Third time lucky: We know the value of nothing and yet the price of everything

November has brought new hardship to virus-ravished Europe, with yet more lockdowns, more isolation and less economic certainty than ever before, yet stock investors were buoyed by an incredible series of good news: Joe Biden was elected President of the United States, signalling re-engagement with allies, international agreements and supranational bodies; Dominic Cummings, the sinister Rasputin in Boris Johnson’s UK government, had to pack up and leave; whatever Brexit-Europe will have to deal with, let’s call it a deal; historic rivals Japan, China and South Korea have joined a group of southeast Asian countries, including Australia and New Zealand, in a new trade enhancing agreement, the Regional Comprehensive Economic Partnership – a boost to world trade; and two vaccines against COVID-19 proved to be unexpectedly effective, marking a turning point in the pandemic.

What was called “risk on, risk off” in the past, describing the fluctuations in investor confidence, may be called “lockdown, unlock” now. The aggregate, astounding advance of stock market indices since its nadir in March papered over quite diverse corporate fortunes, which were regularly graded by market participants according to the pandemic’s expected time horizon. Lockdown-winners like Zoom, Amazon, Walmart and Apple competed with unlock-winners like travel, hospitality, or aviation for gain. What’s odd in these alternating narratives was the lackadaisical approach towards cash flow generation. The financial shape of both momentary winners and losers seemed not to matter. ‘Champions’ were never overly scrutinised.

Stock investors are influenced by economic theory, which changes over time as underlying conditions shift. For investors, politicians and economists, the stagflation of the 1970s was as unexplainable as the seemingly disappearing inflation today. Keynesianism gave way to Milton Friedman’s monetarism, to be replaced by Keynesian Modern Monetary Theory, which claims that governments of developed countries have much more leeway to print money with impunity. Without inflation, money cannot be debased, no matter how much of it is ‘printed’.

While economic theories come and go, some stock market ‘laws’ are cherished no matter what. The market’s price-finding mechanisms are unfailing and rational; value beats growth; small beats big; what goes up must come down; shares trump bonds in the long term, and such. Scientific rigor would demand that theories are only valid until proven wrong. Stock market theoreticians are less scrupulous, taking contradictions in their stride. Most axioms have a longer life than the circumstances for which they were drafted. Think of portfolio ‘insurance’, or ‘beating beta’.

When Yasuo Goto, a Japanese insurance magnate bought a version of Van Gogh’s Sunflowers at Christie’s in 1987 for almost USD40 million, it was the most expensive picture ever auctioned. The price seemed ridiculously high at the time. Who would have thought that three decades later a Saudi dictator would buy a Catholic sacral painting, the Salvator Mundi, perhaps daubed by Leonardo da Vinci, or perhaps not, to decorate his private yacht for USD450 million? Shortly after the Sunflower acquisition the Japanese stock market crashed, never to regain its former glory. If anything, we have to admit that our understanding of events is limited.

Take ‘value’ investing. The idea is that companies that are priced at just single-digit multiples of their earnings, or less than their ‘book value’ are ‘undervalued’, hence prone to disproportionate share price hikes in the future. The opposite camp, the proponents of ‘growth’ investing, ignore astronomical share valua­tions and even a total lack of profitability, in the hope to reap disproportionate gains in a bright, yet distant future – once the world succumbs to the novel, all-beating, business idea.

Such share price movements reflect raw investor sentiment, as opposed to long-term value

It is not difficult to see that both approaches can just as easily fail as triumph. Impressive earnings, hence ‘value’, can be achieved by cutting investment, research and development and a general hesitance to innovate. Not much of a future here, no matter how excellent the value parameters. R&D, moreover, is accounted for as an expense, not as an asset acquisition, thereby diminishing stated income.

Growth without the concept of eventual profitability on the other side should not have much appeal either. There’s a categorical difference between growing like Amazon and growing like Uber, between reinvesting pro­fits and burning capital. Besides, for us retail investors, truly captivating growth stories are beyond our reach anyhow, as the most promising start-ups and business ventures grow with the money of venture capital, private equity, or wealth funds long before they list on a stock exchange. This scarcity of innovative debutants on the stock market explains the excitement for a handful of companies which can signal progress, like Tesla, Zoom or Snowflake.

It is said that the stock market is lately boosted by retail investors and their unbridled excitement. Thinking of the monu­mental powers of index investing, the trillions flashed by asset management, or the firepower of central banks, I find this hard to believe. Yet what should be recognised are the ping-pong movements caused by the untamed emotional forces of the COVID pandemic. Looking at the advances and retreats of stocks which are hammered by lockdowns and lifted by hopes for a final cure, I have lately resorted to buying and selling the same stocks multiple times.

This has little to do with the intrinsic value of a company, which may not even survive in the long run, but rather with milking market sentiment as best as I can.

Carnival plc is the world’s biggest cruise line operator. It is a business that promised last year to go through the roof in 2020, while it is actually going down the drain. Carnival had to scrap ships before their time, to accept delivery of new ships ordered in better times with chagrin, and has them all pledged for rescue cash while these glittering behemoths of the sea moor idly, at enormous costs. No new business in sight. The second-quarter 2020 financial statement indicates zero income, a loss of USD2.7 billion in three months, and survival money collected from shareholders and banks to the tune of more than USD8 billion. If you are not a visionary like the guys managing Saudi Arabia’s sovereign wealth fund, you’d say “not for me”.

Yet the ‘ping-pong’ demands attention. From GBPp 600 in March, Carnival’s shares advanced to 1,573 pence in June. They fell to 800 pence in August, and are now valued 1,200p per share – a potential trading profit of 160 per cent and 50 per cent respectively, if timed correctly. Note: this does not reflect the ability of the business to eventually make money, or estimates of how much. It is not even a verdict on its continuance.

Such share price movements only reflect raw investor sentiment, as opposed to calculating income streams or estimates of long-term value. Betting on the ping-pong is a fool’s game, but quite addictive. The same effect can be observed with airlines, aircraft manufacturers, hotel businesses, or travel companies. No one can safely assume their future, but the up and downs are pretty predictable for now. Crazy.

The purpose of this column is to broaden readers’ general financial knowledge and it should not be interpreted as presenting investment advice, or advice on the buying and selling of financial products.

andreas.weitzer@timesofmalta.com

Andreas Weitzer, independent journalist based in Malta