Maths and the markets
‘Do not worry about your difficulties in Mathematics. I can assure you mine are still greater’ – Albert Einstein
After last week’s biggest positive performance week for the S&P 500 since January 2013 there is a tentative feeling of ‘back to the norms of the last few years’ out there. I say tentative because I think many of the more experienced market participants realise that the volatility of late January/early February was a warning that the investment backdrop is changing: bond yields are edging up, there is a little bit more inflation swirling around and we are entering a different world where progressively stimulus by global central banks is being hauled back.
With stock markets it is easy to get swayed by recent performance and the last few weeks have seen sentiment shift from euphoria to fear to (judging by the above S&P 500 performance statistic) a re-establishment of hope.
I always think there is a danger in becoming too fixated with short-term market moves because by far and away the most dangerous mathematical concept in markets is not high valuation…but extrapolation.
Let me explain a little more. We have noted before in these write-ups that the old expression that ‘in the short-term the market is a voting machine…and in the longer-term a weighing machine’ has more than a hint of truth to it. Over a period of a few weeks or even a few months or quarters faith, hope and even euphoria can buoy share prices (or in the reverse case of fear, disappointment or panic induce sharp falls in share prices) way beyond what a reasonable ‘weighing machine’ appraisal of the truer value of their profit and cash flow levels. And there is nothing that buoys the voting machine investor more than rising share prices or index levels. This is why extrapolation can be so dangerous from performances such as last week as it can often take share prices or an overall index further away from a more reasonable ‘weighing machine’ level.
Far more useful is correlation. One of the keys in managing an investment portfolio is to try to have investments that do not all do the same thing at the same time. One of the rationales for launching the Global Dynamic Opportunities Fund was that we perceived that the correlation levels between individual shares would fall as some of the macroeconomic trends including the aforementioned rise in bond yields and end of the era of material stimulus from central banks. The good news is that this has continued to happen and this bodes well for identifying an interesting collection of portfolio names to own. Far more interesting to me per se than a record week for just over five years on a leading global stock market index.
Ahead of a big week for UK financial sector and US retail sector earnings a quick update on some portfolio composition shifts. We took some good profits on the US advertising name Omnicom as perceptions towards the sector shifted from fear (when we bought) to a more optimistic viewpoint. We invested additional monies into three existing Fund holdings (IBM, Disney and Schlumberger with other new investments under consideration.
Chris.firstname.lastname@example.org Chief Investment Officer Dynamic Opportunities UCITS Fund