Investing: Do stock prices reflect fundamentals or investors’ sentiment?

This question has been in debate by behaviourists and academicians for decades. Do asset prices in stock markets represent economic fundamentals or investors’ emotions? For me, my opinion is that it is mainly due to investors’ emotions.

Take the stock, Duty Free International, that I bought recently at last month Jan for example. On 10 Jan 2018, Duty Free announced its financial results for 3Q2018. Due to foreign exchange losses (about RM 13.3 million), its net profit for the nine months ended 30 November 2017 plunged by 84.7%. The business outlook for Duty Free remains challenging “given current economic conditions, a volatile US Dollar versus Malaysian Ringgit exchange rate, coupled with a competitive business environment and weak consumer sentiment” (excerpt from Duty Free’s press release). Given such unfavourable results and future prospects, a person who believes that the stock price should reflect its economic fundamentals will expect the stock price to plunge also. There should be a sharp sell-off of Duty Free shares in theory. However, on 10 Jan 2018, Duty Free International still traded at $0.275 per share (price chart here). While there was a slight drop in price over the next few days of about $0.015 per share. it actually rose back till the end of the month. There was no sustained major sell-off. It seems to me that Duty Free investors’ had an irrational optimism about the stock. At this time of writing, I actually made an unrealized gain on this stock despite the recent bad financial report.

However, there are times when investors choose to react to unfavourable news release or results announcement. Take Thai Beverage, the counter that I sold off on 20 Feb 2018 for instance. On 14 Feb 2018, the net profit of Thai Beverage fell by about 62%. This fall is relatively smaller than Duty Free’s net profit, but investors chose to focus on this bad report and sell off their shares in the market. On 14 Feb 2018, ThaiBev shares still traded at $0.91 per share. Yesterday, the price fell to $0.84 per share ( price chart here). This is despite ThaiBev’s strategy to increase its beer market share to 45% and becoming a leading beer company by 2020 (DBS Equity Research), which is supposed to be a good thing for fundamentals.

In my opinion, it is very difficult to consistently predict the response of the market to various news event. The market can ignore or brush off certain bad news like interest rate rises or geopolitical news or terrorism. It can choose to overreact to positive news like earnings report or distribution of dividends. While we can assign probabilities through technical analysis, to accurately predict the market’s reaction year after year can only be done by God alone. Even analyst’s prediction about the price direction of a security can be wrong (DBS Vickers Research Team on Suntec Reit). In the last month of 2017 analyst report on Suntec Reit, research analysts Melvin Song and Derek Tan admitted that “We, like all sell-side analysts, were blinded-sided by Suntec’s past performance and missed the 30% share price rally in 2017″. Which goes to show that even experts can get it wrong.

I feel that it is more important to have a trading plan than to attempt to predict the direction of the market. Not even Warren Buffet can do that, according to one of my friends who commented in this blog. Of course, it is good to have an opinion on the current market condition. Just know what to do when you realize it is wrong, for we are all human. We all make mistakes; we won’t get it right everytime…

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