Movie Star Theories To Beat The Market

Walking past a local pub last night, I bumped into a couple of friends having beers. 

It’s an easy thing to do in Singapore, considering that many of the pubs don’t have walls, so they spill out onto the main walking areas.  Think of a summer vacation area, with perpetual 26 degree (celcius) weather, and you’ve got Singapore (where we live) on an overcast day.

One of these guys is a bit like a movie star crossed with one of those CNBC Squawk Box hosts.  He’s extremely sharp, and very, well….”Movie Star-ish”.

To protect his privacy, I’ll refer to him as Tom Cruise—because I think he’ll like that.

Now, Tom was telling me a couple of interesting things last night.  First, he was suggesting that if he lived in the U.S., he could easily take advantage of trends in the business world, allowing him to exploit stock prices and beat the market.  His example related to data he found on certain technology companies, and that their earnings took dips during a predictable part of the year—something he could take advantage of to buy at cheap prices.  I assumed he’d like to sell during the months when those companies had predictably higher earnings, and consequently higher stock prices.

The conversation went something like this:

Me:  No Tom, that’s Mission Impossible.  There are professional Hedge Fund managers and Mutual Fund managers constantly trying to exploit differences in price and value.  If there was such a trend in seasonal sales for a given sector, they’d notice it.  And professional fund managers don’t beat the markets, as an aggregate.  (In other words, they don’t beat the stock market indexes after all fees)  So what makes you think you could do it based on something so….obvious?

Then Tom went into a discussion about a book he read:

Cruise:  Andrew, I can tell that you’re not a numbers guy.  I can find these sorts of predictable irregularities.  Plus, fund managers are like sheep.  They all do the same things at the same times.  They can’t do what I could do if I lived in the U.S.

To be fair, I think Tom is a lot smarter than I am. But I also think I have the upper hand in this area.

For those who believe they can exploit company earnings, cyclically, by determining that stock prices will react accordingly with information they’re getting exclusively, I’ll explain why you can’t:

1.  In the case of Mr. Cruise’s technology sector example, technology sectors have analysts that predict business earnings for those specific businesses.  If there was a trend associated with annual earnings cycles, they’re going to know about it.   Citing that computer companies have lower earnings during months A,B,C—and that you’re the only one who knows about it, signifies that you’ve likely had a few too many beers, and that you’re talking out the side of your Heineken. 

2.  Drops in earnings or rises in earnings have nothing to do with short term stock prices.    Short term, rising earnings don’t move stocks—not without an added element.  Let’s assume that Apple computer’s earnings rise by 50% next quarter.  But let’s also assume that the analysts following Apple have expected the earnings to increase by 60%.  They will have published their expectations, and Apple would “disappoint the street” if they increase earnings by 50%, and not 60%.  The price of the stock would fall (not rise) because the earnings would have fallen below expectations.  If the price of Apple’s shares was $400 before the earnings announcement, that expectation of a 60% rise in earnings would have already been priced into Apple’s shares.  Reported earnings increases of 60% would likely do nothing to the share price, if a 60% increase was already expected of Apple.  As Wharton business professor, Jeremy Siegel points out:  “Investors will receive a superior return only when earnings grow at a rate higher than expected, no matter whether that growth rate is high or low”

It’s very important that serious investors don’t fall into these kinds of traps.  Beating the market is a very tough thing to do, and it’s nearly impossible to figure out short term price movements—no matter what kind of advantage you might think you have.

Tom Predicted A Market Crash For Today—Or Did He?

Another thing that’s tough to predict, is the market’s movement in any given day.  When looking back at the past 90 years, if we examine market moves of 5% or more in a single day, we can only attribute a historical/economic event to a quarter of those big changes.  Think about that for a moment.  Looking in the review mirror and playing “match-up” only 1 in 4 big market moves can be explained by a world/economic event.  The rest of the big, one day market moves were unexplained.  So if we can’t explain the big historical moves, we must be very careful trying to play soothsayer, by predicting future market moves based on tea leaves, astrology signs, technical analysis or…even Tsunamis of 8.9 on the Richter scale.

Tom Cruise told me last night that he was going to sell every one of his stocks this morning (except Apple) after hearing about the Japanese earthquake last night.  His plan was to sell, and then buy back low, partway through the day…or the next day…or the day after.  That second part of his plan wasn’t clear.

Let’s have a look to see what would have happened if Tom sold his stocks this morning.  Below, we have a chart of the S&P 500, the day after the Tsunami struck Japan.  Tom’s sell order would likely have been filled by roughly 10am.  But look at what would have happened.  Hoping to buy back the shares at a cheaper price, Tom would have noticed that the stock market increased throughout the day.  Tom would have sold on the daily low, and if he wanted to buy back the shares later that day, he would have had to pay a higher price.  Tom mistakenly thought he could predict the “obvious”—a stock market drop after the Tsunami.

 But you can see that he would have been wrong.  Nobody can predict short term market moves with consistency.  Nobody.

What do you think?





Andrew Hallam

I’m a financial columnist for Canada’s national paper, The Globe and Mail, as well as for AssetBuilder, a financial service firm based in Texas. I’m also the author of Millionaire Teacher: The Nine Rules of Wealth You Should Have Learned in School (2nd Ed. Wiley 2017) and The Global Expatriate’s Guide To Investing: From Millionaire Teacher to Millionaire Expat (Wiley 2015). My mission is to educate, motivate and inspire people on basic retirement planning and best practices for investing, using evidence-based strategies. I’m happy to comment on your questions. However, please read the Terms of Use, Privacy Policy and the Comments Policy.

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13 Responses

  1. DIY Investor says:

    I think you have produced an excellent example and also that you will have a hard time convincing "Mr. Cruise".

    At this point many Mr. Cruise types would be totally confused (Mr. Market is playing with his head) and swear off investing totally – that is, until the next time the market pops 20% and he identifies the next "obvious" pattern.

    All financial advisors have been at the table trying to convince Mr. Cruise's long lost brothers and sisters on the value of a well defined plan, and participating in the overall markets.

  2. Robert,

    As I was writing a comment on your blog, you wrote a comment on mine. What are the odds of that happening at exactly the same time. If that happened twice, we'd get fooled by randomness…if we didn't know better.

    Mr. Cruise is very very smart. But at the same time, the market's sirens can delude the very best of us.

  3. 101 Centavos says:

    So Mr. Cruise thinks he can do better than high-frequency trading managed by quants and computers? This is a reality check learned the hard way by many an aspiring day trader.

  4. Hey Centavos,

    I suppose a lot of smart people think that. It's part of what inevitably moves the market. How many of our friends would suggest that they're below average in driving ability? My guess is that none of them would claim this. And the friends of our friends wouldn't claim it either. We have scewed perceptions of our abilities sometimes.

  5. Robber Baron says:

    Please tell "Mr Cruise" that historically, yes, for isolated stocks, you could "time" the market about 75% of the time. Timing may require 6 month swings. For example: Historically, you could time Disney (before it went conglomerate with TV networks, etc) to lows in February and highs in Sept, forgoing the annual dividend (paid in December). Three out of four years, it worked.

    BUT…

    the one year it failed ate all the profits from the other three.

    AND…

    nowadays everyone has much better technology to trace historicals and trends.

    In-house trades move faster than those by (smaller) individual traders.

    There really isn't any evidence you can pounce on news "across the market".

    Sounds good over a beer, but these kinds of trades just aren't available any longer. If it were easy, there would be a lot of early-retired millionaires…

    • Good points Robber Baron:

      I'd suggest that even when those trends were there, unless they surprised analysts' expectations (which you are suggesting they wouldn't have) then those patters of earnings would have been priced into the stocks beforehand already. Only surprise earnings levels move stocks, short term. So if you could guess right 70% to 75% of the time, where earnings would trend, then there was no surprise anyway. Therefore, you couldn't take advantage of the trend that 75% of the people already knew. What do you think?

      • Robber Baron says:

        Hi Andrew. I agree with you. As noted, there is so much more, better, faster information now than in the past. Some people are still living in the past (perhaps based on popular movies from late '80s & early '90s). And perhaps some of the "wins" from ages past were based on some insider information which is no longer tolerated? Traders nowadays look several quarters ahead in valuations, unlike 20 years ago.

        Ten years ago "day-trading" became available to anyone able to open a $10,000 online account in Korea. Nearly all were wiped out in less than 6 months. Folks lived on their computers, still couldn't compete.

        If we mortals could just "match the market" after fees, we'd be ahead of the game. Which is why your index investing makes a lot of sense — it comes closest. But since so many of us are "above average" it's hard to not try to beat the market..

        Rob

  6. Totally in agreement with you, predicting market moves on any time frame is a waste of time. It's even more of a futile exercise when one is basing his decisions by looking back at events through a rear view mirror!

    • Robber Baron:

      Do you think Koreans have a keener gambling bone than the average North American? I know that we're all wired similarly, but there's something about this part of the world (Asia) that makes me wonder whether there's a greater tendency to gamble. The markets are more volatile, and housing…wow….rental prices (at least in Singapore) can swing wildly, doubling in 6 months. Then back down. Then doubling again a short while later. Crazy.

      • Robber Baron says:

        Tricky currents, indeed, generalizing about character, but yeah, Koreans, Chinese, and some other Asian ethnic groups seems to have a greater penchant for gambling at higher rates. For such reasons, gambling is often tightly regimented in countries — not sure about the present status of Genting (Malaysia) but in the past Malaysians couldn't gamble in Malaysia, Chinese couldn't gamble in Macau, and Koreans couldn't gamble in Korean casinos (minor bets at racetracks). Korea has opened a casino for locals, some strict regulations on how much an individual can carry in (but of course, folks find ways around that).

        My working assumption is that "fatist" (not same as "fatalist") societies are more willing to risk that:

        (a) "it's their time to win"

        (b) if they don't win, they were destined for a bad outcome anyways, so it doesn't matter.

        Are Singaporeans allowed to gamble in the new Singapore casinos?

        • Hey Robber Baron,

          Great question about those casinos!

          Singaporeans are allowed to gamble in them, but they're discouraged from doing so.

          How are they discouraged?

          If I went to the casino with a Singaporean friend, I'd be allowed to walk right in and gamble. Singaporeans have to pay a $100 entrance fee, just to walk in the door.

          What do you think of that?

  7. This tends to be a rookie investor mistake to think they can time the markets … Why does he need to live in the U.S. to pull it off? To feel the vibe from the other citizens?

    It looks like he does invest. What kind of investor is Tom? Apart for the day-dreaming version 🙂

  8. Hey Passive:

    It is pretty interesting. Tom is actually on his way to earning his CFA. But after looking through the CFA material myself, I found it long on obscure math and short on wisdom.

    To Tom's credit, when I asked him yesterday if he sold all his stocks, he said that he didn't. That's a good thing.

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