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Investing and Forecasting

Anand Vardarajan

Anand Vardarajan,
Business Head – Banking, Alternate Products & Product Strategy,Tata Asset Managment

Investing and Forecasting

In 1906 famous statistician Francis Galton attended a fair in Plymouth where participants had to guess the weight of an ox and the one who guessed it right, won a prize. Galton looked at each of the entries and deduced the average weight guessed by all participants came in at 1198 lbs whereas the actual weight of the ox was 1197 lbs and that the crowd was often right. In his book ‘Wisdom of Crowd’, James Surowiecki mentions this incident, which was later entertainingly op-ed by John Kay where he went a few steps further to say, that over the period the weighing scales gave way and since the crowd was guessing the weight of the ox so accurately, there was no need to actually weigh. Over the years, the guessing game only intensified with wagers talking to the farmer informally, looking at what the ox was being fed, the health of the ox and so on. There were 2 organisations identified to set health standards for the ox. The rules got tighter and the farmer was required to publish the data only 4 times a year and informal passing of information was denied. The scales were never repaired and eventually it was believed that the weight of the ox was the average of all guesses. Fundamentals had completely disconnected form reality.

Ditto in investing. A company publishes its results only 4 times a year and there are several forecasts about the earnings. Eventually when earnings are reported it said that earnings missed estimates. Should be the other way round that estimates missed earnings. Do we ever say monsoon missed forecast? Wet streets don’t cause rain and the cause-effect relationship should be well understood! That calls for another post, but the key to remember is that forecasting a company’s earnings accurately is difficult. It is even more difficult to predict price movements since that is based on the expectation of various market participants.

While results are reported only 4 times a year, there could be a zillion views about the company’s prospects and the price keeps changing tick by tick every second in such anticipation. Price changes every second, but value of the company changes very slowly. Not surprisingly markets are called voting machines in the short run and weighing machines in the long run.

Imagine you are asked to predict the score of a cricket match where the players are a mix of professionals who have played international/national level, school boys and even some bankers and accountants who just showed up to swing their bat. The rules of the game are not set and some play this in T20 format i.e. playing unorthodox cricket in a hit out, or get out manner, some play like an ODI with constraints of limited overs and striking a balance of scoring quick runs and preserving wickets. There is also this set of test cricketers who are in no hurry to score and are happy to play orthodox cricketing shots and are not worried about run rate or strike rate.

The equity market set up is almost identical with different types of participants. For some investors short term could be 9:30 am and long term could be 3:30 pm the same day while for other short could be a couple of years and long term could be even longer. Price movement is a function of the interaction of all these types of ‘investors’, technical, fundamental analysts on stocks and markets and some “breaking news” to top this all. To believe that anyone can accurately call the aggregate outcome of the interactions of such a heterogenous crowd & events is even remote.

When we don’t know what is happening, “I don’t know” is always a better answer than “I think so”. “I don’t know” sounds foolish but “I think so” looks smart. Our key role as money managers or advisors is to try not to predict but to prepare the investor. We can’t prepare the road for the client, but we should surely prepare the client for the road. Basics like asset allocation, matching investment with time horizon, risk appetite are the right things to do rather than trying to guess market levels, entry or exit points which are very difficult to call. Advisory, not astrology, is our role.

Are key events meaningless? Should we look the other way when markets are hit by key events like policy changes, elections or for that matter Covid-19? Investing is always about being probabilistic rather than deterministic. It is like a game of chess where one move can open various possibilities and outcomes and one must look at tradeoffs before making the next move. Two things that are important are survival and patience and the key for that is to not risk anything which threatens survival.

Markets have to navigate through a lot of uncertainty during these Covid times and the only 2 people know, when and how this will end, are God and a liar. Given what we are passing through during these uncertain times, a quote from Den Voltaire sums it up well, “Uncertainty is not a comfortable place, but certainty is absurd”. Let that serve as a reminder when we hear any ‘expert’ quoting where markets are headed next.

Disclaimer: The views expressed in this article are personal in nature and in is no way trying to predict the markets or to time them. The views expressed are for information purpose only and do not construe to be any investment, legal or taxation advice. Any action taken by you on the basis of the information contained herein is your responsibility alone and Tata Asset Management will not be liable in any manner for the consequences of such action taken by you. Please consult your Financial/Investment Adviser before investing. The views expressed in this article may not reflect in the scheme portfolios of Tata Mutual Fund.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.

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