Share market movements can seem almost random, and it can often be difficult to rationalize the daily changes in value. At any given time there are a multitude of influencing factors that will impact investor sentiment and share prices, and understanding the dominant factors and predicting their exact influence is no easy task.
After the fact, financial experts will be able to explain all with precision and clarity, and there will often be a broad consensus on the interpretation. But why is it that when it comes to predicting the future these same experts rarely get it right, and often disagree. (Earlier this year well respected and well resourced institutions were forecasting that oil would hit $200 per barrel, and that the worst of the credit crisis was over).
I don’t mean to be critical, far from it. The business of forecasting is an amazingly complex one, and the fact that people can get it right at all is amazing. The fact is that markets are chaotic systems, and as with all such systems they are by definition unpredictable and susceptible to change from seemingly small influences.
The weather is another well known chaotic system. No matter how well we understand meteorology, we will never be able to accurately and consistently predict what the weather will be like more than a week or so out. It’s a different story with the climate however, as we can forecast with a high degree of accuracy things such as mean rainfall and temperature for a given region at a future date. It is the same with the market. No one can really know what a share price will do tomorrow, and it’s virtually impossible to know what a share price will be a week, month or year from today. But we can know the “climate” of the market down the track. For example, who knows what BHP will be trading at in 2016?? But I’d bet you anything that it would be higher than it is today. In fact, I’d be confident that it would have easily passed its high for 2008 by then. Similarly, who knows the exact value of dividend payments shareholders would receive between then and now? But you can be confident that shareholders will receive regular and reliable dividends that will most likely increase over time.
Share prices are determined through a continuous auctioning process that involves many thousands of participants. And these participants, being human, are irrational, emotional and imperfect. In many ways, you would be better equipped to understand the nature of the market through an understanding of psychology rather than economics or finance. (Indeed, this is the underlying concept behind a growing school of thought known as behavioral finance).
The point is that a focus on specific share prices is a dangerous distraction. What is important is to be confident of the long term outlook. Consider the current situation, where we are occupied with questions such as: Has the market bottomed? How long until the market recovers all of its losses? Will Australia enter a recession? If so, how long will it last? These are indeed important questions, but as we have seen they will be notoriously difficult to answer, and for every expert who advocates one point of view, there will another that has the opposite view.
So let’s just be pragmatic about it all. No matter how bleak the next few years appear to be, we can be confident that markets and economies will recover and go onto bigger and better things. Chances are you won’t get in at the exact bottom, and things won’t improve immediately after you make your investment. But if you can afford a longer term view (at least 5 years) then you can ignore the chaotic nature of short term price movements, and instead focus on the broader market climate. And since the beginning of time, despite the occasional correction, the market has enjoyed a very pleasant climate indeed.
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