This was a week of many lessons. And when the market teaches, one must pay attention.
Let’s start with Apple. AAPL had a stock split on the 31st of August. If you owned 100 shares of Apple priced at $499.24 each at close on the 28th, you woke up with 400 shares of Apple priced at $124.81 each on 29th morning.
What happened next is the “stock split” effect. Apple stock rallied close to 8% in the next two trading days. Apple is one of the most followed stocks globally and the split was announced in advance. Stock splits are well studied in investing literature. The consensus is that, on average, stock splits lead to a small increase in price.
Why it happens is a bit of a mystery?
A stock split is what can be termed as a purely cosmetic exercise. It does not change the economic interest of any investor in the company nor does it have any impact on any fundamentals of the company for future investors. All it does is that it makes the stock price “cheaper” and that is enough for some investors to value it more and drive the price higher.
Now before you laugh at this, do note we have something similar happens in India as well – the Mutual Fund New Fund Offering (NFO). For long NFOs were sold as cheap because of the low starting NAV of Rs 10. The “advantage” that the investor got was they got more units for the same Rs 1,000 investment than a comparable fund in the same category. Even today, unscrupulous distributors will market the “advantage” of owning more units as NAV is only Rs 10.
The second lesson is on Index inclusion. Again an event that does not change the fundamental prospects of the stock but can have a significant impact on the stock price – but this time with some reason. Take for example the case of Salesforce. On 25th Aug Dow announced that Salesforce will be included in the Index as of Aug 31st. The stock popped ~25% at open on the next day i.e 28th Aug.
While index inclusion in itself does not change the companies prospects, it changes the liquidity in that stock. Every index fund tracking Dow 30 index is required to add this stock to ensure it continues to track the index well. The buying that ensues pushes the stock up.
At one point active managers could make significant alpha just by predicting index changes. But then the strategy caught on and the excess returns from this strategy all but disappeared. So, what happened to Salesforce is an exception, as the event was unanticipated.
This is also a good reminder that if a lot of investors are using similar strategies, the excess return from that strategy disappears quickly.
Closer home, YoY India’s GDP declined by 23.9%.
But the market was unperturbed. It didn’t care much. As it turns out the market cares about the economy, but more so of the future economy. The market is the weighted average of what investors think will happen in the next few years and not what just happened. It discounts expectations and adjusts for surprises against those expectations.
In this case, the markets crashed ~36% by March in anticipation of weak future numbers (earning and GDP) for the next few quarters. The information was incorporated in prices as quickly as it was widely accepted to be happening. So when the data did actually come out, it was not that big of a surprise and investors were prepared for it. The subsequent financial easing post-March has brought the market back to previous levels. But the jury is still out on whether what was done is enough.
The common thread in all the three examples is that prices move too much. Prof Shiller of Yale says it best :
‘Prices fluctuate too much to be explained by a rational process.’
It is hard to believe that investors expectations of future changes so dramatically and so quickly. The volatile price moves we see so often are the biggest mystery. The price moves, though, are unpredictable. So, regardless of what all those trading seminars say, you cannot reliably profit from the price moves. Your best option is to ignore these short term price changes and stick to long term plans.
CEO | kuvera.in
In this week’s episode of Kuvera QuickTakes, Ajay Tyagi (CFA), Fund Manager & Executive Vice President – UTI AMC and Neelabh Sanyal, COO & Co-Founder – Kuvera.in speak about the patience horizon when investing in Mutual Funds
Check what happened in different markets this week here.
1/ SEBI has revised disclosure requirements for debt and money market securities. With effect from October 1, fund houses will need to disclose details of transactions with a lag of 15 days from the current allowed time lag of 30 days.
2/ SEBI allows Mutual Funds to side pocket debtin cases where borrowers approached the AMCs for debt restructuring amid Covid-19 pandemic. If the restructuring by the lenders is solely due to covid 19 related stress, the credit rating agencies may not consider it as a default event.