Monday, September 30, 2019

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‘Miracle on Wall St’

History is riddled with moments where things were uncertain, and yet years later the economy was bigger and stocks were higher. This is why investors should be measured when they think about the uncertainties of today.

This may begin to explain why things may seem so terrible today, and yet markets reflect a much more bullish story. Bank of America Merrill Lynch strategist Michael Hartnett calls it “Miracle on Wall St.”

“Yield curve inversion, US-China trade war, recession in Germany, collapse in Chinese industrial production, contraction in global profits, oil price spike, BREXIT, Trump impeachment inquiry, Argentine default/Ford downgrade/Thomas Cook bankruptcy...yet risk assets close to all-time highs and US stocks on course for 30% annualized returns, global stocks 24%, commodities 17%, global IG & HY bonds 14%, US Treasuries 10%,” Hartnett said in a note to clients on Friday.

“Breathtaking stuff.”

But maybe, the market is overweighting what may be a much brighter future ahead.

There’s actually some very sound theory to support all this. In theory, the value of a stock can be derived by calculating (or estimating) the present value of a company’s future cash flows. More or less, it’s the value of all the potential profits that a company will earn as long as it exists. Warren Buffett calls this exercise (a.k.a. discounted cash flow analysis) the “ultimate formula.”

The theoretical value of a business based on this formula overwhelmingly depends on the future, not the present. This is why investors line up to buy the IPO of an unprofitable young company — it’s a bet that the company will eventually turn profitable and generate the kind of profits to justify that billion dollar valuation.

By extension, the stock market is also about the future. Sure, the near-term future is often an extension of the present. And to be crystal clear, none of this is to say that the market doesn’t get hit by its bouts of volatility, especially when massive macro forces like international trade policy threaten to put a dent in the global economy.

But the long-term future... who knows what the long-term future will be driven by, but the world seems to like things like innovation, growth, better quality of life, and all those things that drive economic growth and value.

And so perhaps the miracle is not that the market would go up amid today’s bad news. Rather, the miracle may be that investors and traders are level-headed enough to be positioning for a future that looks a lot better than what we’re seeing today.