Preparation for any exam is somewhat of an art and people use different techniques. Still, we know that hard work is the key to success. Also, there are some methods which work better than others. I just wanted to mention some of the techniques which I followed during the last 30 days or so in all the 3 levels of the exam. Hopefully these will help everyone.
General Tips for last 1 month
Mock Exams
• I usually used the final month to give 3-4 mock exams in the first 15-20 days or so. After every exam, I put in my scores in an excel sheet to see topic wise scores.
• While giving the exam I usually marked the questions which I found difficult and the questions which I just answered on guess work.
• Next, I identified my mistakes by looking at the correct answers for not only the mistakes but those I got correct through guesswork. When I was unable to understand the answer, I went back to the text book.
• When I scored poorly on a topic I revised that topic and then went for the next mock exam. I repeated the same thing for the next exams but also observed whether my scores are improving or not overall and my weaker segments. Usually I put a lot of emphasis on my ethics score.
Revision
• In the last 10-15 days I usually went for a revision of the whole syllabus. Usually I went LOS by LOS. The objective was to see whether I could understand the concept crystal clearly for all the LOS. Once a LOS was mastered I crossed it out.
• I constantly revised the formulas. I usually made my own formula sheet and used to carry it wherever I went.
Things not to be missed
• Make sure you have done ALL the end of chapter (EOC) questions from the original book. I would suggest that people do not waste time on questions from Schweser as real exam is very different from Schweser questions. If you have completed everything else and still have time then do Schweser exams.
• Some of the EOCs are quite complicated. I usually marked them to review them over and over again until I mastered them.
• Go through all the blue box examples from original book.
Planning for the 30 days
• I used to make a 30 day plan specifying what I will revise or read in the last 30 days. Sometimes I fell behind my plan due to family obligations or work pressure but by studying more on other days I used to cover it up.
• Normally I suggest that people try to beat their own plan and stay ahead.
Notes
• Some people make their own notes. I usually only made notes for the most critical chapters. However, notes are supposed to be made 3-4 months before exam. Trying to make notes at the last moment is not advisable as it will eat away time.
• If however you already have own notes then instead of reading the book you can just read your notes (depends on the depth of the notes).
Day before the exam
• This day is very important. Confidence level is as important as the preparation itself. To cool the nerves remember that you have studied hard and given your best shot. After this it does not matter whether you pass or fail.
• Try to go to sleep early. I had insomnia problems on this day on almost all three levels and as a result on the exam day I felt weak. If you see any such problems take a sleeping pill on the night before the exam.
• Check your admit card, pencils, eraser, pen, passport, calculator. Check your calculator settings and go through the important functions in your calculator. If you can borrow an extra calculator then borrow one for emergency purpose. Also carry batteries and screwdriver.
• Go through the formula sheet quickly. See if you correctly remember the notations and symbols used in the formula.
Exam day
• Wake up early in the morning and take a shower. Go to the venue as early as possible. Do not try to study just before the exam. You can off course take a look at the formulas.
• When the exam starts, go to your favorite topic and start answering. THERE IS ONE GOLDEN RULE I FOLLOWED. IF I COULD NOT ANSWER A QUESTION ON THE FIRST ATTEMPT I SKIPPED IT. I GOT BACK TO THEM LATER ON. Please do not waste time on any questions. All questions carry the same marks. However some of them can make you lose a lot of valuable time. TIME MANAGEMENT IS ESSENTIAL IN ALL 3 levels.
• Read all the questions carefully and understand what is being asked. The worst thing that can happen is failing due to silly mistakes.
• If the AM session feels exceedingly hard do not lose hope. In that case PM will be easier. I remember coming out of the Level 2 AM session with the feeling that I will surely fail. However the PM was much easier and I actually scored >70% in 9 segments and between 50-70 in 1 segment.
• While filling out answer boxes please make sure you are answering the correct question. A mistake in answering sequence could change your grade absolutely.
• Even if you have finished the exam with 1 hour extra please recheck all the answers.
• Fill out answers for each and every question as there is no negative marking.
Level 1
• In level 1 you just need to go through the entire syllabus. The actual exam is usually quite easy and has more focus on theoretical questions. The quantitative questions are also quite simple.
• Normally, you would not even have to think for many of the questions. Also, some of the quantitative questions can be answered without even calculating anything.
• Focus on the ethics segment which is very crucial.
• Overall you can expect to finish both AM and PM within 2.5 hrs. But like I mentioned earlier, please use the whole time and recheck.
Level 2
• Level 2 has the largest syllabus, highest number of formulas and much tougher study material compared to level 1.
• Even though the focus is on asset valuation and FSA, I found derivatives to be quite complicated. In fact, I probably had to read the derivatives chapter 3-4 times to get the basic essence of it. In spite of that, I found the actual derivative questions to be exceedingly difficult.
• Unlike level 1, the portion of quantitative questions is larger. Also the questions are not that straight forward. CFAI throws some curveballs from time to time. After reading a particular vignette the questions might look absolutely alien to you. Use your common sense in answering in those times.
• Put strong emphasis on formulas. Also notice whether questions states annual, quarterly or monthly compounding etc. These can be tricky while doing Swaps, Forward Rate Arrangements etc.
Level 3
• Level 3 syllabus is slightly smaller than level 2. It is not as difficult as level 2 to understand but the trick is to apply the knowledge in the actual exam.
• To pass level 3 the candidate must know the concepts like the back of his/her hand. Even the simplest topic can be made very difficult by structuring the question in an obscure manner.
• The key to succeeding in level 3 largely depends on managing time for the AM (written) section. I would recommend that candidates practice as many AM sessions as possible. CFAI website has a lot of such practice exams.
• Just because AM was difficult do not expect PM to be much easier. Some questions had a lot of curveballs which many candidates did not even realize existed. However it is easier to score more in the PM compared to the AM section.
Final Words
Give your best shot and study as hard as possible. However, success or failure also has a bit of luck in it. However know that you can pretty much pass if you get 70% on average. So even if you get 50% of the questions right, eliminate one wrong answer on 25% of the questions and blindly guess the rest 25% you can score about 70.75% statistically. Also the pass marks for level 3 is definitely set at a lower level.
Showing posts with label Bangladesh. Show all posts
Showing posts with label Bangladesh. Show all posts
Saturday, May 5, 2012
Saturday, March 5, 2011
Whose money are we spending?
As per statistics the Bangladesh economy has been growing at a rate of 6% (Real) on average per year. Even though statistics are always a debatable issue it seems from indicators of people’s new found affluence and wealth that real incomes have indeed grown by 6% (or even more).
With rising incomes (on an aggregate basis) we are also seeing other factors coming up. One is the rise of “consumerism” and the other is “increasing inequality”. Let us talk about the former first. To prove this I do not need to work very hard. The signs are everywhere. Even though car taxes have been increased significantly I do not see any slowdown in car sales. Apartment prices have increased but sales did not slow down. Expensive tickets of dance shows that feature foreign artists are “sold out” instantly. How are people affording these things despite the high prices attached? The answer is very simple. These consumers represent a small portion of the population having a large portion of the wealth. It does not really matter to them whether prices have doubled or quadrupled. They can afford it.
On the contrary there is this other group (which off course represents the vast majority of the population) who are having a hard time to simply gather food and lodging. As per ILO’s Global Wage Report 2010/2011 the real average monthly minimum wage in Bangladesh has been on the slide, although its annual rate of fall had increased from -7.2 per cent in 2008 to -5.7 per cent in 2009. These people are seeing their purchasing power and living standards fall continuously.
I don’t think it requires any explanation to show that the rich are actually getting richer because of the sacrifices of the vast majority of the country’s people which includes the minimum wage workers, remittance earners and the farmers. Problem is GDP growth through inequality does not help the country but rather helps a particular group of people. Both governance systems as well as religious systems have acknowledged this issue and had tried to find ways to solve inequality. Governments try to do it by taxing the rich and providing safety nets for the poor. Religions (like Islam for e.g.) have a system of ‘Zakat’ and ‘Fitra’ which ensures that inequality is reduced. Unfortunately, most of us neither pay taxes properly nor pay ‘Zakat’ properly. Furthermore, because of corruption the tax that is paid by honest tax payers are also not utilized properly and thus these groups are being deprived even more.
A person like me can go out and spend my money as I wish thinking that it is my earnings. But when I look closely I need to remember that while economy is growing some people are being worse off. This indirectly suggests that there are people whose efforts led to my increased wealth.
The case becomes even stronger when we think of imported goods. When people become rich somehow they start wanting goods of higher quality and status (basically I am talking about imported goods). Let me use the example of a luxury car which people are buying even after paying 600% tax. Apart from the duty the actual import cost is paid in dollars. Thing is the importing consumer did not earn the foreign currency. “It is our migrant workers working and toiling away in far away countries away from their families (and presently risking their lives) who earned it”. You might say that we do earn foreign currency through exports but please remember that we have a trade deficit. Along with export earnings we do have associated import costs of raw materials and capital machinery. So, imported goods are bought using the migrant workers toils. Now tell me whether we give these guys their due respect for working so hard and being one of the major growth factors of our country. We don’t. Instead they are harassed, cheated and deprived.
Its now time to ask ourselves the very basic question “whose money are we spending?”. Relying on our government to reduce inequality is going to be futile. We ourselves have to find out ways to help solve this problem. I do not have a solution right now but I am going to try to find ways. Inequality harms the long term growth prospect of countries. This has been realized by the second largest (and fastest growing) economy in the world. China has already decided that they will lower growth expectations for 2011-2015 to 7% from their current double digit growth rates and instead focus on equality. Instead of focusing on exports they want to go for internal demand lead growth, which is only going to be possible by reducing the rich poor gap. Given the current state of the global economies where we are seeing shocks after shocks, as well as inevitable fiscal austerity programs (Europe started it already while US will go for it from 2013) this is probably the right way Bangladesh should move towards.
Please share article if you have liked it.
With rising incomes (on an aggregate basis) we are also seeing other factors coming up. One is the rise of “consumerism” and the other is “increasing inequality”. Let us talk about the former first. To prove this I do not need to work very hard. The signs are everywhere. Even though car taxes have been increased significantly I do not see any slowdown in car sales. Apartment prices have increased but sales did not slow down. Expensive tickets of dance shows that feature foreign artists are “sold out” instantly. How are people affording these things despite the high prices attached? The answer is very simple. These consumers represent a small portion of the population having a large portion of the wealth. It does not really matter to them whether prices have doubled or quadrupled. They can afford it.
On the contrary there is this other group (which off course represents the vast majority of the population) who are having a hard time to simply gather food and lodging. As per ILO’s Global Wage Report 2010/2011 the real average monthly minimum wage in Bangladesh has been on the slide, although its annual rate of fall had increased from -7.2 per cent in 2008 to -5.7 per cent in 2009. These people are seeing their purchasing power and living standards fall continuously.
I don’t think it requires any explanation to show that the rich are actually getting richer because of the sacrifices of the vast majority of the country’s people which includes the minimum wage workers, remittance earners and the farmers. Problem is GDP growth through inequality does not help the country but rather helps a particular group of people. Both governance systems as well as religious systems have acknowledged this issue and had tried to find ways to solve inequality. Governments try to do it by taxing the rich and providing safety nets for the poor. Religions (like Islam for e.g.) have a system of ‘Zakat’ and ‘Fitra’ which ensures that inequality is reduced. Unfortunately, most of us neither pay taxes properly nor pay ‘Zakat’ properly. Furthermore, because of corruption the tax that is paid by honest tax payers are also not utilized properly and thus these groups are being deprived even more.
A person like me can go out and spend my money as I wish thinking that it is my earnings. But when I look closely I need to remember that while economy is growing some people are being worse off. This indirectly suggests that there are people whose efforts led to my increased wealth.
The case becomes even stronger when we think of imported goods. When people become rich somehow they start wanting goods of higher quality and status (basically I am talking about imported goods). Let me use the example of a luxury car which people are buying even after paying 600% tax. Apart from the duty the actual import cost is paid in dollars. Thing is the importing consumer did not earn the foreign currency. “It is our migrant workers working and toiling away in far away countries away from their families (and presently risking their lives) who earned it”. You might say that we do earn foreign currency through exports but please remember that we have a trade deficit. Along with export earnings we do have associated import costs of raw materials and capital machinery. So, imported goods are bought using the migrant workers toils. Now tell me whether we give these guys their due respect for working so hard and being one of the major growth factors of our country. We don’t. Instead they are harassed, cheated and deprived.
Its now time to ask ourselves the very basic question “whose money are we spending?”. Relying on our government to reduce inequality is going to be futile. We ourselves have to find out ways to help solve this problem. I do not have a solution right now but I am going to try to find ways. Inequality harms the long term growth prospect of countries. This has been realized by the second largest (and fastest growing) economy in the world. China has already decided that they will lower growth expectations for 2011-2015 to 7% from their current double digit growth rates and instead focus on equality. Instead of focusing on exports they want to go for internal demand lead growth, which is only going to be possible by reducing the rich poor gap. Given the current state of the global economies where we are seeing shocks after shocks, as well as inevitable fiscal austerity programs (Europe started it already while US will go for it from 2013) this is probably the right way Bangladesh should move towards.
Please share article if you have liked it.
Monday, February 21, 2011
Where did all the money go?
Disclosure: The article was written on Thursday, January 13, 2011 at 10:47pm. It reflects the writer's personal opinions based on own analysis. The writer is not responsible for decisions taken on the basis of this article. Send your views at kh.asif@gmail.com.
Recently the drastic fall in the stock index made headlines and became a much talked about issue. A large amount of blame was put on the stock market regulator and the government. However, the biggest blame was on the Bangladesh Bank which decided to increase the Cash Reserve Ratio from 5.5% to 6%. According to financial market “experts”, the increase in CRR caused a liquidity crisis in the money market which ultimately led to the stock market sale pressure (which off course led to panic sale).
Without going into all these arguments about who is to blame I would rather focus on the money market situation. As per newspaper reports, because of the hike in CRR the central bank took out BDT 2,000 crore from the system. A similar amount was brought out through issue of government securities. However, the Bangladesh Bank claimed that they had injected more than 20,000 crore to the system through repo financing. So in simple math (20,000-2,000-2,000=16,000).
If 16,000 crore (net) has been added to the system then definitely the fund crisis that banks and other financial institutions were in should have been resolved. The funny thing is that the crisis is not over. Even though the call money rates have come down, most financial institutions are still in a fund crisis. This is EXACTLY why stock brokerages and merchant banks are unable to give margin loans to their clients. If banks dont have money, then brokers and merchant banks also do not have money. If the brokers and merchant banks actually had money they would have definitely given out loans because that is how they make profit. Unfortunately neither the media understands this nor does the retail investors. While one segment is busy breaking offices the other is adding fuel to the fire by making illogical media reports. At the same time the SEC increased the margin loan ratio from 1:1.5 to 1:2 in a period when most brokers can’t even provide 1:0.6. What I don’t further understand is, in such a volatile (and off course highly overvalued market) why the hell would someone need additional margin loan? I guess the general investors know more about stocks than me, so I will leave it to that.
Now there has to be a reason why the liquidity crunch has not been resolved in spite of BB injecting more funds, banks increasing deposit rates (to attract more deposits), financial institutions liquidating part of their portfolio etc. At first I thought that maybe the CRR hike led to a reverse multiplier effect on the money supply. The mistake in this logic was that it would actually take some time for the reverse to occur and off course the magnitude would not be as big as I thought (pointed out by my colleague Ali bhai).
Now what happened in reality (this is still a hypothesis) was that we were seeing rapid increase in imports (in a period when remittance growth was negative). For quite some time, the banks were using deferred LC’s to finance these imports. This meant that they were only buying the dollars when they had to pay the money (not at the time of opening these LC’s). As expected Bangladesh Bank intervened and stopped them from creating deferred LC’s. Now, while opening LC’s the banks had to buy dollars using BDT. So supply of BDT was automatically decreasing from the financial system. Now let us again look at some numbers for the period between July-Nov 2010.
Exports Receipts (BDT 57,925 crores), Import Payments (BDT 66,871 crores), Remittances (BDT 32,067 crores), Fresh Lc opening (BDT 87,472 crores)
The key number here is the fresh LC opening which is much greater than all the other figures. Moreover, when banks suddenly have to make payments for the deferred Lc’s a substantial amount of BDT has to go out of the system to buy dollars. Further proof of this hypothesis is evident since dollar is getting stronger against the BDT.
I agree with the view of the BB governor who believes that 160 mn people cannot suffer because of the greed of few stock market investors. With inflation inching up, the prudent step (debatable according to some people) by the central bank was probably tightening of the monetary policy. Then again, if that is the case then BB should probably stop saying that there is adequate liquidity. The truth is that the liquidity shortage still exists. Because of this if real sector investors are deprived of financing then the ultimate loser will be the country.
Please share article if you have liked it.
Recently the drastic fall in the stock index made headlines and became a much talked about issue. A large amount of blame was put on the stock market regulator and the government. However, the biggest blame was on the Bangladesh Bank which decided to increase the Cash Reserve Ratio from 5.5% to 6%. According to financial market “experts”, the increase in CRR caused a liquidity crisis in the money market which ultimately led to the stock market sale pressure (which off course led to panic sale).
Without going into all these arguments about who is to blame I would rather focus on the money market situation. As per newspaper reports, because of the hike in CRR the central bank took out BDT 2,000 crore from the system. A similar amount was brought out through issue of government securities. However, the Bangladesh Bank claimed that they had injected more than 20,000 crore to the system through repo financing. So in simple math (20,000-2,000-2,000=16,000).
If 16,000 crore (net) has been added to the system then definitely the fund crisis that banks and other financial institutions were in should have been resolved. The funny thing is that the crisis is not over. Even though the call money rates have come down, most financial institutions are still in a fund crisis. This is EXACTLY why stock brokerages and merchant banks are unable to give margin loans to their clients. If banks dont have money, then brokers and merchant banks also do not have money. If the brokers and merchant banks actually had money they would have definitely given out loans because that is how they make profit. Unfortunately neither the media understands this nor does the retail investors. While one segment is busy breaking offices the other is adding fuel to the fire by making illogical media reports. At the same time the SEC increased the margin loan ratio from 1:1.5 to 1:2 in a period when most brokers can’t even provide 1:0.6. What I don’t further understand is, in such a volatile (and off course highly overvalued market) why the hell would someone need additional margin loan? I guess the general investors know more about stocks than me, so I will leave it to that.
Now there has to be a reason why the liquidity crunch has not been resolved in spite of BB injecting more funds, banks increasing deposit rates (to attract more deposits), financial institutions liquidating part of their portfolio etc. At first I thought that maybe the CRR hike led to a reverse multiplier effect on the money supply. The mistake in this logic was that it would actually take some time for the reverse to occur and off course the magnitude would not be as big as I thought (pointed out by my colleague Ali bhai).
Now what happened in reality (this is still a hypothesis) was that we were seeing rapid increase in imports (in a period when remittance growth was negative). For quite some time, the banks were using deferred LC’s to finance these imports. This meant that they were only buying the dollars when they had to pay the money (not at the time of opening these LC’s). As expected Bangladesh Bank intervened and stopped them from creating deferred LC’s. Now, while opening LC’s the banks had to buy dollars using BDT. So supply of BDT was automatically decreasing from the financial system. Now let us again look at some numbers for the period between July-Nov 2010.
Exports Receipts (BDT 57,925 crores), Import Payments (BDT 66,871 crores), Remittances (BDT 32,067 crores), Fresh Lc opening (BDT 87,472 crores)
The key number here is the fresh LC opening which is much greater than all the other figures. Moreover, when banks suddenly have to make payments for the deferred Lc’s a substantial amount of BDT has to go out of the system to buy dollars. Further proof of this hypothesis is evident since dollar is getting stronger against the BDT.
I agree with the view of the BB governor who believes that 160 mn people cannot suffer because of the greed of few stock market investors. With inflation inching up, the prudent step (debatable according to some people) by the central bank was probably tightening of the monetary policy. Then again, if that is the case then BB should probably stop saying that there is adequate liquidity. The truth is that the liquidity shortage still exists. Because of this if real sector investors are deprived of financing then the ultimate loser will be the country.
Please share article if you have liked it.
Since I made a 100% return this year I must be the next Warren Buffet? Sorry wrong number
Disclosure: The article was first written on Sunday, November 21, 2010 at 11:45pm. It reflects the writer's personal opinions based on own analysis. The writer is not responsible for decisions taken on the basis of this article. Send your views at kh.asif@gmail.com.
Why do we need stock indices?
Have you ever wondered why we need a stock index? It took me quite a while to understand what a stock index is and why we need it. Everyday a number of stocks go up and a number of stocks go down. The index is a mathematical calculation used to understand whether the market as a whole went up or went down. The popular indices that we have in Bangladesh (DGEN DSI) are “market capitalization” weighted indices which means that they put more importance to the price movement of larger companies rather than smaller ones. This is exactly why you see the index move by a greater amount when large caps like Grameenphone or the “banking sector” moves.
The index gives us a benchmark to compare our returns with the market returns. For example if I say that I made a 100% returns in 2010, it might sound super impressive. But given the fact that all stocks on average increased by close to 100% in 2010 it sounds quite normal because I barely beat the market. Furthermore, the additional information that corporate earnings would probably increase by a maximum of 25% makes the situation even riskier.
The conclusion from the above discussion is that I can only be considered a good fund manager/investor if I can consistently get a return above the market indices. Now comes the bad part. The indices that are available to us (DGEN, DSI etc) are absolutely incorrectly calculated. So, there is no way we can compare performances. Until and unless the calculation is corrected, we cannot compare our performances.
Stock market cycles and long term average returns
Whatever I write I tend to come back to macroeconomics somehow. The economy usually moves in cycles. So sometimes you have a situation when the economy is growing strongly, unemployment is low, inflation starts picking up etc (so Interest rates also start rising). Then we also have the other extreme when the economy is in a recession, unemployment is high, prices start falling (deflation) and interest rates are low. In between there are transition periods.
Similar to economic cycles, stock markets also move on cycles. Usually we see stock market cycles move in a similar pattern to the economic cycles but it is not necessary that this will happen every time. During periods of bull runs the investors are highly optimistic and are willing to pay a high price for shares and hence the market P/E ratios are high. The strong faith in the market brings stock prices to such a high level that is far beyond their stocks “intrinsic value” (true value). So naturally the next phase is the bearish one when stock prices steadily fall and the panic button starts ringing causing investors to sell shares even at high losses. So suddenly, despite the blind faith in the market the investors lose a lot of money causing their confidence in the market to fall down to tatters. This is the period when market volume falls to extremely low levels and most stocks trade at bargain prices. It usually takes quite some time for the confidence in the market to come back.
The reason I took so much time to explain these cycles is to explain that ultimately capital market performances are driven by macroeconomic performance. When the macro economy performs well, the corporate earnings improve and thus stock prices increase. However, there should be some sort of uniformity between these variables. Many a time stock prices move far ahead of earnings (like in 2010 stock prices in Bangladesh increased by around 90% while earnings growth would be around 20-25%) which is why we see some sort of correction (I am referring to fall in stock prices).
The interesting thing that we notice is that stock markets tend to overreact on both positive and negative news. When earnings were growing 20-25% stock prices grew 90% and when the correction should have been 10-15% they might fall by 20-25% or even more.
The part which most people overlook is that, if you take a 5-10 year period the average return you get should more or less be similar to the growth of earnings. I have used some dummy numbers to show the stock market returns for 5 years over two different scenarios.
Scenario 1 (Prices moving ahead of fundamentals and then subsequent correction):
65%, 100%, -30%, 0%, 10%.
Scenario 2 (Steady and stable increase in price and earnings):
20%, 20%, 20%, 20%, 20%.
You might be surprised (Some of you may not though) that the returns under both these situations are identical at the end of the fifth year. However, under scenario 1, there are many other adverse impacts. I can think of a couple of them at the moment
1.People might lose faith in the stock market for a prolonged period of time. We saw that after the 1996 stock market crash in Bangladesh.
2.Equity financing will become less attractive because they will get lower price for their shares (far below true value).
All of this suggests that a steady and sustainable growth in stock prices backed by “core” earnings growth is much better compared to a boom and bust. But reality is that the world is not a textbook full of theories but a place where people’s emotions have more (probably way more) importance than rationality and logic. So, we will continue to experience such ups and downs in the stock market. And in such a market to judge our performance we should not look at absolute returns but compare our returns with the broad market index.
Please share article if you have liked it.
Why do we need stock indices?
Have you ever wondered why we need a stock index? It took me quite a while to understand what a stock index is and why we need it. Everyday a number of stocks go up and a number of stocks go down. The index is a mathematical calculation used to understand whether the market as a whole went up or went down. The popular indices that we have in Bangladesh (DGEN DSI) are “market capitalization” weighted indices which means that they put more importance to the price movement of larger companies rather than smaller ones. This is exactly why you see the index move by a greater amount when large caps like Grameenphone or the “banking sector” moves.
The index gives us a benchmark to compare our returns with the market returns. For example if I say that I made a 100% returns in 2010, it might sound super impressive. But given the fact that all stocks on average increased by close to 100% in 2010 it sounds quite normal because I barely beat the market. Furthermore, the additional information that corporate earnings would probably increase by a maximum of 25% makes the situation even riskier.
The conclusion from the above discussion is that I can only be considered a good fund manager/investor if I can consistently get a return above the market indices. Now comes the bad part. The indices that are available to us (DGEN, DSI etc) are absolutely incorrectly calculated. So, there is no way we can compare performances. Until and unless the calculation is corrected, we cannot compare our performances.
Stock market cycles and long term average returns
Whatever I write I tend to come back to macroeconomics somehow. The economy usually moves in cycles. So sometimes you have a situation when the economy is growing strongly, unemployment is low, inflation starts picking up etc (so Interest rates also start rising). Then we also have the other extreme when the economy is in a recession, unemployment is high, prices start falling (deflation) and interest rates are low. In between there are transition periods.
Similar to economic cycles, stock markets also move on cycles. Usually we see stock market cycles move in a similar pattern to the economic cycles but it is not necessary that this will happen every time. During periods of bull runs the investors are highly optimistic and are willing to pay a high price for shares and hence the market P/E ratios are high. The strong faith in the market brings stock prices to such a high level that is far beyond their stocks “intrinsic value” (true value). So naturally the next phase is the bearish one when stock prices steadily fall and the panic button starts ringing causing investors to sell shares even at high losses. So suddenly, despite the blind faith in the market the investors lose a lot of money causing their confidence in the market to fall down to tatters. This is the period when market volume falls to extremely low levels and most stocks trade at bargain prices. It usually takes quite some time for the confidence in the market to come back.
The reason I took so much time to explain these cycles is to explain that ultimately capital market performances are driven by macroeconomic performance. When the macro economy performs well, the corporate earnings improve and thus stock prices increase. However, there should be some sort of uniformity between these variables. Many a time stock prices move far ahead of earnings (like in 2010 stock prices in Bangladesh increased by around 90% while earnings growth would be around 20-25%) which is why we see some sort of correction (I am referring to fall in stock prices).
The interesting thing that we notice is that stock markets tend to overreact on both positive and negative news. When earnings were growing 20-25% stock prices grew 90% and when the correction should have been 10-15% they might fall by 20-25% or even more.
The part which most people overlook is that, if you take a 5-10 year period the average return you get should more or less be similar to the growth of earnings. I have used some dummy numbers to show the stock market returns for 5 years over two different scenarios.
Scenario 1 (Prices moving ahead of fundamentals and then subsequent correction):
65%, 100%, -30%, 0%, 10%.
Scenario 2 (Steady and stable increase in price and earnings):
20%, 20%, 20%, 20%, 20%.
You might be surprised (Some of you may not though) that the returns under both these situations are identical at the end of the fifth year. However, under scenario 1, there are many other adverse impacts. I can think of a couple of them at the moment
1.People might lose faith in the stock market for a prolonged period of time. We saw that after the 1996 stock market crash in Bangladesh.
2.Equity financing will become less attractive because they will get lower price for their shares (far below true value).
All of this suggests that a steady and sustainable growth in stock prices backed by “core” earnings growth is much better compared to a boom and bust. But reality is that the world is not a textbook full of theories but a place where people’s emotions have more (probably way more) importance than rationality and logic. So, we will continue to experience such ups and downs in the stock market. And in such a market to judge our performance we should not look at absolute returns but compare our returns with the broad market index.
Please share article if you have liked it.
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