This article was inspired by a Seeking Alpha writing contest designed more to find out what readers might find interesting in inflation-laden investing environments than to realistically find out what specific stocks or stocks might be. . useful to readers. Good idea for SA, and maybe for the readers.
I took this latest twist on the investor-facing opportunity and compared the upcoming price outlook of Microsoft Corporation (NASDAQ: MSFT) with those of more than 3,000 other potential investments exposed to the same scene of high inflation.
So, I misjudged what SA wanted and found that different considerations were needed than the writer’s speculation about what might happen to investments during a time of high inflation. The “fundamental” notions are ultimately translated into comparable value judgments by the experienced and knowledgeable investment professionals employed by market-making firms.
Most individual investors lack the training or experience to comfortably assess the impacts of economic outcomes on portfolio candidates. You might feel like you know which farm should get the boot, but which is the best candidate for the replacement? Where can I find useful advice?
Institutional investing typically involves maintaining portfolios of at least several million dollars, often even several billion dollars. Meanwhile, the individuals who make up the rest of the “investing public” are effectively served by markets operating from a computerized system of automated stock trading servers.
The presence of individual investors has greatly contributed to the competitive arena in which many small transactions are processed without human intervention. This has now eliminated the 20th century need for competitive brokers to charge “trading commission” fees.
But institutional investment transactions are far too large to process systematically, so they require negotiated, disruptive and special “block-trade” transactions. Such volumes usually rarely find sellers “on the other side of the trade” providing enough stock to properly fill the buyer’s orders.
Thus, the market-making trader of each trade is usually motivated to find equity lenders (for a fee) to deliver to the buyer as the block trade is “filled” and reported to the rest of the investing public via stock exchanges. The MMs of these loans are on call from the lenders to return the borrowed shares without notice.
For such lending to take place, the MM must benefit from the risk shelter of a hedging arrangement that protects against rising prices while being short. Derivative markets provide this type of “insurance” for the MM, at a price covered by the trade initiator as the “cost of liquidity” and on terms dictated by the protection seller defining the value of the ‘stock. All these entries define, according to the inescapable rules of arbitrage, the future price limits of the action in question (higher and lower) most likely seen by traders.
These trades and deals make up the bulk of the “market” volume of actions, which is in the billions of dollars a day. Records of their involvement in the negotiations have been kept private by us for decades and will be used in this discussion. Here in Figure 1 is the current picture of how a once-a-week multi-month price range forecast record for MSFT occurred over the past 2 years.
(used with permission)
Many investors confuse any picture of stock prices that repeat over time with typical “technical analysis”. graphics” of past stock price history. Instead, the vertical lines in Figure 1 are a daily updated visual forecast recording expected price range limits in to come a few weeks and months. The thick dot in each vertical is the closing price of the stock on the day the forecast was made.
This market price level gives an explicit definition of the price reward and risk exposure expectations that were held by market participants at the time, with a visual display of the vertical balance between risk and reward.
The measure of this balance is the Range Index (RI). Here, only 26% of the full MSFT forecast range is downside from the current $280, leaving 74% of the upside range.
Having such precise measurements of price expectations makes it much easier to directly compare all securities at any time, as is currently the case in Figure 2.
And one benefit of these predictions is that they are all made by market participants on both sides of the trade with “skin in the game” at every turn at the trading “table”.
The data line between the images in Figure 1 contains, in addition to price range forecasts and RI metrics, a history of market price outcomes following all previous daily forecasts for the past 5 years that had RI risk-reward balances like those of today.
Here there were more than 300 such forecasts, almost a quarter of the 1261 daily events. The average price change experiences shown for MSFT have a high degree of credibility. Other actions may be at different RI stages of their risk-reward balance.
Comparisons with other actions
(used with permission)
Upside price rewards come from behavioral analysis (of what to do right, not mistakes) by market makers (MMs) as they protect their risk capital against possible future price movements damaging. Their predictions of potential rewards are measured by the green horizontal scale in Figure 2.
The risk dimension shown corresponds to the most extreme points of actual price decline recorded while held in the previous pursuit of upside rewards similar to those currently seen for this security. They are measured on the red vertical scale.
Both scales are percent change from zero to 25%. Any stock or ETF whose current risk exposure exceeds its reward outlook will be above the dotted diagonal line. Our primary interest is MSFT in location (10) and its relationship to others.
The recorded histories of the price range predictions provide insight into the performance of each security prediction in the following markets. It also reinforces under what circumstances the risk-reward balance better predictions could be made in the past, and as in Figure 1, can be made at present for the future.
Specific to today’s upcoming MSFT price range forecast, the derivative contracts used in the forecast agreement that dominate the current stock market on this date are unlike perpetual action instruments in that they all have time limits to their effectiveness. The hedge therefore has a limited lifespan, as does the price range forecast.
Rather than being a limitation, it is a strength. Each forecast combines the prospect of gain but also the realistic magnitude of the probable loss of capital within the time horizon of the forecast. An increase in this potential loss in a shorter timeframe warns of the potential need to replace a preferred investment with a better alternative investment before a painful surprise arrives.
But not too soon. A change should only be made when an alternative can compete with the favorite position under the same forecast time conditions. Still, there is a need to be on the continual search for viable and desirable replacements. The short time horizon forces forecasts to be revised more frequently, which should reduce surprises.
The vastly changed portfolio management economics of today’s investment scene greatly favors this type of Active investment management. The elimination of trading “commissions” when decisions are made by the wallet owner and executed on command through an automated transaction system via the Internet now promotes this type of constant scrutiny.
One of the most painful but preventable losses is the loss of investable time. Examples are due to changes in technology (Eastman Kodak, IBM (IBM)) and corporate management (General Electric (GE), General Motors (GM)) where sleepy, long-term “conservatives” passive investment management allowed years of inactive review and diminishing value to be lost without any possibility of replacement. Other examples continue today.
Figure 3 shows the opportunities existing in just the 30 well-known and closely followed Dow Jones stocks (past performance), including MSFT. Where forward-looking forecasts of the price ranges of the upside and downside limits are frequently available for comparison purposes, the sophisticated investor may take advantage of the best available guidance, on terms consistent with their particular circumstances.
In Figure 3, the leftmost Expected Price Change Range column is MSFT, the DJ stock with the least exposure to price decline based on today’s expectations, and is among the best prospects for gain. . The far right column is Boeing (BA) with the best hopes of upside shift gain, but not insignificant risk exposure.
A regular weekly check on the evolution of the most informed (institutional investors) future price range expectation forecast helps to stay on top of the likely growth in value. See the balance of reward-risk ratios shift favourably, the probabilities of closing profitable investment positions increasing, and the lengthening of historical increases in compound annual growth rates (CAGR) from shorter average holding positions , are all desirable goals.
Microsoft Corporation Future Price Outlook Comparison along with those of the other 29 stocks Dow Jones confirms its opportunity as a premier equity investment in the weeks and months ahead of a likely high inflation environment.