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The difference sentiment makes
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billywows
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14-Jan-2007 23:21
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Like this statement from below article: "But investors have to make sure that ultimately, there is a fundamental story behind a stock." |
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lg_6273
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14-Jan-2007 19:41
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The difference sentiment makes Changes in investor sentiment have different effects on different stocks By TEH HOOI LING SENIOR CORRESPONDENT, Published January 13, 2007 INVESTOR sentiment hasn't been this good for a long while. The stock market is into its fifth year of growth, and in the broader market, stocks have made their steepest climb in six months.  Obviously, improving sentiment has a positive effect on most stocks. But as many experienced market watchers will tell you, extremely bullish sentiment has the strongest effect on certain types of stocks. This is confirmed by empirical studies. For example, research by Malcolm Baker from Harvard Business School and Jeffrey Wurgler from NYU Stern School of Business found that when sentiment turns from low to high, returns are high on both extreme growth and distressed stocks. More stable stocks chalk up smaller returns. However, when sentiment turns from high to low, the reverse is true. One possible definition of investor sentiment is the propensity to speculate. Under this definition, sentiment drives the relative demand for speculative investments. Sentiment, if it continues to be positive, can carry stocks along a while more. But investors have to make sure that ultimately, there is a fundamental story behind a stock. So what makes certain stocks more vulnerable to broad shifts in the propensity to speculate? According to Baker and Wurgler, the main factor could be the subjectivity of their valuations. For instance, consider a young, unprofitable, extreme-growth-potential stock. 'The lack of an earnings history combined with the presence of apparently unlimited growth opportunities allows unsophisticated investors to defend, with equal plausibility, a wide spectrum of valuations, from much too low to much too high, as suits their sentiment. 'In a bubble period, when the propensity to speculate is apparently high, this profile of characteristics also allows investment bankers, or worse, swindlers, to further argue for the high end of valuations. 'By contrast, the value of a firm with a long earnings history and stable dividends is much less subjective, and so its stock is likely to be less affected by fluctuations in the propensity to speculate.' Anecdotal history of investor sentiment showed that young growth stocks are especially prone to bubbles and subsequent crashes - consistent with the observation that they tend to appeal to speculators and optimists. Examples are the 'new issue mania' which concentrated on new 'tronics' firms in the US in 1961 and came back to earth in 1962, the bubble in gambling issues in 1977 and 1978, biotech in 1980s, and of course the Internet bubble in the late 1990s. Proxy for sentiment So how do we measure investor sentiment? Baker and Wurgler used several measures - among them share turnover, number and average first-day returns on initial public offers, and equity share in new issues. Turnover, and more generally liquidity, can serve as a sentiment index. In a market with short-sales constraints, irrational investors participate and thus add liquidity only when they are optimistic. Hence, high liquidity tends to coincide with overvaluation. The IPO market is often viewed as sensitive to sentiment, so high first-day returns on IPOs may also be a measure of investor enthusiasm. Singapore investors' sentiment is at its highest level in at least six years. For example, total share turnover on the Singapore Exchange last year was $294 billion - up 44 per cent from 2005. In terms of number of shares traded, last year's figure was more than three times that in 2000. And so far this year, trading volume and value have been higher than the average of last year. As for new offerings, the amount raised in 2006 was $7.8 billion. Compared with 2005, that's almost a 30 per cent jump. And true to the observations of Baker and Wurgler, as investor sentiment turned more positive, it was the loss-making, penny stocks that flew. I've divided all the stocks listed on the Singapore Exchange into 10 groups based on their share price. Ranking the stocks based on their absolute share price, the cheapest 10 per cent are in decile one. The next 10 per cent of the stocks are in decile two. As you can see from Chart 1, stocks with the cheapest absolute share price have performed the best in the first two weeks of 2007. As a group, the average return in the past two weeks was a whopping 26 per cent. The next 10 per cent returned an average 12 per cent, while stocks in decile three chalked up an average 10 per cent gain. Meanwhile, the top 10 performing stocks year-to-date are all below 20 cents. They include Multi-Con Systems, Tastyfood, Liang Huat, Ban Joo, NTI, Action Asia, Sunlight, Baker Tech, Ultro and Advanced System Automation. This is, of course, not to say that all these price increases are speculative in nature. Singapore's domestic demand is expected to pick up strongly on the back of high employment and wage increases, and get an additional boost from major projects like the integrated resorts and the rejuvenation of the Orchard Road area. Companies catering to this upcoming demand are obviously in for a good time, which would explain the superb performance of many construction stocks of late. Having been squeezed by the poor demand for properties in Singapore, many sank into the red. But the tide is turning. And once the work comes in, operational leverage will see the bottom-line of these companies pick up exponentially. It is a well-known fact that capital-goods industries fluctuate more widely than consumer-goods industries. Capital-goods industries - especially those supplying raw materials, construction and equipment to other industries - expand much more in a boom and are hit much harder in a downturn. Of course, having seen how, say, Yongnam Holdings surged from three cents as recently as October last year to 19.5 cents yesterday, many will be eager to identify the next six or seven baggers. And that is when some will be consumed by their exuberance and throw rationality out of the window. Hence the many two or three baggers among the penny stocks in the last couple of weeks. Sentiment, if it continues to be positive, can carry stocks along a while more. But investors have to make sure that ultimately, there is a fundamental story behind a stock. Even feathers have to come back down to earth some day. The writer is a CFA charterholder. Her email: hooiling@sph.com.sg |
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