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MARKET COMMENT
By
"I'd be a bum on the street with a tin cup if the markets were efficient." -- Warren Buffett In an industry littered with underachievers, the world of investment has many advocates of the Efficient Market Hypothesis (EMH). However, the continued existence of many market-beating investors -- whose philosophies are readily understandable -- has always cast a dark shadow over the theory's credibility. Furthermore, recent share price volatility has put yet another nail in the EMH coffin. To recap, the EMH evolved in the 1960s from a Ph.D. dissertation by Eugene Fama. He said: "An 'efficient' market is defined as a market where there are large numbers of rational, profit 'maximisers' actively competing, with each trying to predict future market values of individual securities, and where important current information is almost freely available to all participants. In an efficient market, competition among the many intelligent participants leads to a situation where, at any point in time, actual prices of individual securities already reflect the effects of information based both on events that have already occurred and on events which, as of now, the market expects to take place in the future. In other words, in an efficient market at any point in time the actual price of a security will be a good estimate of its intrinsic value."
In summary, the market is always right. Therefore, outperforming the market effectively becomes a game of chance rather than skill. But theory is one thing; reality is another. Take Tesco (LSE: TSCO) and Rentokil Initial (LSE: RTO). Both companies operate quite steady businesses; Tesco selling its food, Rentokil catching its rats. In terms of official news from both firms, only Tesco has announced anything of any note during July -- the purchase of 13 Polish hypermarkets. Overall, the 'intrinsic value' of both companies has hardly changed since the start of the month. However, the daily share price changes of Tesco (LSE: TSCO) and Rentokil Initial (LSE: RTO) for July tell a different story: Given its stable operational nature, how can 'a good estimate' of Tesco's intrinsic value decline 8% in one day, only to jump 11% a few days later? Same with Rentokil. Down 9%, up 8%, down 6% -- all on separate days. How come? Well, the answer has nothing to do with Tesco and Rentokil. In fact, it's to do with everything but Tesco and Rentokil. The collapse of WorldCom (Nasdaq: WCOME), gloomy market forecasts, countries leaving OPEC, forced disposals from life assurers, nasty shorters, all-round panic selling... you name it, it caused the share price volatility. The large swings in valuation show the efficient market theory being just that -- a theory. Stock markets don't operate in an academic vacuum. Instead, all sorts of issues affect share prices, most of which have nothing to do with an individual company's underlying value. Private investors should welcome the stock market's occasional, irrational and inefficient swings. When they affect robust businesses like Tesco and Rentokil, great investment opportunities will arise. Date Daily Change
Tesco Rentokil
(%) (%)
1 July +2.10 -0.75
2 July -1.44 -0.38
3 July -2.40 -3.79
4 July +2.45 +2.17
5 July +2.71 +0.19
8 July +1.42 -2.79
9 July -3.90 -2.08
10 July -3.43 -2.32
11 July -3.88 -3.83
12 July +1.01 +4.30
15 July -5.22 -8.87
16 July -1.52 -1.13
17 July +2.26 +8.24
18 July +2.33 +0.63
19 July -1.59 -3.99
22 July -8.08 -1.53
23 July -0.75 +0.89
24 July -4.18 -6.17
25 July +10.96 +3.76
26 July -2.26 +2.26
29 July +4.99 +2.54