TradingGods.net

Costly Mistakes when Investing

Humans want to know “why.” Understanding the reasons for events has driven science, theology, and ……the financial media. When your conclusion about the reason is wrong, it can be very costly. Here is an excellent example.

 

By Dr. Jeff Miller

  1. A mid-size company ($2.5 billion market cap) lowers revenue and earnings estimates, citing a reduction of orders from a large customer. Revenues for the quarter will be about $70 million less than formerly expected. This is a reduction of about 17%. It is important for the company but let us also keep the $70 million in mind.
  2. Markets observers quickly deduce who the big customer is. Many conclude that it implies substantially lower sales of an important product.
  3. The major stock and its entire supply ecosystem decline to reflect the potential for lower sales. This leads to a market cap decline of about $100 B in the big company, and maybe another $30 B among the other suppliers.
  4. But that is not all! Because of the craving for a reason – this must be summarized in a few seconds on the nightly news – the lede becomes weakening global growth. The US markets all decline to the tune of about $1.2 Trillion.
  5. Technical support levels are breached. Pundits bemoan the loss of market “leadership.”
  6. The usual suspects warn that this is the “big one.” Frightened investors, believing the narrative, sell their investments – even if they own good companies at reasonable prices.

Now let’s try an alternative viewpoint.

  1. An Apple supplier announces a lowered forecast. Apple(NASDAQ:AAPL) is the only customer big enough for this effect, which is large for the company in question, but small in absolute terms.
  2. Firms seeking a trading edge, a good story, or help for short positions fan the flames of the supply chain story. Some others note that the information is not specific enough to permit inferences about which Apple product might be involved. It might be an older model (less important) or the newer one.
  3. Supply chain arguments are always controversial. Apple maintains many suppliers, and no one really knows their inventory.
  4. The projection of the Apple events to the global economy is tenuous at best.
    1. It might simply reflect Apple’s increasing emphasis on services.
    2. The issue might be a “one-off” affecting Apple but not competing companies or tech stocks in general.
    3. The size of the impact reflects the massive Apple presence in cap-weighted indexes and ETFs. The innocent are dragged down for no real reason.
  5. Market leadership changes. A criticism of the recent stock market action has been the narrowness of the rally. Some see less reliance of FAANG stocks as a healthy development.
  6. The implications for the market in general rest on inferences about a weakening global economy and recession chances. Since the economy can be measured directly, and more accurately, in many ways, there is no reason to speculate based upon this news.

And that is how a $70 million revenue miss turned into a trillion-dollar loss – at least on paper. An insightful investor, who emphasizes knowing his/her companies and their value, should not make too much out of big moves and overly-simplified narratives.

For more examples, check out Trading, Fast and Slow.