Stock Market Efficiency - The Shuts Down of SPO Partners Co. (Assessed Blog 1)

STOCK MARKET EFFIECIENCY

A top line news that was published by Bloomberg on 25^TH Oct 18 caught my attention while I was struggling to look for a topic that best suits in this blog. According to the news, a hedge fund which is worth $5billions is shutting down because it finds exceedingly difficult to deploy capital with an acceptable margin of safety in the recent challenging market environment. SPO Partners & Co., had been advocating in value investing for over almost 5 decades and posted an average annual return of 23 percent across its investments. However, good fortune won’t last forever, the strategy of value investing implemented by SPO Partners & Co. was not compatible with credit crunch that started since the year of 2015 which will be discuss later on this blog.

First and foremost, what is value investing? It is one of the popular investing strategy where investors look for the stocks that are appear to be undervalued. They analyse the value of the company by examining the price-earnings ratio, future prospects of the company, cash flow and etc. hence compare it to its current share price in order to determine whether the company the is undervalued or not. Warren Buffett, an investor with highest prestige globally had made a stunning fortune with this particular strategy over the years and I believe there is no further elaboration needed on his successful investments such as the Coca-cola case as well as the recent investment in Apple. Nevertheless, here comes the question, is the strategy of value investing used by SPO Partners & CO. over the years effective in stocks investment? Or it is what exactly causes SPO Partners & CO. to collapse?

In stock market efficiency hypothesis, there are three market levels of efficiency which consists of weak form, semi-strong form and strong form efficiency. Firstly, the updated public information is not spread freely and easily in an inefficient market (weak form), thus using fundamental analysis that based on public information about a company such as profit, assets, etc is able to predict share prices. This is because the information of the company is not acquired by everyone, therefore the “knowledgeable” people can use it to beat others who don’t know it.  However, technical analysis is not applicable because it is based on past share prices which are known by everyone. Looking into semi-strong market efficiency, the public information spread semi-quickly which is faster compare to weak form. Therefore, fundamental and technical analysis are not applicable because they are both based on public information. Nevertheless, some insiders like company officers have slight advantage over normal investors like us because they had information slightly in advance of the public. On the other hand, nobody can make profits by using any information to “analyse” and predict future share prices because everyone knows all relevant information of a stock at the same time in perfect market efficiency (strong form). In my opinion, perfect market efficiency is not realistic because public information does not spread quickly in a real world situation. This can easily explained by the many of insider trading cases all over the years and normal investors like you and me could only get the last-hand news. For examples, I’ve seen many stocks rises dramatically a few days before the quarterly report of the company is disclosed. It is obvious that some insiders had acquired the information before it was published and started to accumulate the stocks hence sell it after the information is published in order to make a huge profit.

Coming back to the case of SPO Partners & Co., the strategy of value investing might be effective because the stock market is inefficiency in a real-world situation. Thus, the hedge fund could analyse stocks using fundamental analysis and invest on stocks that are “undervalued”. However, the share prices are fluctuating in a random fashion and there is no systematic link between one price movement and subsequent ones according to Kendal Chartists. He also mentioned that it is impossible to predict future share prices without extraneous information and share prices changes when new news enters market. True that people tends to overreacting towards new news on companies and the share prices volatiles in the short-run, this is due to the human nature of greed and fear. I believe that share prices and the value created by companies are consistent in the long run because buying shares of a company means that investors own a part of that company and involve in the business with other shareholders. Therefore, if a company is doing well and generating higher value of itself, there will be more investors buying its stocks and eventually the share prices will rise.

Since year 2015, the FED started to implement contractionary monetary policy by raising interest rate to the current rate of 2.25%. Therefore, companies have to pay more interests for debts and the investments of companies will be reduced. This posted a disadvantage for value investors as well as hedge fund like SPO Partners & Co. because the stocks prices will only grow cheaper due to lesser investments and deleveraging. In contrasts, people are going for “growth stocks” with a fair price and causing the stock prices of “undervalue” stocks to stay cheaper for a long time. This happens when other investors did not discover the so called “cheap stocks” and no one is buying it thus lead to value investors like SPO Partners & Co. to fall into value trap and eventually shuts down.