Market Anomalies or Why Basic Laws Do Not Work at Finance Markets

Рыночные аномалии, или почему не работают основные законы на финансовых рынках,

In the financial world occurrences which have not found their expression in fundamental scientific works yet regularly appear and persist for a long time. Let’s consider the most interesting and fundamental ones.

 High risk does not mean high revenue. Overseeing high risk in a certain group of assets one should not expect to see high relevant revenue. It is one of the most serious anomalies substantially undermining the hypothesis on market quality in models on required assets revenue assessment. For example, such models as Capital Asset Pricing Model (САРМ) or Arbitrage Pricing Theory.

 Experts of one of the world’s biggest unit investment fund PIMCO (Pacific Investment Management Co) particularly paid attention to this phenomenon. Thus, according to their estimates, from 2005 to 2010 ten per cent of companies with the lowest risk of index MSCI World showed annual income at 5.6 %, while 10 % of companies with the highest risk showed 5.5 %. If we consider a 25-year period, the difference in profitability decreases, but all the same stands at 3 per cent minimum.

 A year before famous professors Malcolm Baker from Harvard Business School, Brendan Breadly from Acadian Asset Management and Geoffrey Wrungler from New York Stern did the same research. According to their estimations, within 1968 -2008 one US dollar invested into 10 % of the least risky shares increased to $59.99, while one US dollar invested into 10 % of the most risky shares decreased practically to 58 cents. So we may come to the conclusion that speculations in highly risky assets for a long-term period do not prove their value.

 Minimal interest rate. From a theoretic point of view, revenues at credit markets should be defined by market competitors through supply and demand. But in reality record financial investments of the US Federal Reserve System result in a protracted period of atypical low interest rate in all kinds of income.

 According to Bloomberg estimates, at present liability volume of both private and public sectors of economics at debt markets exceed 7 trl. US dollars. Taking into account the coordination of financial decisions between biggest economies and constantly growing integration of world’s financial markets, minimal interest rate effect is spreading further and further among all developed and developing countries.

 Fund Fidelity gives the following rates: profitability ratio on US five-year bonds differs from its average historic value by approximately 4 % (the period of 1978–2010 is taken as a basis). The same difference in short-term obligations is 5 %, and interest rates are fluctuating at zero. These effects lead to the loss of interest rate control in monetary policy; it is impossible to decrease them any longer. The anxiety is expressed by global investment funds which invest an essential part of their portfolio into public bonds in accordance with a fixed internal policy and federal laws – rate of return of 1-2% cannot secure their investments from inflation.

 All these facts witness an artificial foreign imbalance at public sector borrowing market which at a certain period will have to be leveled with interest rate growth, an unprecedented flight of liquidity and also an increase in default numbers.

 “Stable” US dollar. Credit burden exceeds 300% of gross domestic product, balance of trade deficit for the last ten years is not less than 3.5%, credit rating was reduced in 2011 – all this concerns the US economy. According to macroeconomic theory, these figures should be balanced by national currency devaluation. The probable dollar crash has been told about for many years, but until a real alternative as a global equivalent to the value arises in the world’s financial system, all these “analytical” overviews are idle talks.

 As for the real state of facts, in financial markets short-term dollar obligations (and correspondingly the demand itself for currency) are nearly a single “riskless” asset and a natural guarantee against high volatility. 

 This anomaly is an unsteady balance: no doubt, the dollar will remain world currency No1 in accordance with the status of US economy in the financial world for the next several decades, but one should take China with its yuan into account.

 Separation of market indicators from fundamental data. One of the main indicators on assessment of attractiveness of investments into companies’ shares is ratio P/E (price-to-earnings ratio) according to index S&P 500. Historically the value of this ratio from 1936 to 2010 is 15.9x. At the same time within the last five years the following dynamics is taking places: the highest demand for shares occurred in 2008 when ratio P/E was 60.7x, then in 2009 it decreased to 21.9x, in 2010 it fell to 16.3x; in 2011 it is at 13.8x and it is estimated to fall to 12.7x in 2012. Taking these data into consideration one may assume asymmetry leveling in the market, reinsurance and even some ignoring of companies’ profitability data. Meanwhile, Google has ratio P/E as 125, LinkedIn – 594x and Facebook is planning as 96x; all this makes one think that these companies are eternal. World’s recognition and progressiveness of these companies are well known, but generation of free cash flow, corresponding profit and dividend payment to shareholders have not been cancelled yet.

 What about supply and demand? From macroeconomics basics it is a well known fact that supply and demand for a product determines its price. Factually price growth at commodity markets without fundamental indicators is a frequent thing. Here is an example of one but not a single speculative market. Gold is not a typical metal for the customer’s demand: portfolio investors form a considerable part of demand for it beginning with a certain period. Thus, since 2006 part of industrial and jewellery demand for gold is decreasing and total consumption volume is 76.3 % in comparison with 91.6% in 2005. In 2009–2010 this portion is 50.1% and 57.5% correspondingly. Since that time the last growth of gold quotation has started. Here with the help of hedge funds investors remembered about a historic binding of the precious metal with the dollar and chose it as one of counterbalances to falling market shares. Excess liquidity from other markets is also invested into gold. Thereby, behavioral euphoria on the market caused by self-developing financial investor inflow may for a long time shift demand and supply curves into the side which is beneficial for traders. Nowadays the main issue is how durable artificial demand provided by institutional investor inflow will be.

 The occurrence, development and final conclusion of financial anomalies is a natural phenomenon in the evolution of financial science and real life. At the same time it is obvious that compliance only with financial theories (in their turn, seriously considered and affirmed ex post) in short-term, mid-term and in several cases log-term perspectives may lead to negative consequences for investors ex ante.