Predicting the Market

In today’s Money Morning…markets aren’t as efficient as some people want you to think…the key to your big advantage in markets…predicting Telstra’s fall nine months in advance…and more…

I wrote last week that I didn’t think markets were as efficient as the academic theory suggested.

Today I want to clarify that position a little bit.

Because this is the key to understanding the one big advantage that you, as an ordinary investor, have in making money on the stock market.

But only if you use it…

And to be honest, most investors I know don’t take advantage of it. That’s a wasted opportunity. It’s like the umpire giving you a 50 meter penalty in AFL, and you deciding to kick from where you are anyway.

I’ll get back to this shortly.

Firstly though, what’s the Efficient Market Hypothesis I discussed briefly last week?

The Efficient Market Hypothesis states that share prices reflect all publicly available information.

Let’s think about that.

If this is true, it would imply that no investor has any particular advantage over any other when it comes to investing in stocks.

In this case, stock picking would be a mugs game! A simple game of luck.

But thankfully, it’s not completely true.

And I’ll prove that with an example from just last week…

It was predictable

Let’s start by looking at Tesltra [ASX:TLS].

The stock fell from $4.33 on Wednesday to finish the next day at $3.87 after the release of its annual results.

That’s a 10.6% fall in just one day, on a stock that’s followed by every single big-name fund manager in Australia, and probably a few international ones as well.

That’s a $4.6 billion dollar change in the company’s valuation in just 24 hours.

Does that sound efficient to you?

But you might counter, the stock only fell when new information — the annual results — came to light. The market is efficiently changing the price, based on that new information.

That’s true, to an extent.

But what if I told you that yesterday’s results were actually pretty predictable? And any investor that knew how to read the signs would have played the probabilities and stayed out of Telstra?

No, this is not just hindsight speaking.

In fact, I’m going to show you that you could’ve seen this coming. If you knew what to look out for, and had the right information to back it up.

Let me explain…

One of the perks of this job is that I get a subscription to every service we offer as part of my package.

And though I don’t always agree with every editor’s opinion on every single point, they all make me think about things in a new way and challenge my thinking at the very least.

One of them predicted Telstra’s problems as far back as December 2016.

In December last year, Greg Canavan wrote this to his subscribers in his Crisis & Opportunity service. It was under the heading ‘Avoid Telcos’:

Firstly, here’s the list of stocks that are making new lows:

TPG Telecom [ASX:TPM] — Near two years lows
Vocus Communication [ASX:VOC] — At two and a half year lows
Telstra [ASX:TLS] — Recently bounced from three and a half year lows
MNF Group Limited [ASX:MNF] — Two and a half month lows
Speedcast International [ASX:SDA] — One and a half year low
Superloop [ASX:SLC] — Three month low
Next DC [ASX:NXT] — Eight month low

This tells you there is something wrong with the profit prospects for the sector.

That something is the NBN…

…putting all this together, the industry is in a state of flux. That’s why you’re seeing share prices of the major players hitting new lows. The growth premium is coming out of the sector, and increasing uncertainty is being priced in.

In the short term, this means you should avoid the sector.’

To give you some context, at that point Telstra was trading at around $5.

Then in April 2017 he wrote this under the heading ‘Telco sector still one to avoid’.

Let’s have a look at the recent share price performance of the major Aussie listed players. At around $4 a share, Telstra [ASX:TLS] is at its lowest level in four and a half years.

It’s due for a bounce but the downward trend says a lot about the businesses future prospects.

Greg’s comments turned out to be 100% correct. Check out an updated version of the chart that Greg referred to as part of his analysis. You can see the bounce he talked, about and then the fall he predicted.


Source: Incredible Charts
[Click to enlarge]

So is Greg a psychic? Of course not.

He simply understood the fundamental profit drivers in this industry. And then used technical analysis to confirm his findings. The chart showed that investors were selling out of Telstra over time.

Greg gets some wrong as well. We all do. But his system allows you to consistently weight the probabilities in your favour. And manage risk when you are wrong.

This means that when he’s wrong you should only lose a little bit. And when he’s right you should gain a lot more. In such a system, even if you’re only right 50% of the time, you can make great returns.

That’s the perfect use of the ordinary investor’s advantage.

Efficiency takes time

You see, markets are efficient. But that process of moving from price to price and taking in new information happens over time. Every participant in the market might realise something at a different point.

If you are a big fund, it’s hard to get out of a position too fast. The very fact that you manage so much money can make it hard to get in or out of any position too quickly.

As Warren Buffet put it:

The highest rates of return I’ve ever achieved were in the 1950s. I killed the Dow. You ought to see the numbers. But I was investing peanuts then. It’s a huge structural advantage not to have a lot of money. I think I could make you 50% a year on $1 million. No, I know I could. I guarantee that.

This problem of too much money is how and why trends form. Money flows in and out of stocks and sectors over time as big players have to move money over time. They can’t just do it in one hit like an ordinary investor.

So following these moves can confirm if your fundamental analysis is correct — or at least in line with the market experts.

Are the big player’s always right? No, not always. The world is made up of many moving parts, and the future is always uncertain to a degree.

But if a fund realises that it’s wrong, it will reverse position. And you, as a small investor, can time this point simply by analysing the trends they create.

By combining technical and fundamental analysis, Greg showed that yesterday’s results were pretty predictable. And although nothing ever works 100%, if you want to play the probabilities you have to have both strings to your ‘investing bow’.

But there is a third string to investing that’s little talked about. That’s imagination. By that I mean the ability take disparate events and join the dots to guess what could happen next.

If your theory starts to be borne out by technical and fundamental factors, you can invest confidently at an early stage.

This methodology pretty much sums up Greg’s latest investment idea. If he’s right, and you’re prepared for this event, you could make fantastic gains in this beaten down industry.

Keep your eye out for Greg’s report, tomorrow.

Good investing,

Ryan Dinse,
Editor, Money Morning


Ryan Dinse is an Editor at Money Morning.

He has worked in finance and investing for the past two decades as a financial planner, senior credit analyst, equity trader and fintech entrepreneur.

With an academic background in economics, he believes that the key to making good investments is investing appropriately at each stage of the economic cycle.

Different market conditions provide different opportunities. Ryan combines fundamental, technical and economic analysis with the goal of making sure you are in the right investments at the right time.

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