By Tom Stevenson
What determines a share price? A simple enough question you might think Because a share in a company represents part ownership of that company and the right to enjoy a slice of its profits and dividends, the answer is surely something to do with the level of a company’s earnings and how quickly they are expected to grow.
That’s true on one level, and in the long run it is probably the key determinant of how a share performs, but the past couple of days in the market have shown that other factors, wholly unrelated to the performance of individual companies, can matter more in the short term. This can be very unsettling for investors.
For much of the past five years since the financial crisis began, so-called macro factors have been the main drivers of markets. These are the big picture hopes and fears of investors – things like the eurozone crisis, the fiscal cliff and government policies on taxes and interest rates. It’s less PE (the ratio of a share price to earnings) than QE (quantitative easing).
During the market rally of the past six months or so a feeling has grown that, with the economic backdrop settling down, investors might start to look more closely at company-specific factors. To use the jargon, attention would shift from macro to micro.
In a macro market the differences between good companies and bad companies can be almost irrelevant. Indeed when a market rallies on the back of a change in overall sentiment or a big policy shift the worst quality companies can sometimes outperform the better quality ones – it’s called a dash to trash.
In the last two days, however, we have seen a dramatic return to macro-driven moves. On Wednesday, the UK market shrugged off a particularly nasty bit of company-specific news (the unexpected reduction in RSA’s dividend after a fall in profits) and rose because three of the Bank of England’s rate setters, including the Governor Mervyn King, voted for a further injection of monetary stimulus into the British economy through more quantitative easing. They were over-ruled by the other six members of the monetary policy committee but the split vote suggested that sooner or later more money printing will be on the agenda.
No sooner had the market got used to the idea that governments were committed to stimulating growth whatever the other costs, however, than the US’s Federal Reserve sent out precisely the opposite message.
According to the minutes of its January rate-setting meeting, “many” officials are now concerned that the costs and risks of its $85bn a month asset purchase programme may be greater than the benefits of encouraging economic recovery.
Stock markets immediately responded very badly indeed to this news because it shook their previous conviction that the Fed would keep printing more dollars until and even beyond the point at which the US jobs market recovered its poise with an unemployment rate of 6.5% or less.
Now, markets are concerned that the “open-ended” asset purchases in America are not so open-ended after all.
Although markets are fascinating to watch, the past two days have shown that in the short term they are wholly unpredictable. The best thing to do faced with such random moves is to switch off the screens and think about what we are trying to achieve in the long run which is to accumulate enough savings to not have to worry about any of these things at all.
Sometimes I think we’d all sleep a lot better, and end up a lot wealthier, if we just invested in good companies and left well alone.
Tom Stevenson is investment director at Fidelity Worldwide Investment
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