The Forward Looking Nature of Markets
There is one investment formula which transcends asset classes and prevails across global markets: The intrinsic value of any security is equal to the net present value of future expected cash flows. This is an ever important formula to remember, especially now when many of our lives are in a current state of disruption.
Looking at the effects of the COVID‐19 crisis up to this point paints a clear picture of rapid economic decline. Restaurants, bars, theaters, and tourism have continued to be at a dead‐stop throughout April as stay‐at‐home orders remain in place. As a result, U.S. GDP is undoubtedly in a sharp downward trend, with the inverse being true for unemployment.
Investors who are overly concentrated in the short‐term may think now is a terrible time to invest in stocks, when current activity is bleak in most service industries. However, if we look at how markets have performed, a different story presents itself with most major stock indices posting low double digit / high single digit positive returns over the past month.
The apparent divergence of stock prices and economic indicators may be confusing. But let’s not forget about the formula from paragraph one and the inherent forward looking nature of markets. While economic activity may be heavily impaired in the current state, investors focusing on cash flows (earnings) three, five, and ten years down the road saw opportunity as appetite for risk assets increased during April.
Much is still uncertain about when everyday life, and economic activity, will return to normal. However, when it comes to investing, it’s important to focus on the long term, not short‐term news headlines. As many Americans continue to feel a sense of unrest and anxiety, both in their personal lives and financially, it’s more important now than ever to focus on the future. If there is anything markets have told us over the past month, it’s this: the COVID‐19 crisis is temporary.
Source: FRED, The Conference Board. This is intended for informational purposes only and should not be construed as legal, investment or financial advice. Please consult your legal, investment and financial professionals regarding your specific circumstances.