Trying to speculate when stocks will rise and what will make them fall dangerous

By DAVID MOON, Moon Capital Management
October 20, 2002

With concerns about terrorism and the fear of many public places, many Americans cancelled or changed summer vacation plans. The still weak state of the economy convinced others to stay close to home. Theme parks and other attendance based vacation destinations felt the leeriness of the summer vacationer.

But the real reason is simple. Who needs to go to Six Flags for roller coaster rides when you can stay at home and ride the stock market? Like the long slow initial ascent of an amusement park roller coaster, the stock market spent most of the last 20 years (almost mechanically) climbing to a peak. At a roller coaster's summit, the drive chain releases the cars and the competing forces of friction and gravity tosses, turns and flips the train throughout the rest of the ride.

Such seems the stock market these days.

After declining 24.24 percent in the first nine months of the year, the Dow Jones Industrial Average increased almost 1,000 points, or more than ten percent, in only four days. A little bit of good news from Johnson and Johnson goes a long way.

But we also saw this type of rebound in July - only to reach another short-term peak and begin an August-September downward spiral that would rival the Cyclone at King's Island.

Gravity is not the driving force behind the stock market these days, although, at times, it seems that way. Investors, managers, corporate executives and barbers all have plenty of theories. The fear of war. The economy. The president. The Vols. Corporate earnings. Scandals. Fear of inflation. Fear of deflation. Fear of Martha Stewart.

But none of these factors alone can explain a NASDAQ that declined almost 80 percent from its highest level less than three years ago.

There are two sets of forces on stock prices: a long-term force and a short-term force. In the long-term, stock prices are driven by boring fundamental factors like the earnings of the specific companies in the stock market. Balance sheets. Assets. Market share. Profitability. These are the items that determine the long-term movement of an individual company's stock price.

But in the short term, prices are determined by supply and demand. Why did stock prices stage a four day rally last week? Because the quantity demanded of the specific companies comprising the Dow Jones Industrial Average exceeded the quantity of stock supplied by sellers. There were simply more buyers than sellers. The buyers were influenced by a host of factors. CNBC reports. Sniper stories. The thought of Martha Stewart in cold, steel cuffs (without the lace or matching home-made corsage) doing the perp walk. But on Tuesday, when Johnson and Johnson announced a 19 percent increase in earnings, what impact did that piece of information have on the underlying value of Coca-Cola? None. But Coke stock increased in common euphoria with the Johnson and Johnson news. It made no logical sense.

That is the risk in trying to predict short term movements in stock prices; they make no logical sense. So many investors want to be in stocks when they are going up and out of stocks when they are going down. Sounds good in theory. The only problem is that there is no way to predict "when stock prices are going up," except after the fact. What most people end up doing is buying stocks only after they have gone up - and then selling after they decline. They are constantly fighting the last war.

Look back over the last six months. Every measure of broad US stock market performance declined more than 15 percent. Growth stocks. Value stocks. Small companies. Large companies. Utility companies. Autos. Semiconductors. There was no place to hide. In hindsight, what would you have done differently this year? If your money was in a money market fund, it would have earned only slightly more than being in a shoe box in the garage. But, at least it would not have declined in value.

But shoe box investing isn't investing at all. It is merely a form of speculation: speculating that stock prices are going to decline in the near future. But we have already concluded that, in the short term, stock prices react to a variety of unpredictable factors, most of them unrelated to the value of the underlying business. And recent experience shows us that speculation is a mighty dangerous game.

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

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