Fool's Eye View

[ February 1, 2000 ]

Switch Off The Noise!

By Maynard Paton (TMFMayn)

Carburton Street, London -- As no doubt others who suffer the daily grind of the British rail network can confirm, when leading the life of a London commuter, time is precious. With this in mind, I've found the time spent on my own personal investment portfolio has become limited.

So, to increase the time I spend on my own investments, I'm quickly adapting a new research technique. Basically, it is to avoid reading the "market noise". In the world of investment, the professional and private stock-picker is bombarded daily with "market information".

Fretting Over Interest Rates

Take the current worry over interest rates. We are told that interest rates may go up very soon, and fears of a rate hike have propelled the stock market downwards ever since the New Year. Interest rates, and hence the gilt market, are indeed important for the stock market investor. The risk free return from government bonds gives a benchmark towards the valuation and the profitability performance of any company. But I believe trying to accurately forecast interest rates is a futile exercise.

Here's one of my favourite interest rate quotations, taken from a research note produced by a very Wise broker in May 1999. The note covered PizzaExpress (LSE: PIZ). With the restaurant sector sensitive to a consumer spending downturn, a forecast on interest rates was a definite requirement.

"Interest rates -- Since last summer, UK interest rates have dropped considerably (from 7.5% in June 1998 to 5.25% in April 1999). Six consecutive interest rate cuts starting in October 1998 have been able to re-divert the downward trend and restore confidence. Our economists expect UK interest rates to decline to 4.5% by the end of 1999 and to 3.5% by the end of 2000".

Of course, interest rates have steadily risen from 5% last August to 5.75% today. Needless to say, I don't spend time reading comments from market commentators predicting any short, medium, or long term interest rate changes.

But the academic exercises that really waste so much time, both for the researcher and the reader, concern the stock market itself. There are usually two themes; what the stock market will do, and whether it is fairly valued.

What about the Market?

As we all know, predicting the stock market is a mug's game. Yet comment on the future of the stock market fills countless articles, especially at the beginning of each January.

Think about predicting the FTSE 100. The index consists of one hundred individual companies. All have differing prospects, sizes and valuations. In theory, to try to forecast the stock market as a whole, you would need to predict the share price movement of each index constituent, a movement based on the infinite possibilities of profit-valuation combinations. Then you would have to assimilate all the movements to form your estimated index value. It's all an impossible task.

So, with forecasting the market deemed a fruitless exercise, the overall value of the stock market becomes the attention of those commentators. Here, of course, slightly more rational reasoning can be applied.

For all the individual companies within the index, you can total all the market capitalisations, earnings and dividends, and calculate various valuations for the stock market as a whole.

Thus, you can compare today's market price to earnings (P/E) ratio valuation with that over the last twenty years. You can now declare that the P/E of the market is too high. Or perhaps, too low. Or maybe, just right.

Or instead, you can look at the market dividend yield, and compare it to current returns from gilts. How does that ratio compare to identical calculations performed ten years ago? Then you can throw in some subjective opinion about baby boomers, the disappearance of the state pension and new technology, to justify the opposite of your first conclusion. Much head-scratching is done in the pursuit of the fair value of the stock market as a whole.

Who Cares?

There may be something to all of these stock market forecasts, but I always say this when confronted with a "interest rates are on the rise" or a "stock market is undervalued" claim.

"Is anyone actually interested?"

Why? Because there are broadly two types of equity investor, both of which couldn't care less about the claims.

Firstly, there is the know-nothing investor (granted, slightly unkind terminology). This is the investor that doesn't yet have the knowledge, inclination, or courage to dabble direct with equities. He or she knows they should be investing long term in the stock market, but for whatever reason, declines to invest within individual companies.

Of course, the best course of action in this situation would be for the individual to invest through regular payments into a tracker fund. As Warren Buffett comments: "Paradoxically, when 'dumb' money acknowledges its limitations, it ceases to be dumb."

The investor whose sole stock market contact is through a tracker fund, investing with a long term horizon, cares not for the outlook on interest rates, the direction the stock market is expected to head next month, or whether the stock market gives fair value at the moment. Why should they?

Most investors falling into this category, by the very fact they have chosen a tracker fund rather than study investment in any detail, will spend little time reading the intricate academic theories about the stock market. And who can blame them?

Secondly, there is the know-something investor. This is the investor who does have the knowledge, inclination and courage to select and purchase individual company shares. So what are the usual criteria used to purchase shares in a company? It varies from person to person, but it mostly revolves around the company's type of business, its profits and assets, and its valuation.

If the know-something investor feels Vodafone AirTouch (LSE: VOD) has a great future ahead of it that is not reflected in the share price, then why should the investor consider the overall stock market -- that is, every other company and its valuation -- as well? And will it really matter what interest rates are next year, if the Vodafone shares are to be held for ten years?

To end, not only do I find myself ignoring comments on the "market noise", I'm increasingly wondering whether there are any Fools out there who actually do take any notice.

So, the really intriguing question is I'll leave you is this: why do the stock market pundits and the crystal ball gazers continue to spend a lot of time, effort and money producing haphazard results, when nobody is the slightest bit interested in reading what they have to say anyway?

If you know the answer, please let us know on the Fool's Eye View message board.