Why investors are not better than speculators

New research shows that everything is arranged a little differently. It turns out that the main speculators make the most money when the companies whose shares they trade are in the best condition, and those who are accustomed to consider themselves as fundamental investors earn most of their income when the value of stocks jump simply because of favorable market conditions.

 

Criticism of speculation dates back at least to the 18th century, but British economist John Maynard Keynes gave an accurate definition of this phenomenon in the 1930s. According to him, speculation consists in predicting the psychology of the market and in contrasting it with forecasting future income from assets throughout their lives – he discovered this difference in the national character of the British and Americans. He wrote

 

“When buying an asset, Americans are hoping not so much for its intended profitability, as for a favorable change in the basis for valuation, which in a certain higher sense is speculation.”

 

Today we call speculators those who bet on a change in valuation, and investors – those who are interested in the fundamental indicators of the company. However, oddly enough, strategies in which a bet is made that the price will continue to move in the same direction, in practice, benefit from the improvement of fundamental factors, and value strategies based on the assessment of fundamental factors, earn on the growth of the assessment.

 

The study by Joseph Kouchner, an employee of Goldman Sachs Asset Management, referred to by the Wall Street Journal, is based on data from both types of investments.

 

Kouchner found that, although investors who despise speculation, rely mainly on the intrinsic value of companies, an approach involving the purchase of undervalued securities results in gains due to an increase in valuation. That is, companies are not getting better, just some people are starting to pay more money for their share in them.

 

At the same time, short-term trading with a horizon per month basically implies income on the growth of fundamental indicators – the rise in value due to them covers the fall in the estimate.

 

So it is a matter of definition. The investor should consider both approaches in practice, since they both rely on human nature – and for each of them there are corresponding exchange-traded funds.

 

An analysis of the fundamental factors implies that shareholders will overreact to bad news, and, as a result, the average company will be rated as bad (the downside is that good companies are often evaluated as if they cannot be wrong at all) and when it turns out that this is not the case, the company is going up quickly.

 

The rate for the moment is arranged so the growth of the shares attracts new buyers and provokes further growth, while falling shares, on the contrary, scare the shareholders, and the fall continues. Both approaches have worked well for many years and during this time many mutual and exchange-traded funds have appeared, allowing them to take advantage of them.

 

At the same time, the last decade has been hard for both types of investors and the value approach shows the worst results since 1926. The most difficult was the period from 2007 to 2016, but the recent rally against the background of the American presidential elections straightened the situation slightly.

 

Kouchner’s research explains this phenomenon. The value approach brought low profitability because investors missed a sharp increase in the ratings of large growing companies, including in the technology sector. The speculative approach was relatively successful, but the recovery rate after 2009 worked against this kind of investors and several sharp reversals of the market did the job.

 

If we really live in a world of growing stocks — an example of a high-tech company — then the value strategy, which involves buying undervalued assets, does not work.

 

There is no reason to think that the psychology of market participants has really changed dramatically – both investors and speculators are probably still overpaying for the winners and irrationally underestimate the losers, so sooner or later the reality will win and the value of the company will again become a source of income.

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