Friday, September 4th, 2020

Prices Move Before the News

Junior analysts sometimes have to be reminded about the old stock market saying that “If it’s in the press, it’s in the price.” Nobody can know everything all the time, but when enough people know enough information about a particular security, investors can be confident that the current price is fair and reasonable. The reason why investors do research is not to get an informational advantage – though sometimes this happens. It is to pool their knowledge so that there is greater transparency in the price formation process and greater liquidity as a result.

All this sounds like an introduction to a textbook about capital markets theory, but we want to make the opposite point: the importance of having a process which highlights changes in price for which there is no apparent explanation and which prompts investors to search for one. Over the course of the summer we have had a classic example of why this matters.  From early April to the end of June, our global equity models had an overweight recommendation on Japan which fluctuated in a narrow band between +25 to +35%. At the beginning of July this cracked suddenly. By the middle of the month, we were below benchmark. By the end of the month, we were underweight, with a recommended weight of -31%.

There was no apparent justification for the move – no change of policy by the BoJ, no sudden deterioration in Japan’s management of Covid, no big corporate scandal or earnings downgrade relative to the rest of the world. When asked by clients, the best we could come up with was the disappointing AGM season which had seen the majority of shareholder-friendly resolutions defeated.

However, there was a very big story, which was being deliberately suppressed: the resignation of Prime Minister Abe. Looking back, the timetable fits perfectly. According to the FT, “a regular medical check-up revealed signs of illness in June, from mid-July he began to suffer with bouts of exhaustion and his diagnosis was confirmed in early August.” From then on, it was an open secret because the LDP – his political party – was canvassing opinion as to who should succeed him. Our recommended weight hardly moved and has recovered slightly since the announcement on August 28th.

We make no apologies for not knowing the reason. The point is that we knew something was going on, because our process is sensitive enough to identify these situations and our weighting was adjusted automatically. Instead of fighting the change in prices because it wasn’t justified, we adapted and mitigated our risk. In the same spirit, here is a list of things we have noticed over the last month, which we don’t fully understand. All of them relate to a sudden change in direction in one of our sector or country charts – not an acceleration in a pre-existing trend.

For the bulls, we have a sudden improvement in the recommended weighting of UK Consumer Services relative to the UK index i.e. retail, media and leisure. This is strong enough to influence the Pan-Europe sector model, even though there is no equivalent move in the Eurozone model. We also have sudden upward moves in Chinese Consumer Services and Consumer Goods, which are offset by downward moves in Chinese Financials and Chinese Tech. There is also a downward move in Japanese Tech. We have frequently commented on the fact that big moves in Chinese Technology can be a lead indicator for the US Tech sector.

At the country level, we have sudden upward moves in Norway and Peru and downward moves in Hungary, Brazil, Portugal and Russia. We don’t argue that all of them are unexplained – or even important – but if you are thinking of doing something in these areas, you should make sure you know what’s going on.

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