Upload
dstepien43098
View
226
Download
0
Embed Size (px)
Citation preview
8/12/2019 8 Arata Markets
1/11
2013 Risk and Profit ConferenceBreakout Session Presenters
8. Investing 101 and Why Economists Drive Dodge Darts
Joe Arata Joe Arata teaches courses, provides information and conducts research oncommodity futures, options on futures and off exchange derivatives.Currently he is working on an analysis of futures market price valuation andmarket information; analyzing profit due to underlying asset price changesas opposed to profit due to option mispricing; and decomposing optionmispricing into volatility and formula error.
Abstract/SummaryEconomic financial theory is based in part on the theories that include theEfficient Market Hypothesis, Random Walk theory and other that aremanifestly false and incorrect.
8/12/2019 8 Arata Markets
2/11
nves ngWhy Economist Drive
Dodge DartsJoseph O. Arata Ph.D.
Department of Agricultural Economics
Kansas State University
o ge ar 2
Heres the Plan
Saving - Investing
Stocks
nanc a a os
3
Saving VS Investing
Saving - Postpones spending Has safety precautions
Investing Longer term capital Exchanges money for something with the
u ure expec a on o rece v ng a pro
Has risk factors
4
Saving VS Investing
Places to Invest
Bonds
Mutual Funds
Retirement Plans
Real Estate
Stocks
5 6
8/12/2019 8 Arata Markets
3/11
What Economists Believe
Efficient Markets Hypothesis
Micro Economics Theory
7
Efficient Markets HypothesisTextbook Version
Security prices accurately reflectavailable information, and res ond
rapidly to new information as soon as itbecomes available
Richard Brealey & Stewart Myers,,
8
Efficient Markets Hypothesis
nves ors, as a group, can o no e erthan the market, because collectively theyare e mar e . os nves ors ra emarket because they are burdened by
comm ss ons an un expenses. Jonathan Clements, the Wall Streetourna ,
June 17, 2007
9
Efficient Markets Hypothesis
80-90% of price volatility is the result of thinternal dynamics of speculators watchingother speculators: EMH idea of investors focusing solely
upon expected risk/return is wrong:
Instead,Prices are determined by speculation on
immediate behavior of other speculators,rather than rational calculation
10
Market Realities
Professional managers: choose portfolios thatare c ose o e enc mar ey are eva ua e
against benchmark
Select stocks that other managers select, Again to avoid falling behind and looking bad
Add stocks that have recently done well, and ,
To look good to investors who are getting end ofyear reports on portfolio holdings
11
Market Realities
Individual investors do not do this
Self-defeating (irrational?) behavior as well
follow the advice of financial gurus, Fail to diversify,
Actively trade stocks and churn their portfolios,
thereby increasing their tax liabilities (Shleifer2000 p. 10)
Undermines both EMH and possible gains from marketinefficiency
Also partly explains market inefficiency
As does behavior of money managers12
8/12/2019 8 Arata Markets
4/11
pple StockA le
500
510
480
490
460
470
440
450
3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3
137/29/1
7/30/1
7/31/1
8/1/1
8/2/1
8/3/1
8/4/1
8/5/1
8/6/1
8/7/1
8/8/1
8/9/1
8/10/1
8/11/1
8/12/1
8/13/1
8/14/1
8/15/1
8/16/1
8/17/1
8/18/1
8/19/1
pple Stock
700
750
pp e
600
650
450
500
350
400
14
300
8/17/12
8/31/12
9/14/12
9/28/12
10/12/12
10/26/12
11/9/12
11/23/12
12/7/12
12/21/12
1/4/13
1/18/13
2/1/13
2/15/13
3/1/13
3/15/13
3/29/13
4/12/13
4/26/13
5/10/13
5/24/13
6/7/13
6/21/13
7/5/13
7/19/13
8/2/13
8/16/13
o as o as a c ewan50
45
40
30
35
25
12
12
12
12
12
12
12
12
12
12
12
12
13
13
13
13
13
13
13
13
13
13
13
13
13
13
13
13
13
15
7/20/
8/3/
8/17/
8/31/
9/14/
9/28/
10/12/
10/26/
11/9/
11/23/
12/7/
12/21/
1/4/
1/18/
2/1/
2/15/
3/1/
3/15/
3/29/
4/12/
4/26/
5/10/
5/24/
6/7/
6/21/
7/5/
7/19/
8/2/
8/16/
eere -86
85
83
84
82
81
167/16/13
7/17/13
7/18/13
7/19/13
7/20/13
7/21/13
7/22/13
7/23/13
7/24/13
7/25/13
7/26/13
7/27/13
7/28/13
7/29/13
7/30/13
7/31/13
8/1/13
8/2/13
8/3/13
8/4/13
8/5/13
8/6/13
8/7/13
8/8/13
8/9/13
8/10/13
8/11/13
8/12/13
8/13/13
8/14/13
8/15/13
8 / 1 6 / 1 3
onsan o- yngen a90110
85105
80100
70
75
90
95
6585
12
12
12
12
12
12
12
12
12
12
12
12
13
13
13
13
13
13
13
13
13
13
13
13
13
13
13
13
13
17
7/20/
8/3/
8/17/
8/31/
9/14/
9/28/
10/12/
10/26/
11/9/
11/23/
12/7/
12/21/
1/4/
1/18/
2/1/
2/15/
3/1/
3/15/
3/29/
4/12/
4/26/
5/10/
5/24/
6/7/
6/21/
7/5/
7/19/
8/2/
8/16/
The Richest People
1. Carlos Slim Helu 2. William Gates. manc o r ega . arren u e
5. Larry Ellison 6-7. C&D Koch-. - .10. Bernard Arnault 11. Christy Walton12. Stefan Persson 13. Michael Bloomber14. Jim Walton 15. Sheldon Adelson16. Alice Walton 17. Bobson Walton18. Karl Albrecht 19. Jeff Bezos20. Larry Page 21. Sergey Brin
18
. .24. LeeShau Kee 25. David Thomson
8/12/2019 8 Arata Markets
5/11
People who earned it all
1. Carlos Helu-telecom 2. W. Gates-Microsoft3. A. Orte a-Zara 4.5. L. Ellison-Oracle 6-7.8. L. Ka-shing-stocks 9.
10. 11.12. S. Persson-H&M 13.M. Bloomberg-Bloomberg. . . e son-cas nos
16. 17.- -. . . .
20. L. Page-Google 21. S. Brin-Google22. M. Ambani-oil&gas 23.24. L. Kee-stocks 25.
The Richest Showbiz Women
1. Oprah Winfrey 2 J.K. Rowling
. ar a ewar . e ne on
5. Madonna 6. Mariah Carey
7. Janet Jackson 8. Julia Roberts
9. Jennifer Lopez 10. Jennifer Aniston11. The Olsen Twins 12. Britney Spears
13. Judge Judy 14. Sandra Bullock
15. Cameron Diaz 16. Gisele Bundchen
. .
19. Christina Aguilera 20. Renee Zellweger
What is a Random Walk?Textbook Version
Formal Definition: In simple symmetricrandom walk on a locall finite lattice, theprobabilities of the location jumping to eachone of its immediate nei hbors are the same.The best studied example is of random walkon the d-dimensional inte er lattice(sometimes called the hypercubic lattice) .
21
What is a Walk?
An Intuitive understanding: A series of
randomly decided (e.g., the path a drunk.
Stock market prices evolve according to a.
consistent with the efficient market hypothesis.
22
Random Walk
Individual stocks prices are extremelyvolatile and that volatility is too large to
rationalize with a random walk
23
Definitions of Volatility
. .continuously compounded stock returns.
. .residuals from a factor model for returns.
mp e o a y e vo a y eve awould produce an observed option price.
VIX (fear index) measures the marketsvolatility expectation over the next 30 days
8/12/2019 8 Arata Markets
6/11
Why Volatility Increased
Firm-Specific Factors:
The number of stocks on U.S. exchanges hasmore than doubled since 1980, but theaverage s ze o e new y s e rms ssmaller
, ,need a less proven track record (to be listed)
EPS and ROE (levels declining, variability up)
Stock Price Volatility
Discrete jumps often occur when reported.
Institutional investors now react quite swiftl, .
Thus, stock price change distributions have. ,
especially among lightly traded stocks.
,has exceeded what fundamentals dictate.
Volatility v. Return
Stocks with large sensitivities to marketvo a y ave ower average re urns.
Periods of high volatility tend to occur inbear markets, and periods of low volatilityoccur in bull markets.
Return dispersion is countercyclical, but isrelated ositivel to subse uent marketvolatility, and tends to lead unemployment.
Why Care about Volatility?
High Volatility may make a diversifiedpor o o ess vers e .
Arbitrageurs can get it wrong whenvolatility becomes too high.
Abnormal event-related returns arestrongly impacted by volatility.
associated with changes in volatility.
Explanation for Relationship
It is no surprise that high-risk stocks dore a ve y we n up mar e s, u re a ve y
poorly in down markets. However, the negative effects from down
markets often dominate the positive effectsfrom up markets.
This mi ht indicate an inverse relationshibetween risk (historical volatility) + return.
Liquidity
Liquidity is like pornography. Easy toen y w en seen, u s cu o
define. But, CLM defines liquidity as:Ability to buy or sell significant
quantities of a security quickly,
anonymously, and with minimal or no
price impact.
30
8/12/2019 8 Arata Markets
7/11
Extreme Volatility Events
Volatility Spikes tend to occur during times ofow or nsu c en qu y:
October 19, 1987 (portfolio insurance)
August (2nd half), 1998 (Russian financialcrisis
September 11, 2001 (WTC / markets
May 6, 2010 (Flash Crash)
Extreme Volatility Episodes
The Great Depression
The Internet Bubble
The Recent Financial Crisis
In 2008: the daily DJIA changes were atleast 1% on 134/253 (53%) of all tradingdays
This compares to a 15.6% avg. (2004-2007)
European Debt Crisis / U.S. TreasuryDowngrade (3rd Quarter 2011)
Micro Economic Theory
Normal micro economic theory: Demand a negative function of price
If price rises Demand falls
Supplyy = +x
$8
$9
Hypothetical Beer Supply
$5
$6
$7
Bottle
$2
$3
$4
Price
/
$0
$1
0 2 4 6 8 10 1
Quantity
Demand
$8
$9
$5
$6
/Bottle
y = 12 -x$2
$3
$4
Price
$0
$1
0 2 4 6 8 10 12
Quantity
Market Realities
With the stock market ,
positive function of price If price of assets (shares, real estate, etc.)
,Buyers hope to buy and sell on a rising
The faster the rate of price increase
demand
8/12/2019 8 Arata Markets
8/11
Market Realities
Tendency to move away from equilibriumun amen a va ue , s or c pr ce o
earnings ratios, etc.)
r ce us es a zes an asse mar e Far-from-equilibrium process means verva ua on o popu ar grow s oc s
Undervaluation of unpopular value stocks
Market Realities
Argument that investors eac s ow y o news Under-react and Over-react
Series of good reports leads to expectation
Firm valuation rises, seen as growth stoc rise becomes self-fulfillin bandwa on bu in
Market Realities
Firm cannot sustain above sector/economyper ormance n e n e y
Initial bad news reports ignored as firmrever s o mean
Finally, bear valuations set in; bandwagonse ng growth stock underperforms in medium term
Stocks
Standard & Poors 500: 90 U.S. stocksup o an a er a . ea ersin their industries and among the largestrms ra e on . . ar e s.
Small stocks: Securities traded on theNYSE with market capitalizations in thebottom 10%.
40
Stocks
S&P 500
January 3, 2012 1,258.86
Au ust 13, 2013 1,691.42
, .
January 3, 1977 107.00
41 42
8/12/2019 8 Arata Markets
9/11
Major Stock Classes
Large company growth stocks
Small company growth stocks
Small company value stocks
Mid cap growth stocks Mid cap value stocks
Mid Foreign stocks
Developed
merg ng
43
Small company growth stocks
Growth stock generates substantialand sustainable positive cash flow andwhose revenues and earnings are
expected to increase at a faster ratethan the average company within thesame industry
Small stocks: Securities traded on theNYSE with market capitalizations in thebottom 10%.
44
Wrong ETF
Brazil
Chile
ur ey
United States
South Africa
45
Price Earnings Ratio
Ratio of a stocks price to the companiesearning per share
P0/E1
E1 Earnings per share
average shares
46
Price Earnings Ratio
Ratio of a stocks price to the companiesearning per share
P0 / E1
Conventional wisdom,
Riskier stocks have lower P/E
47 48
8/12/2019 8 Arata Markets
10/11
Price Earnings Ratios
Problems with the P/E
arn ngs anagemen
Practice of using flexibility in accountingru es o mprove apparen pro a y o rm
Large amount of discretion in managing
2012 P/E Ratios
10.2
8.5
Integrated oil & gas
Aero spac e/defen se
14.9
14.7
13.2
11.8
.
Industrial metals
Telecom services
Computer systems
Health care plans
17.4
17.2
16.5
15.6
Chemical products
Pharmaceuticals
Home improvement
Electric utilities
21.4
21.1
17.5
17.5
Restaurants
Food products
Ass et man agemen t
App lic atio n so ftw are
34.7
32.4
28.0
25.3
Business software
Heavy constructio n
Trucking
Aut o man ufac tur ers
0 10 20 30 40 50
P/E ratio
Financial Statements
www.sec.gov/edgar.shtml
dripinvesting.org/Tools/Tools
51
Financial Ratios: Can the
CURRENT RATIO is the ratio of current assets tocurrent liabilities.
Current assets
',million in current assets and $5 million in currentliabilities, ou et: Current Ratio = $10 million/ $5 million = 2.0
As a general rule, a current ratio of 1.5 or greater normally sufficient to meet near-term operatingneeds.
Financial Ratios: Can theus ness ay s e s
TheACID TEST (QUICK) RATIO, the ratio of
current assets minus inventory to current liabilities,. Current assets - inventory
Current liabilities
The balance sheet of Joe's Bar and Grill shows thatey ave . m on o e r curren asse s n
hamburger buns that are sitting in inventory. You'
Financial Ratios: Can theus ness ay s e s
TheACID TEST (QUICK) RATIO,
The balance sheet of Joe's Bar and Grill shows tha.hamburger buns that are sitting in inventory. Younow can fi ure out the com an 's uick ratio:
Quick Ratio = (Current Assets - Inventories)urren a es
= $10 mm - $2.5 mm / $5 mm
54
8/12/2019 8 Arata Markets
11/11
Financial Ratios: Can the
WORKING CAPITAL is the amount ofcurrent assets less current liabilities.
Current assets - Current liabilities
55
Financial Ratios: Can theus ness ay s e s
ACCOUNTS RECEIVABLE TO WORKINGCAPITAL shows the riskiness of thecompany's ability to make current payments.
Accounts receivableor ng cap a
INVENTORY TO WORKING CAPITALstates the riskiness in terms of inventory.
InventoryWorking capital
56
Bottom lineInefficiency markets generate opportunities
Fund mana ers cant ursue because of short-term monitoringIndividuals tend to miss by following the crowd
Fund ManagersShort-term horizon forces index following
n v ua sBehavioral herding causes following of fads
Buy high out of favor sectors, low volatility, low PE
Worse performance over short term possibleBetter performance over medium-long term likely
57 58