Most equity investors believe that they are in the same business as astrologers and soothsayers. There are a wide variety of signs that are said to be convey to us what the future will hold. The positions of stars and planets, human palms and faces, tea leaves, playing cards, spirit boards, crystal spheres, technical analysis and Chinese bamboo cylinders are the some of the ones that I can think of offhand. All of it adds up to trying to know where stock prices will head tomorrow and thereby make some money.
If you ignore the list of superstitions and questionable beliefs above, and stock to analysing financial and economic numbers sensibly, then you are supposed to be able to do better. We all implicitly believe that a research report or an article in the business press have a good chance of predicting the future. But do they? It depends on what you mean by the future. Do you mean the near future financial numbers of well-known companies, or do you mean the something that has a bigger impact?
The answer to this question becomes clear when we look back into the past and see what was predictable and what was not. Think of what has happened in the last quarter century in Indian economy and stock markets . Could any of it be forecast? Think of of both the big long-term trends as well as short-term ones. In the late eighties, could you have forecast the astonishing rise of the Indian software services? Was the rise in urban Indian living standards predicted by anyone? Was the coming drop in interest rates and the easy-money economy predictable in 1995? Was the resultant housing boom predictable? In 1996, when a cheap, basic mobile phone cost 20,000 of those days’ rupees, did anyone make a correct prediction of how many mobile connections India would have in 2008? Was the near collapse of the global financial system in 2008 foreseen two years before that? In 2009, when the equity markets hailed the return of Manmohan Singh as India’s Prime Minister with a stronger mandate, was the sorry mess of the next five years predictable? And of course, recent events are so firmly a part of this list that it’s pointless to mention them.
Of course there are many experts that can predict these events in hindsight now. There’s a kind of person who will now say that the vast pool of english-speaking and technical manpower made the rise of IT and ITES services exports inevitable, and that mobile telephony followed a predictable path in the fall in price of electronic goods. However, you wouldn’t have heard these predictions at the time. And the movements of the stock markets have been just as much of a surprise. The direction as well as the sharpness of each bull market and bear market of the last two decades has been utterly unpredictable even a year or two before they happened.
So does that mean that investors have no basis on which to try and forecast what direction their investments should take? Not quite. In fact, the lack of predictability means that what remains is truly valuable. Which is, to judge quality managements on the basis of long track record, and hold a large and diversified portfolios so that the negative effects of company and sector-specific events can be evened out.
In fact, even though they appear to be part of the same spectrum kind of activity, these are two fundamentally different approaches to investing. One is about trying to predict the future. And the other about taking a reasoned look at the present and try and judge that people who have managed well are likely to continue to do so in the future as well.
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