When we were in high school we were in a band called Felix Flux and the Flemtones. We had it all: the looks, the clothes and the attitude—however that talent thing got in the way getting our star on the wall of First Avenue. What we lacked in talent we compensated for in volume. The Flemtones were loud enough to drown out a fleet of garbage trucks, and we provided about the same audio enjoyment. Luckily our time horizon for the band was short-term fun, in the long-run we would have starved.
The stock market volume as measured by both a return and market multiple basis has been increasing as well this past year. Thankfully we are not writing about if the market is correctly valued at this point in time. Rather, we are wondering what is the investment time horizon the market is implying with current multiples. Theoretically speaking one can back into that number at a certain spot in time via various methodologies, e.g. Black/Scholes, but we do not think that tells the whole story. After all investing is putting a value on future cash flows—therefore adequately predicting the length of time of future cash flows will be discounted by the market is as important as accurately predicting such flows in our opinion. Our question therefore is what is the market’s implied time horizon in the future?
Of course, the correct answer is “it depends” as the market is nothing but an amalgamation of millions of individual investment decisions. But as we remind ourselves every day, we are not always trading with humans. With a good percentage of the market’s volume is done by computerized and algorithmic trading, one can make the argument that the market’s time horizon has been and may continue to shrink. Additionally many institutional investment firms are judged not on a multi-year or even yearly basis—oftentimes it is quarterly. Sometimes in our more cynical moments we think that the market time horizon is the amount of time between Fed announcements. Finally, anecdotally speaking, the past several earnings seasons we often observed certain stocks going up on “beaten” earnings estimates that had been lowered relentlessly throughout the preceding quarter, which also may point to a shortened investment time horizon.
Having said that, there are occasions when we hear market prognosticators say that a stock is “good for the long term investor” we often think that translates to “this is a catalyst-free stock, but it’s cheap.” While we jest, we do believe there is some positive truth to that statement. Time after time it seems that good old-fashioned Graham and Dodd investing wins out in the long run. Mean reversion is a powerful force and buying inexpensive assets at historically lower valuations usually is a great strategy.
What do you think? Is the market time horizon shortening or is the market still driven by long-term fundamentals and investment techniques?