According to Dictionary.com, the definition of endogenous is “proceeding from within; derived internally.” The definition of exogenous is “originating from outside; derived externally.”
This neat division helps one to understand the value of investment predictions. Endogenous factors affecting the stock market include economic data, such as unemployment, and market fundamentals, such as advance/decline lines and market multiples, as well as the all-important corporate profits. There is one set of analysts who can speak intelligently on endogenous factors.
Exogenous factors are primarily geopolitical events but also weather events or natural disasters, such as earthquakes. For example, if Putin flagrantly invades Ukraine, the stock market will object by selling off. To some extent, that uncertainty is already priced into the market, limiting the market’s reaction. However, if something from “left field” or totally unexpected happens, such as a Chinese invasion of Japan, it would produce an absolutely violent drop in the stock market. There is a different set of analysts who can speak intelligently on exogenous factors.
The astute investor must listen to both sets of analysts and then synthesize their observations. That is what I try to do. Some try to take advantage of the tumult by “betting ahead” of the event. If you are confident Putin will invade Ukraine, you could short the ETF for European stocks, but your potential losses are unlimited whenever shorting. Or, you can simply increase your cash levels to match your personal level of uncertainty.
When struck by an exogenous factor, limiting loss should be more important than profiting from it. Converting to cash has a 100% probability of successfully limiting loss in the short run. The probability of successfully betting ahead on exogenous events is much less than 100% and is much more risky.
An old Wall Street adage is that “nobody is smarter than the market.” Likewise, nobody is smart enough to out-smart exogenous events. Smart people know that!
This neat division helps one to understand the value of investment predictions. Endogenous factors affecting the stock market include economic data, such as unemployment, and market fundamentals, such as advance/decline lines and market multiples, as well as the all-important corporate profits. There is one set of analysts who can speak intelligently on endogenous factors.
Exogenous factors are primarily geopolitical events but also weather events or natural disasters, such as earthquakes. For example, if Putin flagrantly invades Ukraine, the stock market will object by selling off. To some extent, that uncertainty is already priced into the market, limiting the market’s reaction. However, if something from “left field” or totally unexpected happens, such as a Chinese invasion of Japan, it would produce an absolutely violent drop in the stock market. There is a different set of analysts who can speak intelligently on exogenous factors.
The astute investor must listen to both sets of analysts and then synthesize their observations. That is what I try to do. Some try to take advantage of the tumult by “betting ahead” of the event. If you are confident Putin will invade Ukraine, you could short the ETF for European stocks, but your potential losses are unlimited whenever shorting. Or, you can simply increase your cash levels to match your personal level of uncertainty.
When struck by an exogenous factor, limiting loss should be more important than profiting from it. Converting to cash has a 100% probability of successfully limiting loss in the short run. The probability of successfully betting ahead on exogenous events is much less than 100% and is much more risky.
An old Wall Street adage is that “nobody is smarter than the market.” Likewise, nobody is smart enough to out-smart exogenous events. Smart people know that!