Consistency of the UK Stock Market with Efficient Market Theory - Case Study Example

Stock market behavior in the UK in 2009 Introduction and background The economy of the UK is one of the biggest and strongest in the whole of Europe.The currency of UK – Pounds is one of the strongest in the world. The economy of UK is based on the long history of trade and commerce that thrived in the country and between her colonies. In the modern day, the economy has become globalized and for obvious reasons the economic implications in one country have an effect on the other country as well. Therefore, the recession, which had its origins in the USA in 2008, had an effect in the markets of UK. The market was characterized by huge levels of unemployment and there was substantial decrease in the spending of the investors. The money available in the hand of the public was lesser than normal. The Government had to introduce a huge amount of money into the system to sustain the stability of the environment. (UK in for prolonged recession, 15th November, 2008). The state of the UK economy can be attributed to some of the policies of the banks in the country. Like the USA, the UK banks were providing loans during the “house bubble”. When the bubble burst out the banks were in serious debt. The status of the borrowers was not analyzed properly and this caused the downfall in the economy. The age-old values of honesty and hard work have to be imbibed in the system to recover fully from the downturn and the system should introduce a system to minutely analyze the credentials of the borrowers before offering them the money. (UK economic conditions, n.d.) As the investments pouring in the company reduced their activities in the business front. The companies were looking to reduce their costs and hence the economic conditions worsened. The effect of these activities had an impact on the stock market of the UK. The paper deals with the effect on the stock market during recession and its confluence with the efficient market theory. Efficient market theory “The Efficient Market Theory” (EMT) is one of the most important theories that has risen in the context of the stock market. The main propaganda of the EMT is that information about the stock market is available to all. The information about various incidents enters the stock markets and is available to all. As a result, the stocks are influenced by the information and the price changes are related to it. Therefore, the investors cannot take undue advantage of the market and has to follow the similar trajectory of the other investors. Any form of fundamental and technical analysis does not help the situation of the investors. Therefore, no investor can earn more than the average rate of return available in the market. However, many of the economists in the modern world are in against the efficiency of the theory. According to them, the prices of the stocks can be accurately predicted. This can be done with the help of the statistical analysis of the past prices. It has to be noted that there is some amount of predictability in the statistical techniques of the market. However, the predictive power is not huge and the investors depending on the statistical techniques for the prediction of the stock prices will earn a minimum percentage. In the case, the investor is to pay brokerage, that amount of profit is not available. Therefore, contrary to the popular belief, the market indeed is efficient. It can be inferred that the market has some inefficiency in it, which allows some persons to earn huge amount of profits (eg: insider trading) but the processes are so overworked that the system develops itself to fight against it. Thus, it reclaims the position of the efficient market. (Malkiel,n.d.; Efficient market theory, n.d.; Kuthbertson, 2004; Pp 54-55) The UK stock market The financial stability of the UK economy depends to a large extent on the development of the stock markets there. The London Stock Exchange dates back to 300 years in the 17th century and developed in the coffee houses. However, from its humble beginnings, the stock exchange has grown to be one of the most developed markets in the world. It lies at the centre of the global capital market today. It is one of the largest international stock markets in the world and host approximately 3000 companies. The company has merged with the Borsa Italiana and has constituted the London Stock Exchange Group. The Group has developed as one of the largest and most developed in the whole world with about 400 investment banks and broking houses associated with it. The market provides live coverage of the happenings through live broadcast. (Company overview,n.d.; Our history, n.d.) Trends in the market in 2009 The recession in the last phase of 2008 put a lot of pressure on the financial markets of the world. The market of the UK was no exception. The stock market of UK is controlled largely by the London stock exchange. The index of the London Stock Exchange is the FTSE. There are various types of indices in the domain of the FTSE. We will look into the FTSE 100, which looks into the hundred top performing companies across all sectors. (FTSE UK index series, n.d.). The market was very low in the last quarter of 2008. However, during January 2009, the index rose by a good margin. The index in 2009 rose by a substantial margin. The month of February and March saw the market crash but it recovered in the latter half of the year. The first part of 2009 saw some of the biggest companies’ world over go bankrupt. This had an effect in the market. However, the Government provided the much-needed impetus to the economy when it pumped in millions of pounds in the economy. This made the market stand off the pressure and sustained the development in the second half. At the start of the year there were widespread fears about the fact that the country will be gripped in the worst recession in its history. It was expected that at the end of the year the economy would shrink by 3.2%. The budget deficit will rise to 11.3% and the debt would increase to 59% of the GDP. At the start of the year Prime Minister Mr. Gordon Brown provided impetus to the market with high financing. However, it resulted in the increase of debt percentage to 40% of the GDP. With the market anticipating the collapse of companies like GM, the index fell in the middle months. (UK economy 2009, n.d.; Walayat, 20th January, 2009) The index prices of the FTSE 100 are tabulated as follows: Date Open High Low Close Volume Adjusted Close 12/1/2009 5190.7 5445.2 5175.7 5412.9 982503800 5412.9 11/2/2009 5044.5 5397 4985.1 5190.7 1100711300 5190.7 10/1/2009 5133.9 5299.6 4955 5044.5 1175992900 5044.5 9/1/2009 4908.9 5190 4776.5 5133.9 1080214200 5133.9 8/3/2009 4608.4 4944.2 4595.6 4908.9 1084924000 4908.9 7/1/2009 4249.2 4646.9 4096.1 4608.4 1036404000 4608.4 6/1/2009 4417.9 4517.6 4213.4 4249.2 1212136600 4249.2 5/1/2009 4243.7 4520.8 4210.8 4417.9 1266231100 4417.9 4/1/2009 3926.1 4293.6 3838.2 4243.7 1331381800 4243.7 3/2/2009 3830.1 3992.4 3460.7 3926.1 1547110800 3926.1 2/2/2009 4149.6 4334 3760.7 3830.1 1315004600 3830.1 1/2/2009 4434.2 4675.7 3956.7 4149.6 1381094300 4149.6 Source: Yahoo finance, n.d. The chart clearly shows that the index prices followed a growth trajectory all over the year except the early months of February and March. The market recovered after the serious downfall in 2008 and it had much to do with the Government impetus received by them. Companies in the FTSE 100 There are various companies in the FTSE 100 with high volume of capitalization. The major companies are the BHP Billiton (BLT), Carnival Corporation (CCL) and Glaxo Smithline (GSK). All these companies have high capitalization value and have good performance in the market. They provide the investors good value for the money invested. (FTSE 100 index share prices, n.d.). The analysis of the five companies is made with the help of the share prices over 2009. The share prices over the year are as follows: BHP Billiton Date Open High Low Close Volume Adj Close 12/1/2009 9.77 11.17 9.31 10.1 123800 10.1 11/2/2009 9.09 10.3 8.83 9.65 205100 9.65 10/1/2009 9.39 10.19 8.57 9.04 241000 9.04 9/1/2009 9.1 9.99 8.71 9.47 120800 9.47 8/3/2009 9.44 10.1 8.58 9.17 145800 9.17 7/1/2009 8.73 9.93 7.93 9.3 203600 9.3 6/1/2009 8.54 9.14 8.04 8.61 259400 8.61 5/1/2009 6.1 8.57 5.39 8.39 358500 8.39 4/1/2009 4.55 6.57 4.39 6.4 274600 6.4 3/2/2009 7.18 7.51 3.76 4.62 320400 4.62 2/2/2009 8.23 9.57 7.24 7.33 225100 7.33 1/2/2009 9.49 10.18 8.26 8.38 206600 8.38 (FTSE 100 index share prices n.d.) Carnival Corporation Date Open High Low Close Volume Adj Close 12/1/2009 32.43 34.64 31.14 31.69 3907100 31.6 11/2/2009 29.39 33.07 28.71 32.03 3810100 31.93 10/1/2009 33.06 34.06 29.04 29.12 5821900 29.03 9/1/2009 29.34 34.95 28.26 33.28 5759200 33.18 8/3/2009 28.64 31.64 28.1 29.25 4179600 29.16 7/1/2009 25.81 28.91 23.99 27.99 5000100 27.91 6/1/2009 25.87 27.09 22.18 25.77 6270800 25.69 5/1/2009 27.1 29.76 23.79 25.44 6047500 25.36 4/1/2009 21.43 28.75 21.25 26.88 7705700 26.8 3/2/2009 19.16 24.94 16.8 21.6 8534500 21.54 2/2/2009 17.8 21.99 17.59 19.56 8047600 19.5 1/2/2009 24.18 25.76 18.14 18.19 6457200 18.14 (FTSE 100 index share prices n.d.) Glaxo Smithline Date Open High Low Close Volume Adj Close 12/1/2009 42.38 43.47 41.3 42.25 1270200 41.62 11/2/2009 40.45 42.98 39.82 41.47 1846500 40.85 10/1/2009 39.46 42.18 38.3 41.16 1603500 40.05 9/1/2009 39.12 40.24 38.4 39.51 1302500 38.45 8/3/2009 38.84 40.49 37.73 39.1 1140100 38.05 7/1/2009 35.6 39 34.34 38.29 1448300 37.26 6/1/2009 34.18 36.91 32.68 35.34 1900600 33.98 5/1/2009 30.81 34.12 30.37 33.71 2739300 32.41 4/1/2009 30.43 31.93 28.67 30.76 3275000 29.58 3/2/2009 29.36 31.41 27.15 31.07 2639400 29.48 2/2/2009 34.34 37.63 29.79 30.13 2359000 28.58 1/2/2009 36.52 39.59 33.24 35.26 1940300 33 (FTSE 100 index share prices n.d.) Analysis The share prices of different companies can be analyzed with the index of the FTSE 100. The best method for finding the relation is the correlation coefficient method where the data are analyzed and their relation can be gauged. The FTSE 100 can be used as the dependent variable (y) and the company prices can be taken as the independent variable (x). After performing the correlation function, we find that the BLT prices are negatively correlated to the FTSE 100 index, which shows that the company performed well in the first quarter of 2009, but it faded away in the latter months. However, the CCL and the GSK prices are positively correlated. The P value of CCL is 0.0048 and that of GSK is 0.005958. The P value is less than 0.05, which shows that the share prices of these companies are very strongly correlated to the index. This shows that the share prices of these companies with the exception of BLT followed the index. In the case of BLT the P value is 0.976687, which shows that the correlation is not as strong as in the case of the other companies. Conclusion The stock market of UK suffered a dip in 2009 as a result of the global economic downturn of the economy. The companies taken for the analysis follows the trend of the market with the exception of one. This shows that the companies of UK are strongly related to the stock market. Appendix I Regression analysis SUMMARY OUTPUT Regression Statistics Multiple R 0.98041 R Square 0.961204 Adjusted R Square 0.946656 Standard Error 123.009 Observations 12 ANOVA   df SS MS F Significance F Regression 3 2999131 999710.4 66.06937 5.49E-06 Residual 8 121049.8 15131.22 Total 11 3120181         Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 650.6082 340.2194 1.91232 0.092201 -133.939 1435.155 -133.939 1435.155 X Variable 1 -1.37523 45.61468 -0.03015 0.976687 -106.563 103.8124 -106.563 103.8124 X Variable 2 47.80602 12.00424 3.982429 0.004048 20.1242 75.48784 20.1242 75.48784 X Variable 3 73.30347 19.75932 3.709818 0.005958 27.73841 118.8685 27.73841 118.8685 RESIDUAL OUTPUT Observation Predicted Y Residuals Standard Residuals 1 4093.356 56.2443 0.536158 2 3784.247 45.85287 0.4371 3 3954.404 -28.3035 -0.26981 4 4181.647 62.05266 0.591527 5 4326.315 91.58478 0.873047 6 4461.273 -212.073 -2.02162 7 4782.699 -174.299 -1.66153 8 4902.489 6.410808 0.061112 9 5124.789 9.110691 0.086849 10 5047.458 -2.95834 -0.0282 11 5208.459 -17.759 -0.16929 12 5248.763 164.1371 1.564664 References: 1. 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London Stock Exchange. Available at: http://www.londonstockexchange.com/about-the-exchange/company-overview/our-history/our-history.htm (Accessed on 16th March, 2010) 8. FTSE UK index series. (n.d.). FTSE. Available at: http://www.ftse.com/Indices/UK_Indices/index.jsp (Accessed on 16th March, 2010) 9. UK economy 2009. (n.d.). Economy watch. Available at: http://www.economywatch.com/world_economy/united-kingdom/uk-economy-2009.html (Accessed on 16th March, 2010) 10. Yahoo finance. (n.d.). FTSE 100. Available at: http://uk.finance.yahoo.com/q/hp?s=%5EFTSE&b=1&a=00&c=2009&e=31&d=11&f=2009&g=m (Accessed on 16th March, 2010) 11. FTSE 100 index share prices. (n.d.). Hemscott. Available at: http://www.hemscott.com/prices/index-prices.do (Accessed on 16th March, 2010) 12. Walayat, N. (20th January, 2009). FTSE 100 Stock market forecast 2009. Available at: http://www.marketoracle.co.uk/Article8366.html (Accessed on 16th March, 2010). http://www.princeton.edu/~ceps/workingpapers/91malkiel.pdf Read More