Many accept the notion that markets are efficient and prices reflect all current and relevant information available to investors. Nevertheless, we are all well aware of the exuberance of capital markets and investors’ willingness to overpay for assets versus their perceived intrinsic value. Although history never repeats itself, it can be a useful guide for understanding the capital markets and investor behavior. An approach that Arnott, Li, and Sherrerd (2009a, b) used to analyze market exuberance is to compare a company’s clairvoyant value to its historical cap-weight. Nobel Laureate William Sharpe coined the term clairvoyant value in 1975. He defined the term as ex post realized value, or value that can only be determined after the fact or measured ex ante only with the perfect foresight of a clairvoyant. Arnott and his coauthors used discounted realized cash flows going back 50 years to calculate clairvoyant value and compare it against the-then market value to gauge how accurate market foresight was.
To bring more color to their analysis, Arnott, Li, and Sherrerd (2009a, b) categorized companies using a range of growth to value segments to determine if the market’s predictive ability was consistent across the spectrum, regardless of whether a company was a popular growth company or a traditional value company. With clairvoyant value as a yardstick, they found that investors tend to overly discount value companies and overpay for growth companies.
Given that today’s titans are heavily skewed toward growth companies, coupled with the concentration risk of their dominating a large part of a market-cap-weighted portfolio, the potential for future underperformance of these (likely overvalued) stocks and the portfolios that hold them has merit.
As Arnott, Kalesnik, and Wu (2021) observed, the 2020 pandemic-related lockdowns contributed to a tremendous rise in retail investor participation in the stock market, leading to some very curious asset-price anomalies over the last 12 months.
The percentage of shares traded in the US market by retail participants increased substantially over the last decade, jumping from 15% to 20% in 2020. Of real concern is a meaningful rise in the use of options, which are ultimately levered positions and serve to exacerbate the inefficiencies in the market. In 2020, higher retail participation introduced a new twist on the potential for a popular stock’s market price to deviate from its intrinsic value. A number of examples, which illuminate the effect of increased retail participation in the markets, are readily at hand.
In the early part of 2020 as offices closed due to COVID-19, the video and web conferencing platform Zoom benefited from the rapid transition to virtual meetings. Unsophisticated investors rushed to buy the stock with the ticker ZOOM, not recognizing the Zoom Video Communication’s ticker is ZM. ZOOM was Zoom Technologies, a Beijing-based company that had zero to do with virtual meetings. The surge in demand sent its stock price up 1000%! Once the realization kicked in that these “investors” had bought the wrong stock, Zoom Technologies’ price quickly collapsed (Wieczner, 2020).