At the end of 2019, the index of Australia’s top 200 public companies, the ASX 200, had been on a tear for 12 months, increasing in value by an impressive 23.4%. Then, in four weeks, the market fell 40%. WTF happened?
Coronavirus has materially impaired the short-term investment outlook for almost every company. The global pandemic is forcing people all around the world to stay inside, not spend money and close their businesses (hopefully temporarily). This inevitably results in consumers spending less money.
People aren’t taking out loans to buy houses, cars or to start businesses. They stop buying clothes, eating in restaurants, drinking in bars and travelling interstate and overseas. They spend less on dry cleaning, coffee and furniture.
If you did grade 10 economics, you might remember the principle that your consumption is someone else’s income. If nobody is spending, nobody is earning. Subsequently, the business owner has to lay off staff to reduce expenses, which causes less spending and less earning. It’s a vicious cycle.
Every company on the stock market is counting on you to consume their goods and services, at a margin, to make them a profit. Now that you are spending less, or perhaps even nothing at all, those companies’ profits will likely fall and the share market is now trying to predict how much they’ll fall by and for how long they’ll stay low.
This partly explains why, as the situation evolves, we’re seeing the price of shares go up and down like a yo-yo, as investors try to work out how a new piece of information is likely to affect a company’s profits both this year and beyond.
The share market, in the short run, is an aggregated ‘best guess’ at an uncertain future and is incredibly susceptible to a range of proven biases.
Fortunately, rather than price reflecting our fickle short term expectations, long term share market returns are significantly more aligned with intrinsic, practical, rational metrics that reflect a company’s ability to generate profits, pay dividends and grow sustainably; the true value of investing your money in a company.
To quote Phillip Fisher, author of “Common Stocks and Uncommon Profits” (a guide to investing that has remained in print ever since it was first published in 1958): “The stock market is filled with individuals who know the price of everything, but the value of nothing.”
“This article is of a general nature only and does not consider your objectives, financial situation or needs. You should consider the appropriateness of the information in light of your objectives, financial situation and needs before acting on it and obtain copies of any relevant disclosure documents.”
Luke Laretive is the CEO and investment advisor at Seneca, he provides clients with a weekly note, which you can access here.