Voting Machines vs. Weighing Machines
“The test of a first rate intelligence is the ability to hold two opposed ideas in the mind at the same time and still retain the ability to function” – F. Scott Fitzgerald
If you’re feeling at all like I am, the past few months have really been a challenge. It has been a constant battle to keep focused, stay optimistic and make sense of everything that is going on in the world. I feel the mental fatigue that comes from extended periods of time away from family, friends, clients and the normal parts of life that I dearly miss.
The latest news moving the financial markets and making headlines is the frenzied buying in the stocks of companies facing pressure from short sellers.
In some cases the stock prices have moved hundreds of percent in a single day. The story seems to be as much about the source of the volatility – the origins of the trading come from the online chat forum Wallstreetbets on Reddit - that has exploded in popularity at the same time that online stock trading has become free through smartphone apps.
The trading moves have focused on stocks that had heavy “short interest” – stocks that Wall Street firms and hedge funds were overwhelmingly betting would go down in price. Traders on the other side seem to have stuck it to the short sellers by driving the stock prices up, causing huge losses for short sellers.
All this seems to have unnerved the broader stock markets this past week. Whether the headlines drove the selling is hard to say, but markets were down sharply after a good start in the month of January and a very strong finish to 2020.
The volatility brings to mind one of those quotes that Warren Buffett is known for: “in the short run, the market is a voting machine … but in the long run, the market is a weighing machine.” (The actual quote is credited to Buffett’s old boss, Benjamin Graham, but it appeared in Buffett’s 1994 annual shareholder letter.)
Clearly the “votes” in the market have been in favor of the beaten down companies in the short run – it is exciting to bet on a stock and see it move up 50 or 100% in a day! Some traders have profited even more by using options to leverage their bets on these stocks. The pleasure of winning on bets like that has to be even greater when you’re taking it out of the hide of a hedge fund. I’d venture that hedge funds are about as well liked as pandemics, lockdowns or polar vortexes.
At some point the “weighing machine” function of the markets will kick in. I’m not knowledgeable enough to know when that will be but I don’t have any doubt it will happen.
Markets have a way of finding the right price for a business over time and I don’t think this time is any different. The “weighing machine” is the way the market accounts for the earning power of a business over time and pricing the shares of ownership in that business based on their fundamentals. A successful company with strong future earnings power will end up with a bigger “weight” (higher stock price and higher market value) in the long run.
Back to the F. Scott Fitzgerald quote – it has been a challenge to keep a clear mind about how the markets have reacted to the events of the past year. The dramatic drops of March and April contrast sharply to the amazing rally back to all time highs in recent weeks in the face of election uncertainty, riots at the Capital and the market upheaval last week.
Making sense of all these events challenges us to separate our emotions from actions in investing and hold two competing ideas in our minds – on one hand the ever growing impact of the virus and on the other hand the potential for strong economic recovery that is reflected in the markets. As an investor, balancing these opposed ideas and continuing to function may be truly be the challenge of our times.
Stay healthy, stay safe and keep the faith!