Excerpt from Alchemy of Finance
I have sketched out a typical boom/bust sequence. It can be followed by two curves that follow more or less the same direction. One represents Stock prices, and the other, earnings per share. It would be natural to envision the earnings curve as a measure of the underlying trend, and the divergence between the two curves as an indication of the underlying bias. The relationship is much more complex. The earnings curve incorporates not only the underlying trend but also the influence of stock prices on that trend: the prevailing bias is expressed only partially by the divergence between the two curves.-partially ist is already reflected in those curves. Concepts that are only partially observable are extremely difficult to work with: that is why we have chosen variables that can be observed and quantified-although, as we shall see later, the quantification of earnings per share can be very misleading. For present purposes, we shall assume that the ‘fundamentals’ in which investors are interested are properly measured by earnings per share.
A typical path for the two curves may be as follows. At first, recognition of an underlying trend is lagging but the trend is strong enough to manifest itself in earnings per share. When the underlying trend is finally recognized, it is reinforced by rising expectations. Doubts arise, but the trend survives. Alternatively, the trend waivers BUT reasserts itself. Such testing may be repeated several times, but here I show it only once. Eventually, conviction develops and it is no longer shaken by a setback in the earnings trend. Expectations become excessive, and fail to be sustained by reality. This bias is recognized as such and expectations are lowered. Stock prices lose their last pro and plunge. The underlying trend is reversed, reinforcing the decline. Eventually, the pessimism becomes overdone and the market stabilizes
We are facing the opening stages of Expectations have become excessive on AUD now the next step is lowered expectations.
I have sketched out a typical boom/bust sequence. It can be followed by two curves that follow more or less the same direction. One represents Stock prices, and the other, earnings per share. It would be natural to envision the earnings curve as a measure of the underlying trend, and the divergence between the two curves as an indication of the underlying bias. The relationship is much more complex. The earnings curve incorporates not only the underlying trend but also the influence of stock prices on that trend: the prevailing bias is expressed only partially by the divergence between the two curves.-partially ist is already reflected in those curves. Concepts that are only partially observable are extremely difficult to work with: that is why we have chosen variables that can be observed and quantified-although, as we shall see later, the quantification of earnings per share can be very misleading. For present purposes, we shall assume that the ‘fundamentals’ in which investors are interested are properly measured by earnings per share.
A typical path for the two curves may be as follows. At first, recognition of an underlying trend is lagging but the trend is strong enough to manifest itself in earnings per share. When the underlying trend is finally recognized, it is reinforced by rising expectations. Doubts arise, but the trend survives. Alternatively, the trend waivers BUT reasserts itself. Such testing may be repeated several times, but here I show it only once. Eventually, conviction develops and it is no longer shaken by a setback in the earnings trend. Expectations become excessive, and fail to be sustained by reality. This bias is recognized as such and expectations are lowered. Stock prices lose their last pro and plunge. The underlying trend is reversed, reinforcing the decline. Eventually, the pessimism becomes overdone and the market stabilizes
We are facing the opening stages of Expectations have become excessive on AUD now the next step is lowered expectations.