Pawęta: Timing of Investments on the Polish Stock Exchange in Accordance with the Economic Cycle

2 stycznia 2010 Prace Dyplomowe komentarze: 0

Autor: Bartosz Pawęta
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Everyone needs to realise one of the most basic investment principles: the stock exchange does not always grow. As many other phenomena occurring in the world, price changes on the stock exchange and the economic growth tend to be cyclical. Many forget (or do not even know) about that, thus they buy on the top, and sell on the bottom. The importance of this matter is significant nowadays, as we are all dependent on the stock exchange. Even if we do not invest our money ourselves, there are institutions which do that for us. This makes the stock exchange one of the main ways in which our money is saved in order to enable us to receive a pension, buy a house, or provide our families with comfort and safety. For this reason, it should be in everyone’s interest to become familiar with the characteristic of cycles, and to use them to make money, not to loose it.

Companies quoted on the stock exchange operate in certain economic conditions, so their financial results are subjected to the macro environment. It implies that the economy has to exert some influence on their share price as well. The aim of this paper is to analyse the relation between the value of the main index of the Warsaw Stock Exchange and the Polish economy, measured by the Gross Domestic Product. Since behaviour of both of them appears to be cyclical, their cycles will be examined with a view to defining in which point of the cycle one is, and what decisions concerning the timing of investments on the stock exchange should be taken. In other words, it will be checked if the correlation between these two aggregates can provide investors with the information on a proper ‘time window’ for their investment decisions.

The influence of the economy on the prices of shares quoted on stock exchange is obviously taken into account in most of the stock analyses. On the one hand, fundamental analysis based on a company valuation requires conducting macro environment analysis. On the other hand, technical analysis, which examines charts, frequently ‘explains’ historical price levels by relating them to the economy. The analysis in this paper combines both: fundamental and technical approach, as charts of past behaviour of share prices and the economy will be analysed. That approach will enable us to observe their cyclical nature, which means that some situations that have already happened in the past are going to occur again in the future. And if there is, or was, a certain dependency between the stock exchange and the economy, it may be used while investing. At that point however, I would like to strongly emphasise the fact that I do not claim that any dependencies observed in the
historical charts, nor investment decisions based on them, will be still valid in the future. Nevertheless, knowledge of the past may be helpful in the future. And with that approach cycles in the Polish economy and on the Warsaw Stock Exchange will be examined.

The paper starts with the definition of the economic cycle, its morphology, and means of its analysis. It introduces vocabulary and methodology which will be used in the following chapters. What is more, the first chapter presents characteristic features of cycles and their evolution, observed by other authors.

The second chapter aims at finding causes of cyclical nature of the economy. It is crucial to understand why cycles occur, what determines their morphology, and if/how their negative impact can be mitigated. In order to find that out, main economic thoughts explaining the matter are presented. Their approach is very often different, sometimes contradictory, which proves the complexity of the matter.

After having defined what the economic cycles are, and why they occur, the information on what data should be employed in the stock market cycles analysis is given (Chapter 3). Next, the cyclical nature of the stock exchange is presented and its causes explained. Moreover, the concept of the investment circle is introduced, which is a theoretical model of the capital flow in the financial market through the whole economic cycle. It is also one of the most important elements of this research. Finally, the information on how to identify inflection points and phases on the stock cycle is provided.

In the chapter four, the analysis of historical data of the main stock index in Warsaw (WIG) and the Gross Domestic Product of Poland is conducted, according to the methodology described in the first chapter. At the same time, it is examined, whether any of the theoretical statements described in the paper are confirmed.

The fifth chapter combines the stock market and the economic cycles, which (in various forms) are presented in the same chart. The relation between WIG and the GDP is analysed. What is more, the verification of the investment circle is conducted. Finally, the conclusion regarding investments on the Warsaw Stock Exchange according to the economic cycle is made.

Economic and stock market cycles are not identical, thus characteristics of both of them need to be determined. What is more, the investment type that is examined in this paper, is the main index of the Warsaw Stock Exchange only. Investors, who can benefit from this paper, are all investors lacking professional tools and data while investing. The methodology used in the paper involves basic mathematics only, while the theory requires understanding of the main economic phenomena.

My final remark refers to the aim of the investment strategy presented in the paper. That strategy aims at medium/long investment horizon only, as it seeks for investment opportunities which are justified from the economic point of view. I try to find out when investments on the stock exchange are reasonable, instead of speculating what the future will be like. On the other hand, I question the Warren Buffet’s assumption stating that some stocks should be bought and kept until eternity[1]. As it will be proved, there are too many fluctuations both in the economy and on the stock market, so that investors could neglect them – cycles and their phases are as important as main trends[2]. For this reason, the conclusion of this paper should be employed as a tool which may help finding a ‘time window’, i.e. a period of time in which a given investment decision should be made with a
relatively low risk level, as according to Buffet, brilliant investment opportunities happen, when because of extraordinary events, very good companies are undervalued[3]. Decisions what to buy (sell), regardless whether it is a parcel of shares, investment fund units, or derivatives based on stock indices, must be carried out independently of what is presented in the paper. Such two analyses, conducted simultaneously and combined together, might result in a smart and justified investment decision.

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[1]R. G. Hagstrom, Na Sposób Warrena Buffeta, MT Biznes, Warszawa 2007, p.151

[2]J. Ritchie, Analiza Fundamentalna, WIG-Press, Warszawa 1997, p. 64

[3]R. G. Hagstrom, Na Sposób Warrena Buffeta, MT Biznes, Warszawa 2007, p.159

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