One should never underestimate the ability of Trump to surprise the markets and indeed the world. The ceasefire in the Tariff War lasted a full 36 hours before a Tweet Storm from President Trump unsettled the markets. Recently, the CFO of Huawei Technologies was arrested in Canada for extradition to the US on suspicions of violating the US sanctions against Iran. This has all the potential to flare up the spat between the US and China again and markets are back in their risk off mode.
Brexit appears to have been all but bungled by Prime Minister May, who narrowly survived a vote of confidence in her leadership. For a while, there was more uncertainty than ever about where the world’s 5th largest economy found itself, which reinforced the justification of a risk off approach to the markets. It would appear now that May’s Brexit will prevent the “Cliff Edge” version and allow for time to adapt to the UK outside the EU.
With this backdrop, it is worth understanding what you are buying when buying a share.
The price of a share reflects market participants’ collective assessment of a company’s future prospects (cash flows and growth) into perpetuity, discounted back to today. Share prices move as market participants adjust their views on those inputs (cash flows, growth, discount rate). To the extent investors are in a heightened emotional state (e.g. euphoric or depressed) the more extreme those underlying assumptions are likely to be.
The chart below is a simplified model of the market’s price discovery process. In the short-term market participants tend to place more emphasis on ‘noisier’ factors – Trump, Brexit. Over the long term, a company’s underlying fundamentals are the key determinant of its share price performance.
One exercise is to infer what the market is assuming with respect to those inputs. Stock after stock, this analysis is consistently revealing that market participants’ assumptions are bearish. Perhaps counterintuitively, this is a good thing. To the extent that bad things do happen, the impact on share prices should be reduced – as that’s what they’re already expecting. If actual outcomes range between ‘somewhat bad’ to ‘good’, your shares should do nicely.
An important point is that shares are part ownership of a business. Do you think Jeff Bezos says “Things are just too uncertain right now, I’m going to dump all my Amazon shares”? Does Larry Page say to Sergey Brin, “B-dog, the yield curve is about to invert, let’s sell our Google shares and load up on treasuries”? Would Mark Zuckerberg trim his Facebook holdings pending the finalisation of the Brexit deal?
While market participants fret over noise, business owners focus on fundamentals. The fact that almost nobody thinks this way likely means that a longer time horizon is one of the only remaining edges left in public markets.
Future returns are like the tank of fuel in a car. When valuations are high, the tank is closer to being empty and the driver won’t get very far. When valuations are low, the tank is full and the driver can travel a great distance. Right now, the tank appears fairly full – there is a long way to travel over the next few years, even if we can’t control the speed or the bumps in the road.
Written exclusively for Moore Stephens by Anchor Capital