The article sheds light on the effectiveness of possessing the skill of predicting the future performance of a Stock in general and of the Stock Market, particularly for a profitable investment in a share or in a Capital Market. What do legendary investors say about it? Had they ever practiced it in managing personal or professional investments?

Should we predict the stock market before investing in a stock? 

This question always bothered many despite the fact that Efficient Market Hypothesis (EMH) negates such a notion. According to EMH, it is virtually impossible to consistently “beat the market” i.e. to repeatedly earn returns by investing in stocks higher than the return as reflected by major stock indices such as PSX-100.

The phrase within the definition of EMH, “Impossible to consistently beat the market”, itself is suggestive that earning a return higher than the market return is possible, though occasionally. This proved to be so intriguing on the face that I decided to explore what legendary investors say about it. And had they ever been involved in predicting the market before investing?

In search for quenching this thrust, the writings of three renowned Investors, Mr. David M. Rubenstein, Mr. Mark Tier, and Mr. George Soros. Mr. David M appeared to be a major help.

Rubenstein is the Co-founder and Co-Chairman of The Carlyle Group, one of the world’s largest and most successful private investment firms, which manages $369 billion, and the author of many bestselling books. Mr. Mark Tier is a famous successful businessman, an investment blogger, and a famous writer, whereas George Soros stands above any introduction.

Mr. David M. Rubenstein wrote in his book “How to invest” that skill of predicting the future, and taking preparatory actions is quite helpful to achieve a profit by investing. Similarly, Mr. Mark Tier, in his book “The Winning Habits of Warren Buffet & George Soros” quoted Mr. George Soros as saying that “I insist on formulating a thesis before I take a position”, both simply reflect the beliefs of these two leading investors in predicting future performance of an asset before investing in it.

In fact, the more we study George Soros’s way of investing the more firmly we are convinced that he is not only a staunch believer in hypothesizing an investment but also an ardent advocate of the same. He never missed a chance of promoting it publically too.

In his famous theory on “The Boom & Burst Model,” he explicitly explained how staying ahead of the price curve could help generate returns over and above the average market through investing in stocks.

Mentioning prevailing bias at an early stage of the Boom & Burst Model and suggesting its continuity with greater momentum in form of price appreciation of stock in a post-testing phase, is a classic example of emphasizing the importance of predicting the future direction of the stock price for profitable investing.

He demonstrated the effectiveness of this investing approach when he shorted GBP in 1992, which symbolized him as a person who broke the Bank of England. He earned $1 billion in a single day by short-selling GBP worth of $10 billion.

It was a time when Britain joined, the European Exchange Rate Mechanism as a part of the European Monetary System. The aim of EMS was to facilitate the unification of European currencies into a single currency euro. This requires member countries to keep exchange rate variability within a band through fiscal & monetary measures.

Accordingly, Britain was obliged to keep the pound 2.95 Deutschmarks with a 6% margin of error either way. It means that the GBP could dip as low as 2.78 and rise as high as 3.13 Deutschmarks, however, whenever the Pound approached 2.78 DM, the UK government was required to intervene to bring the exchange rate back to £1 = DM2.95 –through buying Pounds and raising the interest rate.

During 1992, the British economy experienced low inflation, 4.7% as compared to 6.9% and 7.6% in 1990 & 1991 respectively, and relatively a high economic growth rate, 4-5% a year. In a bid to keep Pound above 2.78 DM, i.e. preventing the devaluing GBP against DM, Britain adopted a tightening Monetary Policy and raised the interest rate to 15% gradually from 10%.

It resulted in slowing down the UK economy.

George Soros was the first to judge inherent weakness in Britain’s monetary policy. He viewed that pursuance of tight monetary policy in a low inflation environment is bound to set in recession. Once the recession is in, it would become difficult for Britain to keep the exchange rate in favor of GBP.

He hypothesized that sooner or later, GBP would lose its battle against DM. It was a contrarian view against the general market belief that the British government would keep its currency stable against DM.

He was so sure about his assessment that he shorted British pounds aggressively, around $10 bn worth of pounds in a single day, on September 15, 1992. It was such a precise prediction about the future exchange rate between DM & GBP that let him earn $1 billion. The Bank of England intervened twice on that day. Each time bought huge quantities of pound sterling but to no effect and collapsed.

This validates the contention that possessing the skill of predicting the future of the stock market in general and of stock, in particular, helps to generate returns over and above the market’s average return, though not consistently. The only question left to answer is:

“How a dependable prediction of the future performance of a stock or the stock market could be made?”

*The writer is a business graduate in Finance and MIS from IBA, Karachi with a MSc Statistics from University of Karachi and a fellowship in Life Insurance from LOMA, USA and a certified trainer by the US-AID Programme. He has has been associated with business schools as a visiting faculty teaching courses on investment, finance, and financial risk management.

He is currently engaged in investment research and policy with one of the leading life insurance companies in Pakistan.

Posted on: 2023-01-12T09:55:27+05:00