Hello!
I know, you missed me in the 3 weeks or so I have been away. But family commitments yo!
I went to Chennai and spent a few days in Pondicherry. I did absolutely nothing and it was everything I thought it could be. The Maplai was treated with much deference and I was fed until I looked like I was about to pop a baby.
I also discovered that my wife’s uncle is good friends with my first boss. Now I am mostly worried I will be judged heavily once they exchange notes about me.
Ah well, can’t be helped….
Today, I thought let’s explore a mildly interesting way of looking at markets. Again, just mildly interesting. No big revelations will be had here. You've been warned.
1. Markets gone Wild
Unless you live under a particularly dense rock, you have been affected by the recent events. Markets have gone, up, down, sideways and then some. My Twitter feed is full of all kinds of opinions which are simultaneously predicting the imminent arrival of Utopian Edens and the collapse of civilization as we know it.
So, being the data driven steely eyed market operators that we are, lets begin with what the Nifty VIX looks like:
OK. Predictably, lots of movement. You can see where Vol went crazy Late Feb / Early march when Putin decided to point to Ukraine and say - “Mine”.
How are we to deal with this shit?
2. Voting Machines and Weighing Machines
Lets go to one of the heavyweights of the pantheon of markets gods - Benjamin Graham.
He is reputed to have quipped:
"In the short run, the market is a voting machine but in the long run it is a weighing machine."
Sage words, but what do they mean?
In the short run, the market is like a voting machine - tallying up which firms are popular (Zomato, PayTM in 2021) and unpopular (Zomato, PayTM in March 2022). Winning here involves figuring out what others will prefer and making use of that information.
But in the long run, the market is like a weighing machine - assessing the substance of a company. What matters in the long run is a company's actual underlying business performance and not the masses’ (fickle and uninformed) opinion about its prospects in the short run. Weighing machine approach uses the concepts of intrinsic value and durability to gauge what anything is worth.
Put another way, psychology and emotion can sometimes cause markets to ignore to overreact or underreact to fundamental information, thus affecting a share price, but eventually, the fundamentals win out.
The key word is “Eventually”. One can spend a lifetime contemplating the meaning of this word.
3. Test, ODI and T20
If you see the activity on twitter, you can broadly see a few types of investors. Most people seem to trade on momentum and recency bias - effectively playing T20. Some play ODIs, holding the stocks for medium term and a much smaller group plays test cricket. Now, the idea of this note isn’t to come to what is a better format (such as it relates to the markets), but to point out that one should play the game one can play. Putting VVS Lakshman in a T20 matches can be underwhelming in the long term (even if all of them are against Australia).
Now, here is the funny observation. Most people claim they are test players. In reality, a vast, overwhelming majority of the market plays the T20 pinch hitting game. Most pretend to be Weighing machine investors. We don’t want to be seen as one hit wonders. and the gods of investing have told us that fundamentals are all that matter. Of course, respectability doesn’t factor in the fact that most people have made their wealth by capitalizing on short term distortions.
So, we are really voting machine investors claiming to be weighing machine investors and in the process it seems we are deceiving ourselves more than anyone else.
Think about it. The only people who are really sitting pretty in the market today are the ones who had enough spare cash in March/April 2020 to deploy in a big way in the markets. Now, unless they had someone telling them that the weighing machine was going to go full tilt in March/April 2020, most played the Voting Machine game. You either had idle cash or you didn’t.
Moral of the story: same shit, different day….
4. Voting in Disguise
Even in situations where it seems like weighing is going on, it might be just voting disguised in such a way that it seems to be something it isn’t.
For example, were stocks driven up in 2021 because Covid-19 made for a great business environment? Were we pricing in good performance on the back side of recessions? Or were we just buying them because everyone else was?
Now, this is a good time to make a confession. Ben Graham never really said the utter pile of horseshit above. The quote is taken from something Warren Buffett said when referring to Graham. Here is what he actually said in Security Analysis:
“In other words, the market is not a weighing machine, on which the value of each issue is recorded by an exact and impersonal mechanism, in accordance with its specific qualities. Rather should we say that the market is a voting machine, whereon countless individuals register choices which are the product partly of reason and partly of emotion.”
So, Markets are a voting machine, which sometimes factors in fundamentals - often only when it is forced to. That would explain PayTM’s dizzying fall to a quarter of it’s listing price.
5. Are Fundamentals irrelevant?
Although the market is almost always a voting machine, I also believe it is a rational one in the long run1. And when investors are rational and are buying shares of businesses, eventually the cash flows generated by those businesses will matter. The principles that ultimately drive the intrinsic value of a public company are the same ones that drive the value of a private one. At some point the cash flows have to be there or investors will turn their attention elsewhere.
We have been (for some time) in a unique situation in the past decade where capital has been widely available and rates have been near zero. In a situation like that, companies don’t need to rely on their own cash flows to fund their businesses2.
When that changes, companies that are able to fund their operations internally will likely have a huge advantage. And companies that have relied on debt and ultra-low borrowing costs and FOMO will likely have that weakness exposed (once again, PayTM and Zomato). But that day could be further out than many of us who invest using fundamentals would like to see.
In the end, I think those of us who hope that the market is a weighing machine in the long-term have to accept that there will always be periods where weighing won’t occur. Similarly, those who endorse that view that the market is a voting machine need to accept that the day will likely come when cheap money isn’t as widely available as it is now and that voting will be more based on fundamentals than it has been in recent years.
When that will happen, however, is anyone’s guess.
In the long-run I continue to be a believer in the quote I started the article with, even if Graham never said it.
JPM Payments Report
While I was away, JP Morgan wrote a pretty decent Payments report. While I may raise questions about the rigour or the "Captain Obvious” takeaways from it, it has great data, pretty charts and an useful mnemonic using the word POWER. Here is a link:
Housekeeping
As always, I look forward to hearing from you. If you liked this post, pls feel free to share this or subscribe to this newsletter using the links below. While I have been tardy of late, I try to write a 1000-2000 word essay once a week.
to believe otherwise will cause me a lot of existential angst.
Example - every single fucking unicorn splashed on the pages of the business newspapers