Smart Money: Acceptable financial fulcrum or see saw into sandpit

Getting back to normal. That's what the markets are trying to do. Not hitting stellar highs, (gold is the exception), but just getting back to normal. Or the new normal, as it might more correctly be described.
This year's frothy volatility is in part generated by global forces simply doing this: trying to make up their minds if we are back to the new normal.
What is the new normal? Have we reached an acceptable financial fulcrum where things look stable or is this the see-saw that dumps us in the sandpit? There are no hard and fast answers.
Couple this with the fact that it is beyond all human powers to know sharemarket movements in advance, and you've got yourself a challenge.
Although normal doesn't sound like a particularly racy thing to aim for, research analysts spend much time trying to determine this exact measure, except they usually call it the long-term average.
These are applied to everything under research; currency, individual companies, whole regions, the entire global universe of stocks. They are applied to ratios, cash flow valuations, net tangible assets, discounts, premiums and many more.
The statistical reasoning, and indeed proof, is that when things get too far out of whack and skewed one way or another, at some point they will revert back towards the long-term mean. The numerical mechanism lies somewhere at the level of junior university mathematics, but there is no debate about the validity and this is why market researchers attribute so much time to it.
One of the more practically applicable measures is a record of how cheaply or expensively markets trade based on a price to earnings (P/E) ratio. This is useful in a general sense when markets are volatile, like now. During last year the NZ market at one point as a whole traded on a P/E that was so cheap, (prices were so low and trading on such huge negative sentiment), that it was questioned whether it was worth bothering with fundamentals.
But fundamentals are facts and not subject to the human foibles of emotion and irrationality.
Those that bought during that colossal dip profited hugely. In the same vein those that sold on the same measure at the beginning of 2007 avoided loss.
Price to earnings is just one of a clutch of market indicators but the theme remains the same for all: buy or sell the outliers and wait for them to retrace towards the mean. Profit and repeat or protect and repeat as required. Active portfolio managers use these techniques every day, or month, or quarter for clients as appropriate.
So, whilst it may not be trendy to be Mr Average, it is definitely highly sought after to have access to a team that knows exactly where normalcy is.
Caroline Ritchie is an NZX adviser for Forsyth Barr in Napier and holds an NZX Diploma, BCom and BSc. For sharemarket advice contact her on (06) 835 3111 or caroline.ritchie@forbar.co.nz. The comments in this note are for general information purposes only. This article is not intended to constitute investment advice under the Securities Markets Act 1988.