more on discounting

In actual practice, judging what the market has already discounted in the price of an individual stock or the prices of stocks in general, is a tricky thing.  Even seasoned professionals are often wrong.

There are trends in overall market direction that are relatively easy to spot.  In a bull market, investors tend to ignore bad news and respond strongly to good.  In bear markets, the opposite happens.

Perhaps the main reason for professionals that technical analysis is more than a curious practice of a more primitive time is that watching for deviations from the usual daily price action of individual stocks can give clues to what other investors are thinking/doing.  Rises on unusually high volume, for example, can suggest that others are figuring out what you already know and have acted on.  On the other hand, failure of the stock to react positively to news that supports your positive thesis suggests that what you thought was a new, investable insight actually wasn’t.

The reality that investors only act piecemeal, or the idea that we act differently when infused with greed than when in the vise grip of fear are both much too untidy for the statisticians who formulated the Efficient Market Hypothesis/Capital Asset Pricing Model that arose in the 1970s (and which–mind-bogglingly–is still taught in business schools).

These theories have no place for observation/practical experience.  They assume that everyone has the same information and that the market factors new information into prices instantaneously.  What’s particularly ironic is that they were formed during the early 1970s.  How so?

–1972 was the peak of the “Nifty Fifty” or “One-Decision Stocks” speculation.  Investors believed that a small number of stocks–Kodak, Xerox, National Lead, for example–would grow rapidly forever.  Therefore, they should never be sold, and no price was to high to pay to acquire them.  The result was that this group of names traded at as high as 110x earnings–in an environment where the 10-year Treasury yielded 6% and the average stock traded at 11x.

–this high was immediately followed by a vicious bear market in 1973-74 that saw stocks trade in mid-1974 at discounts to net cash on the balance sheet–and still go down every day, on the theory that money in the hands of management scoundrels wasn’t worth 100 cents on the dollar.

How is it that these guys didn’t notice?

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