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Sunday, 7 September 2008

Analyst's analysis --- to be taken with a tonne of salt?

I read with amusement the morning news about the effect of quitting of Japanese PM on NIKKEI, on Channel NewsAsia on 2nd September 2008:

0846 hrs: Japanese shares open lower after PM's resignation
0917 hrs: Japanese stocks turn higher after PM resigned

How do these analysts know the stocks went up or down due to his resignation? Apparently they didn't, reversing their views just around an hour. This brought me to recall what I heard when I attended the analyst briefing of Surface Mount Technology sometime this year when its CEO commented:

... there are two professions who does not need to take responsibility for what they say, one is the weather forecasters, the other is stock analysts...

As a whole, their hits and misses are seemingly so evenly distributed that it became common sense to take them with a huge tonne of salt. Thus it is rather surprising (at least to me) that people still believe them (else why ask them for opinion) and even more surprising why they are still employed and so highly paid.

Reasons behind salty analysis

I read somewhere, in one of the books on the left column (can't recall which) that it is human nature to attribute cause and effect, e.g. trying to find a pattern when there is none. It works pretty well during hunting, i.e. aiming and throwing a spear ahead of a speeding deer instead of directly at its body when one can almost predict (correctly) that it will run straight.

But it is altogether a different story making forecast in a stock market, especially on a short term basis. It's as good as trying to predict the next roulette spin. The reason is that the sheer number of participants and events affecting a short term outlook in the market make the next price movement almost a perfectly random event.

I do not believe these highly educated professionals, with their training and experience could not understand the fundamentals causes behind macroeconomic events unfolding before them. But many seemingly like to make straight line forecasts. If that is so easy, anybody can become an analyst.

Lastly, being an accredited analyst, market expect them to give an answer, a projection. They have to call a number (any number is better than no number). "oil will hit 400 usd per barrel" sounds much better than "I don't know, probably the oil price will be very volatile".

Layman's view

I do not need to call a number if I don't know and I am under no pressure to kid myself. So it is great to look back at my past comments to see how I fare in my own macroeconomic views.

SGD vs USD (and other foreign currencies)

When USD was fast depreciating in 2007 and most of 2008, many analysts are calling ever lower targets with each record high achieved by Sing dollar against the USD. The lowest target I recall is 1.32. Might as well say parity. But the fundamental events clearly pointed otherwise as I wrote the article on 10th May 2008:

10th May 2008: High-yielding notes a good buy?

In it, I pointed out the limitations on how far US can allow its currency to drop and how badly it will hurt Singapore if MAS continue to strengthen SGD endlessly. Ironically, after being so bullish before the August decline in Sing dollar, many analysts now forecast a steeper decline in Sing dollar. Given MAS's policy of using SGD as an inflation fighting tool and mounting US debt, I doubt there will be a clear trend in SGD vs USD. It will most probably be volatile exchange rates until the dust settle down in the next few years.

On a separate note, my post was actually targeted at the prevailing interest then to buy high yielding fixed foreign currency deposits but I cautioned against the risk involved. There must be a reason for the high interest attached, and it is definitely not risk free.

Since that post, New Zealand dollar, NZD had depreciated about 7% against SGD:

and Australian dollar, AUD by about 7.5%:

Thus offsetting the 'high' interest rate on these fixed deposits (about 6 to 7% then). I'm not the first to see these fundamental changes, I read them somewhere, so can these 'analysts'.

Oil prices --- aiming for the moon?

When crude oil crosses USD 140 a barrel in June this year, analyst again extrapolated crude oil to shoot for the moon. Supporters of peak oil (oil supply had peaked but growing demand will ensure rising prices without conservation or alternative sources) are right to point out that growing global demand (esp. due to rising demand from China and India) will drive up prices.

However the run up in prices are seemingly more of a speculative adventure then a shift in fundamentals. I wrote another article on this back then on the unsustainable crude rise:

1st June 2008: Oil bubble or trouble?

When it hit above 140 a barrel, some predicted a 200 a barrel by year end. Now, when crude collapse below 110, some predicted it to retreat back to 80. In the long run, I do not doubt crude demand will definitely outpace supply unless more economically exploitable fields are discovered or more serious adventure in alternative fuels takes off. The following figures put the key consumers in perspective:

Crude oil consumption per capita per year:

US: 68.81
China: 4.96
India: 2.18

GDP to Crude oil consumption ratio:

US: 1.65
China: 0.94
India: 0.86

Crude oil consumption in absolute terms (1,000 barrels per day):

US: 20.59
China: 7.27
India: 2.53

Crude oil consumption if China & India's consumption per capita matches US:

US: 20.59
China: 100.86
India: 79.86

Even if China & India become as efficient as US in terms of consumption per GDP:

US: 20.59
China: 12.76
India: 4.85

(But this assumes China and India's economy remains unchanged. At the rate they are growing, both economies will match, if not surpass, that of US within the next decade. Thus at the same efficiency, both consumption will exceed US by a significant margin)

However, in the short term, it is somewhat incredible for oil to double in just 2 years. Similar to SGD vs USD, going forward, crude oil price could just be as volatile in the near future before it settles down to a price dictated by fundamental supply and demand.


It is sometimes amusing to read analyst reports on stock valuations. Many like to use P/E ratios. It is a convenient tool because it allows practically any number to be called for a stock valuation. In a bull run, for a forward or historical earnings, just pluck a high P/E ratio and you get a huge target price. Conversely in a bear market, with the same earnings, pick a low P/E ratio and you get a much lower target price. It is as good as a doctor trying to diagnose you with a wheel of fortune.

It is no wonder they are so handsomely paid. Not because their job are difficult to do, but its difficult to keep because any Tom, Dick or Harry can become one. Fortunately I do not depend on analyst reports for my stock picks.


I am not saying all analyst are not up to mark, but the significant number of black sheep amongst the good ones are indeed bringing a bad name to the collective lot. It is those that can and dare to give better quality comments and reports that will capture the trust and confidence of rational investors.

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Anonymous Anonymous said...

hi uncle,
should i then be contrarian and buy into AUssie/NZ dollars now?
But the graph in yahoo looks like it has fallen below the support level of about 78 cents. how?

30 January 2009 at 07:20  
Blogger Market Uncle said...

If you look at the interbank rates just updated yesterday:

You'll notice RBNZ had slashed its rates to record low of 3.5% and RBA at 4.25%. As this economic crisis drags on, there are definitely still room for further cuts when FED and BOJ are already at near 0%.

Thus, unless MAS changed its stance (no change until next meeting sometime in April), there should still be room for further NZD and AUD depreciation.

But things are changing pretty fast now as each gov. are trying v. hard to fight the crisis... so gotta be careful if you are into this for the short term (anything less than 5 years position).

30 January 2009 at 10:34  
Blogger angelhee said...

i agree with you. the analysts can be way off the mark. e.g. one gave a target SPC to $1.80 citing a host of bad reasons recommending sell.Now it is $2.45. I regretted following this advice.

31 January 2009 at 07:28  

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