I have a red hot stock tip for you that I'm going to give you by the end of this post. But...first, I want to give you a little background on how I came up with this tip.

I was reading a few interesting articles by Aaron Pressman over at businessweek.com. Apparently, James Montier has a blog. I know, I know. Who's James Montier? Well, he's an economist and the former global equity strategist at Dresdner Kleinwort Wasserstein.

*crickets*

OK, OK, probably not the most interesting story so far, but stay with me, I do have a point to make. The reason I thought that that was interesting is because a lot of the money for the financed planning (leveraged financial planning) I do comes from Dresdner. So...at the advice of Pressman, I read some of Montier's stuff. It's probably a good thing he's a former strategist because after reading his theory about psychology applied to investing I have to admit I think he's a bit off...way off actually...on his assumptions. Montier insists that:

...there is an enormous amount of evidence to suggest that we simply can't forecast [the market] with any more accuracy than a coin toss...One of the papers that didn't make it into the Behavioural Investing book (but with hindsight perhaps should have been added in) was on the performance of economists in forecasting recession. In it I pointed that economists are simply hopeless when it comes to forecasting recessions (I could have stopped that sentance before the word recessions).

One reason Montier is kinda wrong: Warren Buffet. Even though Buffet can't predict exact stock prices or how much money he'd have over the next 20 years (provided he can live that long), Buffet's accomplishments do speak to the idea that forecasting is still possible to some extent. But that's not all, Ben Steverman of Businessweek also had a few keen insights on investing, particularly in oil. He notes, and I think this is hilarious, that:

S&P’s MarketScope quoted one trader saying: “There is a strong uptrend in this market and prices won’t come down until that trend is broken.”

That's right folks, the price of oil will keep going up until it starts to come down. I'm glad Wall Street has that covered.

Whether you are talking about an overall investment philosophy, or specific investments - whether it's oil or Amazon's Kindle ebook reader - you need to be very careful about whom you trust. Investing is serious business. There are a lot of "gurus" out on the web who aren't really gurus at all.

Sure, they offer "hot" stock tips and trading advice, and some of the plays actually pan out. At least if you believe the sales literature.  But there is a real problem with "hot" stock tips:

There is no such thing as a hot stock tip

That's right, there is no such thing as a hot stock tip, and by hot stock tip I mean "a tip about a company that will give you special information about a company that no one else has." The reason for this should be obvious: Insider Trading laws prevent you or anyone else from having a legal edge over anyone else in the market. Unfortunate and unjust as this is, it's the law.

For a stock tip to be "hot," you would need special information, but where is the only place you are going to get special information? An insider. If you are trading on information that you received from an insider, you run the risk of going to jail. If the stock tip you received didn't come from an insider, then: 1) there is nothing "hot" about the stock; and 2) there's nothing special about the information. It is not a "hot tip."

That doesn't mean though, as  James Montier suggests, that markets can't be forecast. On the contrary. The entire idea of value investing is based on the idea that some companies are undervalued. If you can pick those undervalued companies, they should - at some point in the future - rise in price. That is, essentially, predicting the future movement of a stock based on whether all of the information about a company's stock is represented in the price. You don't need to know the exact future value as long as you get it right in a general sense. So, the question is: does value investing work? Well, is Warren Buffet rich? You tell me.

So, I guess it really depends on the definitions you are relying on when you talk about "forecasting," "stock tips," and so on. So yes, you can intelligently forecast the market, but forecasting doesn't mean "predicting the future" in the popular sense (knowing with 100% certainty what will happen and when).

Here's a real stock tip: Investing properly by analyzing a company's fundamentals gives you an idea about how valuable a company is. But, by relying on the fundamentals, you want to make sure that there is a clear connection between the company and the management. For example, when the management has no interest in the company (the management doesn't own any stock in the company), it can create a situation where the value of the company is divorced from the price of the stock.

This is, I believe, where you see anomalies in stock prices where the fundamentals say the company ought to be doing well, but it isn't. It's not all about quantitative analysis. Some of this forecasting stuff (a lot of it, actually) is qualitative, I think.

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This entry was posted on December 31st, 2011 by David C Lewis, RFC. Edits may have been made to keep this entry current. · No Comments · Investing, Philosophy In Financial Planning