Pricing in financial markets, its all about best of probabilities

Often we here the words bubble, irrational, expensive etc as a context in reference to financial markets and market prices of various instruments traded in financial markets. While retail investors may feel that the markets have a complete disconnect with reality and rationale, this interpretation is subjective. Financial markets have a different way of interpretation of on ground situation and that may not resonate with the “reality” as defined or understood by investors.

Financial markets are always forward-looking and probable impact of negative news are always priced in prevailing market prices on real time basis. More negative news being spread and circulated across the worldwide web or media may not affect the prices in long run. At times, sudden drop in prices turn out to be buying opportunities. Probabilities keep changing every moment and financial markets price in corresponding impact of these probabilities.

In the post-Covid era, a rise in interest rates by central banks globally have affected businesses. Yet, financial markets have rallied beyond imagination in the recent past despite interest rates remaining higher for longer. One of the reasons for this rally in the last few months is the assumption that central banks have achieved their inflation target and the next course of action may be reduction in interest rates, known as “rate cuts”, leaving behind the “rate hike” era. It is a well-known fact that in financial markets, celebrations are always well in advance before the actual event takes place. Financial markets are typically celebrating a Goldilocks situation where everything is fine or will be made fine with the intervention of central banks.

The bigger players in financial markets know the road much better than retail investors. At any given time on a working day, transactions in financial markets globally average billions of dollars. It’s purely a liquidity-driven market and buyers are ready to deploy funds even at today’s pricing and valuation. Given the substantial interest in market participation by investors of any size and stature globally, any dip in financial markets is bought rapidly.

Rather than questioning the valuation, multiples and other parameters that the investors may be using to evaluate market prices, efforts may be made to identify stocks and investment products that have potential to further rally against the odds. Technology is developing and changing at a rapid pace. Efforts may be laid in analysing available data and information to identify companies that have potential to scale from small cap stocks to mid-caps and mid-caps to large cap stocks. The Fortune 500 companies will go through churn a in the next decade, being replaced by the new entrants to the market. Funds deployed in companies that are at the cusp of the next phase of growth may generate returns in multiples in the coming years if they are held with patience. Failures in the process should not distract the investors so far as they follow their own rule book and limit the loss to the extent they can bear the brunt.

As a process flow, investors may identify the geography and its stock market, then the sector preferred based on analysis and stock within the sector that has the potential to navigate through the headwinds while tailwinds will propel this investment journey further towards growth and rewarding returns. In every financial market, it is not only the top 50 or 100 or 200 or 500 companies that may be offering returns, but there is also much more to explore in the next layer for retail investors to identify a gem among the hundreds of mid cap and small cap stocks listed financial markets. Globally, there are more than 55,000 companies listed and global stock market cap exceeds $110 trillion, empowering the investors to choose their preference based on their analysis.

As a retail investor, it’s never too late to board this train and commence their investing journey on a gradual basis. Accumulating funds and deploying them in the financial markets gradually may be an ideal strategy to build a decent portfolio with the aim of achieving desired returns in the envisaged time frame. Start to plan and plan to invest be the mantra. Markets open every working day and the new dawn always brings surprises that investors should be wary of during this journey and Investors should be prepared to weather this storm of surprises.

Wishing the investors the very best while they pursue their investing journey, with pre-defined rules, risk appetite and reward expectation.

The writer is founder and CEO of ZTI Global.

• Business