Oct. 28th, 2008

peterbirks: (Default)
It really does take a lot of faith to buy equities when the world and his wife are telling you to sell them.

The basic line is "sure, equities are good value at the moment, but they have further to fall".

Now, just think about that. It reminds me of two other lines of argument, one historic, and one a logical paradox.

In the first case, think of tulip mania. The argument was "sure, these are overpriced, but they have further to go". As Mr Young pointed out to me on the phone, the trouble is, many people make money following such trends.

In the second case, it's the paradox of the surprise announcement. A head teacher tells the class at assembly that, one day this month, he will call a fire drill, but that, when the drill announcement comes, it will be a surprise. A clever student says "ahh, then it can't be on the last day of the month, because then it wouldn't be a surprise". A second clever student then says "hmm, then that means it can't be on the second-last day of the month, because we know it can't be on the last day of the month, so it wouldn't be a surprise if it happened on the second-last day, either". The two students thus work out that it is impossible for the announcement to take place on any day of the month and still be a surprise.

The head teacher announces the fire drill on the sixth of the month, and it's a surprise.

And thusly, the trend will end, and when it ends, it will be a surprise.


Japanese stocks are, theoretically, trading at 0.8 of book value at the moment — about as good an indication of fundamental value as you can get. But this is misleading, because the fall in the value of equities is somewhat intertwined with "book value". The latter is the theoretical break-up value of the company. But, of course, such assets are relatively illiquid, and its the lack of value in illiquid assets that is causing the current equity collapse. We are now hearing nonsense such as £1.8tn in losses as a result of the subprime crisis. But this loss assumes that all of the bits of paper floating around at the moment that have a mark-to-market value of zero, end up with a termination value of zero. That won't happen. I'm sticking with my $300bn to $500bn (£200bn to £350bn) or thereabouts "real" loss.

Equities are in freefall this month because of two factors, deleveraging (no-one is investing with borrowed money because they can't borrow the money) and forced selling (if you can't sell your illiquid assets, you have to sell your liquid ones, at any price). Eventually this will end, and it will be a surprise.

So, trying to actually call the bottom and holding off buying something which is a fundamentally good buy "because it probably has further to fall" strikes me as a play that might make you money, but buying stuff that is fundamentally good value will make you money, even if you don't call the bottom correctly.

This, of course, assumes the second part of the equation -- how far will profits fall because of the recession? And that is where things get less technical and more fundamental. A story for another day. Meanwhile, I've still got the chequebook out, casually watching my cash burn away as I plough on in my lonely furrow. Like I say, it's nerves of steel time. Either I'm going to be very rich in seven years' time, or very broke.

__________

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