Should You Believe In Markets?
Academics have for years debated the ‘Efficient Market Hypothesis’ (EMH) – ie the extent to which the stock market is efficient and reflects all the information made available at any given time.
The EMH maintains that all stocks are ‘perfectly priced’ according to their properties. Many investors, whilst accepting stocks will go up and down, assume that EMH will give them some security, without delving into the ‘fundamentals’ of the company they are buying, or its valuation.
Written by Jonathan Wade
Director
This week, it’s the three-year anniversary of one of the strangest financial market events ever.
On 20th April 2020, the price for of the West Texas Intermediate Crude Oil contract went negative.
Although this market oddity only lasted a day, it was an extremely visible signal of just how strange the world was during the early days of COVID-19 lockdowns – and a great reminder that in times of panic, financial markets don’t behave rationally.
Here’s another incredible oil-related example from the same period.
In mid-2020, Shell and BP were the fifth and eighth biggest oil companies in the world, between them employing 155,000 people, and generating $199 billion in sales.
At the same time, Zoom Video Communications had 2,700 employees, and was going to do around $620 million in sales in 2020.
Now of course, 2020 was the year of Zoom. It became one of the key tools in our day to day lives – working, socialising, pub quizzing and so on. Even so, it wasn’t more important than ENERGY!
But investors were panicking, thinking that no-one would ever go outside again – bidding up anything virtual, and selling down anything related to the real world.
Which led to this surreal situation in October 2020 (circled), where Zoom was a $160 billion company, while BP and Shell were worth just $150 billion – combined!!
Source: Bloomberg/7IM
Fast forward to today though – away from the COVID-19 claustrophobia and panic – and markets have re-evaluated.
Video calls are still important, but maybe not the ONLY thing in the world.
Oil is back at around $80, BP and Shell are worth more than $300bn and Zoom is worth around $20bn. \
Decisions made in one-off scary or stressful moments are often affected by our emotions. What feels sensible at the time, can end up seeming surreal a few months later …
Now, more than ever, ‘fundamentals’ – the rational analysis of a company and its valuation based on ‘known knowns’ and ignoring ‘noise’ and speculation – is vital. Whilst background macro trends and technological developments are important, they should always be viewed in the context of basic stock valuation parameters.
There are two lessons to be learnt from the above example. Firstly, assuming the EMH will protect you can be dangerous – markets are often highly ‘imperfect’. Secondly, following trends or acting on short term ‘noise’ driven by events such as Covid, or Russia’s invasion of Ukraine, can also be dangerous.
Fundamental company research and valuation based on objective measures is essential and is at the heart of our investment process.