A good tale can tempt us to forget the truth about markets

The author is the editor-in-chief of Money Week

One thing the stock markets are good at is storytelling. Every bubble, every change in market sentiment, comes with a good thread. You can even characterize a market as a story competition – the best that knows how to provide the framework for the winning investment strategy.

Take a closer look at the market, and you will see that everything people say about stock market driven by models and math is not really true. We heard the story of Bitcoin – how cryptocurrencies would save us in an era of government over-achievement and collapse of funds – long before the models that compared its market value to that of gold justified a forecast price of $ 500,000.

The same is true of ESG investments (the one that has an eye on environmental, social and government issues).

The story goes that if fund managers just get over it and focus on non-financial issues, we can avoid another financial crisis and everyone will also make more money. The problem with this narrative is that for years it did not have a real statistical base – before that, that is, the growth bubble gave it some happy numbers to work with, mainly because most stocks that fit ESG models are also growth stocks.

The same is true of the growth momentum itself. Stories tend to come before the models that back them up. I think the market participants all know this is true. But contact Nature magazine and you will get a hint of how this may be the case in many professions. The journal cites a recent academic paper researching theories on the relationship between consciousness and neural activity (which are more relevant to Markets Than you might think, by the way). The authors of the article note that most studies “interpret their findings after occurrence, and do not examine a priori critical predictions of the theories.” In other words: stories before all.

This is unfortunate in the markets (fun, of course, but unfortunate) – because, unrestricted by the absolutism of environment-first-models, we tend to take things to extremes and expand our stories to the point where they become nonsense. And so it has been with the great growth momentum of the last decade.

The story started well, with the recognition that the potential for growth in technology in particular was underestimated in the wake of the 2008 financial crisis. The market for growth stocks and value stocks.

Those who have been investing in the past have spent the last decade mocking as losers on the part of the former. And those who invested in the former invested in it as optimistic fanatics on the part of the latter. Like I said: fun, but too bad that in the end the difference is less obvious than it seems.

An up-to-date comment by Ben Inker on GMO looks at the pitfalls you may find yourself in with both. One of the things growth investors like to take value investors on a mission for is the risk that they will end up investing in value traps – that is, stocks that look cheap on the basis of valuation but simply continue to be cheaper because both have “disappointed in earnings over the past 12 months. “Also a decrease in the revenue forecast in the future.”

The criticism is absolutely correct. Inker notes that each year “about 30% of the shares in the MSCI US Value Index turn out to be value traps, and they exhibit less than that index by an average of 9%.” However, there is something more common than a value trap: a growth trap.

Every year about 37% of the shares in the MSCI US Growth Index turn out to be disappointing in current and projected revenues. They yield a low performance on average of 13 percent. (Stock growth has had a terrible year), and when stock markets hate uncertainty even more than usual, it does matter.

As Inker points out, value companies are already cheap by definition, so the pain of disappointment usually does not mean that valuations go down much. But growth stocks are valued solely on the basis of growth expectations. Without it they are nothing – so you can expect a very dramatic fall. What they have. Over the past 10 months, growth traps have demonstrated a 23% lower performance of the growth universe. Not long and they will be value stocks – or for that matter value traps.

There is a lesson here. Good stories make us forget the enduring truth of the markets: unless you are a very rare trading genius, in the end your returns will not be a function of the stories you most believe in but a function of the price you paid in the first place. There is no point in saying do not hold on to value traps or, more importantly, growth traps – no one does it on purpose.

A better way is to remember that when reality hurts stories, reality wins. Last week there was a rally in the markets. A perfect moment to leave the settings (and ridicule), rise above the stories and try to wriggle out of the traps.

A good tale can tempt us to forget the truth about markets Source link A good tale can tempt us to forget the truth about markets

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