.   These are the minority of investors who usually wish or dream about making money on the sharemarket without doing the necessary leg work beforehand. These people have the race track mentality, eagerly on the look out for an easy way out, looking for a sure tip or winner. This may apply to certain people in the know but, for the rest of us, including this writer, putting in the hard yards is the only other plausible alternative.

From time to time, one needs to examine oneself to see, not where one is standing at a particular point in time, but where one is heading. One needs to ascertain the likely trend.

A knowledge of this trend and of its process also applies to the sharemarket. These days, some of the prerequisites for ascertaining this trend include the need to be continually well informed and up-to-date, not just in financial and economic matters, but also in other disciplines as well, such as political, social, and local issues, as all these tend to rebound on the markets, to varying degrees. One must read widely and analyse deeply, and this entails a lot of hard work. But it must be done.

Some time back, I read an old saying somewhere, that, if a person works diligently and persistently in a potato field, the potatoes will eventually grow, and rarely otherwise. Similarly, people who do not make an effort to be well informed continually and persistently, will likewise rarely grow their stocks.  No work, again and again, yields no gain and plenty of ...   pain.

Warning and Disclaimer on the above Bourse Basics.   Kindly consult your own Bourse Basics adviser. Cosepp Corporation Pty Limited does not accept any responsibility of any kind whatsoever in relation to the above Bourse Basics. Readers who rely on the above Bourse Basics do so at their own risk. Refer also to the warning and disclaimer below and to the adjacent Table of Contents for further details on Cosepp Corporation Pty Limited's non acceptance of any responsibility of any kind whatsoever.

Warning.   Readers or other who deal in the above stocks, and in those mentioned below or elsewhere in this publication, do so at their own risk. Refer also to the disclaimer below and to the adjacent Table of Contents for further details on Cosepp Corporation Pty Limited's non acceptance of any responsibility of any kind whatsoever. Any of the above stocks, those below, or any other, may be sold or purchased at any time, in any quantities and in any manner whatsoever.

Disclaimer.   Cosepp Corporation Pty Limited does not provide advice on shares to the general public nor to clients in any way whatsoever. Cosepp Corporation Pty Limited, its officers, its employees, and any other person or entity mentioned herein accept or bear no responsibility for this publication's contents, accuracy, completeness, reliability, timeliness, or other. This publication is only about general discussion, and is not intended to constitute any form of recommendation in any way whatsoever, including any possible recommendation which may so be construed on what to buy or not buy or sell or not sell or hold or other, either similar or distant or directly or indirectly, or other. A person reading this publication should not rely on the information provided, but instead should discuss the issues raised with his or her own adviser who, necessarily having details of his or her individual particulars, would have due regard to his or her specific circumstances, requirements, and objectives.

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