2020 – The Year That Was (Unforgettable)
Friday, 18th December 2020
One for the history books
This year has been described as many things (unprecedented being the most common), but one thing it has done is to provide a great amount of lessons in financial markets. Whilst this may appear trivial on the surface, the lessons are invaluable for the next few years.
The main lesson that 2020 has provided is the fact that share prices are not a reflection of company earnings in times of extreme optimism and pessimism. Often in times of heavy selling, the mainstream commentators will say that the market is moving on ’emotions, not fundamentals’.
Of course, this usually occurs when the commentator is unaware that the real driver of share prices is human emotion. From the panic selling in March to the current manic buying, the argument for a ‘fundamental’ approach to share analysis disappears.
This does NOT mean that fundamental analysis is of no use, far from it. It is a valuable tool in understanding the financials of a company and good for sector comparison. It also proves its value when we can analyse the market on a macro approach and compare different eras.
What we have seen in 2020 is evidence of the market entering into a mania phase, with Tesla leading the way. With a PE ratio that exceeds 1100 times earnings, the stock is in a bubble. There is no doubt that the bubble will burst, but the timing is the uncertain part. Many people have lost millions of dollars trying to short Tesla stock over the years.
Extraordinary Popular Delusions and the Madness of Crowds
Whilst the above headline is a reference to a study done by a Scottish psychologist back in 1841, it applies to current thinking. The level of optimism is so extreme that every measure of sentiment across 50 recoginised readings is at an historic extreme
One area that is almost frothing at the mouth are the strategists that work for the top financial firms in America.
Below is a summary of some comments made for the American market recently. Carefully read through the comments and think about what they are saying. Effectively, these forecasters are saying that the share market is just about to BEGIN a massive rally that will drive the Dow to 180,000 points in the next 6 years.
The last time people were making these predictions was back in 1999/2000 when the market was heavily in the dotcom boom. That was when people gave up jobs to day-trade stocks because it was so easy. The rise of trading apps and the explosion in novice traders ironically due to a pandemic, has seen the same thinking return.
In summary, 2020 has shown us that social mood drives share prices and when the sentiment becomes extreme, prices overshoot what is considered ‘normal’. However, it should be remembered that prices reflect what people are thinking and when prices rise quickly it merely shows that people are in a bubble and they are behaving that way.
When magazine covers join the mania it is usually a time close to the end of the rally. Below is a cover shot from a UK publication called Money Week. According to them we are just about to start the Roaring 20’s all over again. History suggests otherwise…
We hope you have enjoyed the Weekly Wrap throughout the year. This is the last report for the year and we will start again on 8th of January, 2021.