Rock, Twist & Roll is an inspiring evocation of the music of the sixties. But for those considering the “present perfect” of the stock markets, they may find an interesting introduction to metaphoric representations about the behavior of the markets. A look at the curves is enough to witness this rock, twist and rolling behavior of stock values, often deviating from analysts’conventional predictions.
Back in the 60s, a new frontier for the job of valuing stock prices was thought to have been drawn thanks to the research from Modigliani Miller, Bates, Black, Scholes, Merton… And yet, this new frontier happened to be somehow of illusion. Indeed, price to earnings ratios in excess of the 100 x level – without any apparent impairment on the value of the underlying stocks – are becoming common place. We are seeing at the same time stocks strenuously keeping with very low price to earnings ratios – say, less than 10 x, – when confronted to the long term interest rate benchmarks. Such stocks should have adjusted upwards to this benchmark. They haven’t. Hence, an explanation is quite urgently needed to theorize both about the behavior of over reacting buyers and about the behavior of under reacting ones.
In their efforts to better capture “unexpected events”, analysts have imported new theoretical approaches from across the frontier. One was the fractal theory, quite a “follower success”, in the aftermath of the 2008’s global financial crisis. The idea was that stock behavior could follow self-replicating complex patterns over time. Since the 2014’s recovery, this theory has lost some of its steam. But as the philosopher Pascal said “nature abhors vacuum” (“la nature a horreur du vide”) other explanations are to come soon on the front line about why the stocks are currently troubled by rising interest rates or, by trade tariffs or, by the fact that CEO doesn’t own shares, so on and so forth. Maybe the next culprit to unmask will be the “information theory”, another input from the 70s. that computers have helped urbanize.
Insofar as the issue is to bet on the very long term, maybe it is safer to get back, even against the odds, to the “Rock, Twist & Roll’s approach of the financial theories of the “founding fathers” of the 60s. At least such theories are grounded on tangible data and fueled by empirical assessment of corporate asset and profit behaviors with, as a condition, that this “Rock, Twist & Roll’s” approach be tamed by rigorous analytical rationales.
Dominique F. Pasquier (www.brcsas.com)