Rally ho!

Stocks rallied on Friday with the S&P500 finishing above a key technical level. Traders’ obsessions took over the session – they were satisfied.

It’s just a number. What is the S&P500 worth? If you took every stock in the index and did a bottom-up dividend discount model of each one. If you took all of those intrinsic values, first weighting each one by its relative value, and then divided each value by their outstanding number of shares… oh, wait, this is an index, so we have to go back to 1943 and figure out which were the largest US-traded stocks and go through this exercise in order to have a base value. Then, and only then could you divide today’s value by that base value to come up with the actual number for the S&P500 Index. Really! You want to go through the math? It’s Ok, we can wait… … … Never mind. We know what the S&P500 is worth because we can look it up on any financial site. It is worth exactly 5026.61, AND THAT’S IT. Accept it, because that is what the market says that its worth.

Way back in 1970 – ah, the 70s – now famous Eugen Fama wrote his seminal article that formed the basis for what most Wall Streeters know as The Efficient Market Hypothesis, or EMH (Fama, E. F. (1970). Efficient Capital Markets: A Review of Theory and Empirical Work. The Journal of Finance, 25(2), 383–417. https://doi.org/10.2307/2325486). In the very first paragraph of the introduction, appeared the critical statement that “security prices at any time ‘fully reflect’ all available information.” In other words, the market reflects reality.

Fama’s theory tests three types of information that he calls the weak form, semi-strong form, and the strong form. You may have heard about these, and though they sound like they are describing the characteristics of a hunk of cheese, they are actually quite clever descriptions about the level of depth of information about a stock. Commonly available, more complicated, and finally information that is not quite publicly available. Anyway, at the end of the day, Fama goes on to show that stock prices do, in fact, reflect all the available information about it.

Back in May of 1970, when the article first appeared in the Journal of Finance, most of us got our financial information from the Wall Street Journal. Don’t quote me on this but I believe Lou Rukeyser’s famous PBS show Wall Street Week began airing in November of 1970, a few months after the Fama article. So, let’s just say, you had two primary ways of getting information about stocks back then. You could get yesterday’s closes and possibly an article or two about specific companies that was written and vetted for weeks prior to publication, OR you could wait until Friday and get some interesting ideas from Lou Rukeyser from the week prior. Wall Streeters, on the other hand, had a bit more information and they got it in a more… timely manner. In other words, by the time your broker called you with a so-called tip, Wall Street insiders were already well positioned for whatever information their analysts dug up.

As you may guess, information dissemination was highly ineffective in those days, which created opportunities for smart folks like Warren Buffet, who was… er, is notorious for uncovering hidden value opportunities. You see, back then, if you did your homework, you could, indeed get the jump on your obnoxious brother-in-law’s golf buddy who claims to know everything about the markets, even though he sells vinyl flooring for a living. But as we well know, today is a very, VERY different scenario. Today, we are only limited by the laws of physics as we get information at 186,282 miles per second (that’s the speed of light 😉). I would argue that the person in the glass offices in Wall Street’s most prominent investment firms have no more information than you or me about any stock. Indeed, the only people who have more information than us are most likely in prison for insider trading. That, my friends, is the world we live in today, I hope you would agree. Therefore, price discovery about a stock along with the indexes it belongs to happens at the speed of light.

CAVEAT EMPTOR: Not all that information we receive is correct. There are plenty of would-be geniuses on the internet with very convincing missives on stocks. Additionally, big traders are hiding amongst little traders in the shadows, and they can move markets temporarily (also at the speed of light), making us believe that something is happening, or that some unverified news on the tape is important. That can force smaller traders to take action or get stopped out before they even realize what is going on… and long after that big trader logged a profit. These are temporary anomalies. Long-term, however the markets clear these with deft, and what we are left with is, in fact, a perfect reflection of all the information available about all stocks. So, what is the S&P500 worth? 633.87 million units that traded last Friday say that it is worth exactly 5026.61. The S&P500’s current PE is 22.71x, which is slightly richer than it was at the end of last year. However, it is far cheaper than it was from 2020 through 2022, and only slighter richer than it was from 2016 through 2020. Historically speaking, it has been richer, and it has been cheaper, but does it matter, because each time its value was exactly what it should have been given all the information available at the time. Folks, a close above 5000 was indeed an important technical achievement, because traders love round-number milestones, but don’t get hung up on what it is worth or not worth. Do, however, maintain your long-term focus.

FRIDAY’S MARKETS

NEXT UP

• NY Fed 1-year Inflation Expectations (Jan) Last month’s came in at +3.01%, economists will be looking to see if those expectations are increasing or decreasing in this morning’s release.
• Fed speakers: Bowman, Barkin, and Kashkari
• Later this week: more and more earnings as well as Consumer Price Index / CPI, Producer Price Index / PPI, Retail Sales, housing numbers, and University of Michigan Sentiment. Download the attached economic and earnings calendars for details.
• Earnings after the closing bell: Cadence Design Systems, Waste Management, Lattice Semiconductor, Avis Budget, ZoomInfo, and Goodyear Tire and Rubber.