Nah…you just ain’t seein’ the ball

When I hear someone mope “the market doesn’t care about fundamentals” I change the channel.

Market prices are a collection of point spreads. I don’t really understand the logic of such an argument.

If the relationship between fundamentals and returns were easy to understand in advance, then price would adjust to make the trade hard. A “cheap” company that stays cheap is implying a low future ROIC. If you buy shares and the company is able to find better opportunities to re-invest its capital than what was implied, you’ll win.

But it’s going to take time to find out. You can’t make a statement like the “market doesn’t care about fundamentals today”.

Moaning that NVDA is unmoored to fundamentals, besides being underperforming-the-index cope, is comparing something you can see (a price) to what you can’t (what happens later). The price itself is mostly driven by the future. You can’t evaluate if the price did a good job until the later happens.

And even then you can be fooled.

In my early SIG days I remember Jeff gave a talk arguing that the dot com boom then bust wasn’t irrational. You only needed to look at the options market to see why.

A price is just an expected value — if the underlying distribution is highly uncertain, exactly as you might expect the distribution to be in 1999 when the internet and fiber promised to change the world. The price of dot coms are bounded by zero so they have no choice but to go through the roof based on such world-changing mathematical expectation. But option surfaces make higher resolution statements than the 2-D nature of a share price. [See the Market Innovation section]

AMZN used to be a 250 vol name. Stick 250 vol into a 1-year option price and look at the difference between the mean and median expected stock prices (median = geometric mean)

The options market said the stock was probably worth zero.

[Relevant reading: this post about the windowmaker is a lesson in what option butterflies mean]

And the options market was right for many of the dot-coms.

In fact the AMZN we are familiar with today is a delightful justification of the prevailing pricing back then — some company is going to reach breathtaking proportion if this tech is as important as we think. We just couldn’t predict which one. And in fact, owning the basket and following a index rebalance algorithm that sheds the losers (aka the Nasdaq index) worked out just fine because AMZN made up for

[Fun fact: iirc, AMZN did end up trading down to the implied mode, ie the most expensive butterfly, in the early 2000s washout.]

You can disagree with share prices. Your portfolio is how you disagree. And when the “later” happens you’ll find out if the future fundamentals were well anticipated by the today price.

I’ll be blunt. When I hear investors bitch about prices vs fundamentals I just hear a confession. “I can’t see the ball clearly anymore.”

Which is exactly what you should expect to happen in a competitive red queen domain unless your learning rate increases faster than the market’s lesson-internalization script runs.

Competing for provable alpha, the type that sits on many reps lending itself to statistical summary, means playing the trading game. Finding mispriced coins that will be flipped in the short term. Similar to arbitrage-inspired trading where futures and options expirations are a catalyst for convergence between prices and reality.

The competition for provable alpha is fierce. However the focus does open the door to alphas from having a long horizon. Long-term investors call this “time arbitrage”. That’s more of a clever marketing term than an investing phylum but it does hint at the reality of investing. (The fact that there is alpha in having a long-term horizon is also convenient cover to say “ignore our short term results”.)

You are unlikely to find the kind of provable alphas that are easy to raise money for. In fact, most investors who have such alphas don’t need or want your money. The “time arbitrage” people will happily take your money though. And you won’t be able to prove if they have alpha (otherwise you’d never hear from them), but this also means it’s the only chance you have of investing with someone who has an edge.

You just won’t know until later.

And even then you might still not know.

[Unless they boot you as an LP. Then you definitely know.

“Wait so if I pick the best horse my reward is being asked to redeem?”

Sorry, there’s no luxury more protected than a sure-fire compounding machine. You can buy your way into almost anything else from sex to a trip through space — but if you try to buy your way into a money copier the price adjusts until the ink runs out.

(Actually, as “strategic” investors know, you can buy your way in with other ways to add value. But nobody’s money is greener than another’s.)]

A couple pieces I’ve read recently suggest market prices are doing their job. And also enlightened me on a significant (and not what I expected!) reason for “value” underperforming.

[Emphasis in the excerpts is mine]


The rest of the post is on Substack

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