Market efficiency

Market efficiency

Martin VAN DER BORGHT

In this article, Martin VAN DER BORGHT (ESSEC Business School, Master in Finance, 2022-2024) explains the key financial concept of market efficiency.

What is Market Efficiency?

Market efficiency is an economic concept that states that financial markets are efficient when all relevant information is accurately reflected in the prices of assets. This means that the prices of assts reflect all available information and that no one can consistently outperform the market by trading on the basis of this information. Market efficiency is often measured by the degree to which prices accurately reflect all available information.

The efficient market hypothesis (EMH) states that markets are efficient and that it is impossible to consistently outperform the market by utilizing available information. This means that any attempt to do so will be futile and that all investors can expect to earn the same expected return over time. The EMH is based on the idea that prices are quickly and accurately adjusted to reflect new information, which means that no one can consistently make money by trading on the basis of this information.

Types of Market Efficiency

Following Fama’s academic works, there are three different types of market efficiency: weak, semi-strong, and strong.

Weak form of market efficiency

The weak form of market efficiency states that asset prices reflect all information from past prices and trading volumes. This implies that technical analysis, which is the analysis of past price and volume data to predict future prices, is not an effective way to outperform the market.

Semi-strong form of market efficiency

The semi-strong form of market efficiency states that asset prices reflect all publicly available information, including financial statements, research reports, and news. This implies that fundamental analysis, which is the analysis of a company’s financial statements and other publicly available information to predict future prices, is also not an effective way to outperform the market.

Strong form of market efficiency

Finally, the strong form of market efficiency states that prices reflect all available information, including private information. This means that even insider trading, which is the use of private information to make profitable trades, is not an effective way to outperform the market.

The Grossman-Stiglitz paradox

If financial markets are informationally efficient in the sense they incorporate all relevant information available, then considering this information is useless when making investment decisions in the sense that this information cannot be used to beat the market on the long term. We may wonder how this information can be incorporate in the market prices if no market participants look at information. This is the Grossman-Stiglitz paradox.

Real-Life Examples of Market Efficiency

The efficient market hypothesis has been extensively studied and there are numerous examples of market efficiency in action.

NASDAQ IXIC 1994 – 2005

One of the most famous examples is the dot-com bubble of the late 1990s. During this time, the prices of tech stocks skyrocketed to levels that were far higher than their fundamental values. This irrational exuberance was quickly corrected as the prices of these stocks were quickly adjusted to reflect the true value of the companies.

NASDAQ IXIC Index, 1994-2005

Source: Wikimedia.

The figure “NASDAQ IXIC Index, 1994-2005” shows the Nasdaq Composite Index (IXIC) from 1994 to 2005. During this time period, the IXIC experienced an incredible surge in value, peaking in 2000 before its subsequent decline. This was part of the so-called “dot-com bubble” of the late 1990s and early 2000s, when investors were optimistic about the potential for internet-based companies to revolutionize the global economy.

The IXIC rose from around 400 in 1994 to a record high of almost 5000 in March 2000. This was largely due to the rapid growth of tech companies such as Amazon and eBay, which attracted huge amounts of investment from venture capitalists. These investments drove up stock prices and created a huge market for initial public offerings (IPOs).

However, this rapid growth was not sustainable, and by the end of 2002 the IXIC had fallen back to around 1300. This was partly due to the bursting of the dot-com bubble, as investors began to realize that many of the companies they had invested in were unprofitable and overvalued. Many of these companies went bankrupt, leading to large losses for their investors.

Overall, the figure “Indice IXIC du NASDAQ, 1994-2005” illustrates the boom and bust cycle of the dot-com bubble, with investors experiencing both incredible gains and huge losses during this period. It serves as a stark reminder of the risks associated with investing in tech stocks. During this period, investors were eager to pour money into internet-based companies in the hopes of achieving huge returns. However, many of these companies were unprofitable, and their stock prices eventually plummeted as investors realized their mistake. This led to large losses for investors, and the bursting of the dot-com bubble.

In addition, this period serves as a reminder of the importance of proper risk management when it comes to investing. While it can be tempting to chase high returns, it is important to remember that investments can go up as well as down. By diversifying your portfolio and taking a long-term approach, you can reduce your risk profile and maximize your chances of achieving successful returns.

U.S. Subprime lending expanded dramatically 2004–2006.

Another example of market efficiency is the global financial crisis of 2008. During this time, the prices of many securities dropped dramatically as the market quickly priced in the risks associated with rising defaults and falling asset values. The market was able to quickly adjust to the new information and the prices of securities were quickly adjusted to reflect the new reality.

U.S. Subprime Lending Expanded Significantly 2004-2006

Source: US Census Bureau.

The figure “U.S. Subprime lending expanded dramatically 2004–2006” illustrates the extent to which subprime mortgage lending in the United States increased during this period. It shows a dramatic rise in the number of subprime mortgages issued from 2004 to 2006. In 2004, less than $500 billion worth of mortgages were issued that were either subprime or Alt-A loans. By 2006, that figure had risen to over $1 trillion, an increase of more than 100%.

This increase in the number of subprime mortgages being issued was largely driven by lenders taking advantage of relaxed standards and government policies that encouraged home ownership. Lenders began offering mortgages with lower down payments, looser credit checks, and higher loan-to-value ratios. This allowed more people to qualify for mortgages, even if they had poor credit or limited income.

At the same time, low interest rates and a strong economy made it easier for people to take on these loans and still be able to make their payments. As a result, many people took out larger mortgages than they could actually afford, leading to an unsustainable increase in housing prices and eventually a housing bubble.

When the bubble burst, millions of people found themselves unable to make their mortgage payments, and the global financial crisis followed. The dramatic increase in subprime lending seen in this figure is one of the primary factors that led to the 2008 financial crisis and is an illustration of how easily irresponsible lending can lead to devastating consequences.

Impact of FTX crash on FTT

Finally, the recent rise (and fall) of the cryptocurrency market is another example of market efficiency. The prices of cryptocurrencies have been highly volatile and have been quickly adjusted to reflect new information. This is due to the fact that the market is highly efficient and is able to quickly adjust to new information.

Price and Volume of FTT

Source: CoinDesk.

FTT price and volume is a chart that shows the impact of the FTX exchange crash on the FTT token price and trading volume. The chart reflects the dramatic drop in FTT’s price and the extreme increase in trading volume that occurred in the days leading up to and following the crash. The FTT price began to decline rapidly several days before the crash, dropping from around $3.60 to around $2.20 in the hours leading up to the crash. Following the crash, the price of FTT fell even further, reaching a low of just under $1.50. This sharp drop can be seen clearly in the chart, which shows the steep downward trajectory of FTT’s price.

The chart also reveals an increase in trading volume prior to and following the crash. This is likely due to traders attempting to buy low and sell high in response to the crash. The trading volume increased dramatically, reaching a peak of almost 20 million FTT tokens traded within 24 hours of the crash. This is significantly higher than the usual daily trading volume of around 1 million FTT tokens.

Overall, this chart provides a clear visual representation of the dramatic impact that the FTX exchange crash had on the FTT token price and trading volume. It serves as a reminder of how quickly markets can move and how volatile they can be, even in seemingly stable assets like cryptocurrencies.

Today, the FTT token price has recovered somewhat since the crash, and currently stands at around $2.50. However, this is still significantly lower than it was prior to the crash. The trading volume of FTT is also much higher than it was before the crash, averaging around 10 million tokens traded per day. This suggests that investors are still wary of the FTT token, and that the market remains volatile.

Conclusion

Market efficiency is an important concept in economics and finance and is based on the idea that prices accurately reflect all available information. There are three types of market efficiency, weak, semi-strong, and strong, and numerous examples of market efficiency in action, such as the dot-com bubble, the global financial crisis, and the recent rise of the cryptocurrency market. As such, it is clear that markets are generally efficient and that it is difficult, if not impossible, to consistently outperform the market.

Related posts on the SimTrade blog

   ▶ All posts related to market efficiency

   ▶ William ANTHONY Peloton’s uphill battle with the world’s return to order

   ▶ Aamey MEHTA Market efficiency: the case study of Yes bank in India

   ▶ Aastha DAS Why is Apple’s new iPhone 14 release line failing in the first few months?

Useful resources

SimTrade course Market information

Academic research

Fama E. (1970) Efficient Capital Markets: A Review of Theory and Empirical Work, Journal of Finance, 25, 383-417.

Fama E. (1991) Efficient Capital Markets: II Journal of Finance, 46, 1575-617.

Grossman S.J. and J.E. Stiglitz (1980) On the Impossibility of Informationally Efficient Markets The American Economic Review, 70, 393-408.

Chicago Booth Review (30/06/2016) Are markets efficient? Debate between Eugene Fama and Richard Thaler (YouTube video)

Business resources

CoinDesk These Four Key Charts Shed Light on the FTX Exchange’s Spectacular Collapse

Bloomberg Crypto Prices Fall Most in Two Weeks Amid FTT and Macro Risks

About the author

The article was written in January 2023 by Martin VAN DER BORGHT (ESSEC Business School, Master in Finance, 2022-2024).

Netflix’s announcement impacts Disney’s stock price

Netflix’s announcement impacts Disney’s stock price

Ines ILLES MEJIAS

In this article, Ines ILLES MEJIAS (ESSEC Business School, Global BBA, 2020-2024) analyzes how Netflix announcement regarding its decrease in earnings and subscribers also affected Disney’s stock price.

Description of firm

Netflix (1997) and Disney + are both world leading entertainment streaming services. They both offer a wide variety of content ranging from TV shows, Movies, Documentaries and even original series and movies. Both streaming services are available as an app for mobile phones, tablets, etc, as well as streaming to watch online on our computers. This allows users to enjoy from their services anytime and anywhere, and, through the app even download content to watch offline. They both work as subscriptions with different plans which customers can choose to subscribe to depending on their income and needs. However, Netflix, having been launched before, was the market leader in the streaming entertainment industry for a very long time.

Description of event

Netflix reports its first customer decline of 26% in over 10 years, and Disney stocks fell 5.3% also consequently. Netflix reported a loss of 200,000 members in the first quarter and forecasted a loss of 2 million subscribers in the current quarter (April 2022). Investors and analysts are rethinking on new ways of boosting their forecasts for the entire industry, and fear that a reopening economy will cripple entertainment companies.

Figure 1. Impact of Netflix announcement.
Impact of Netflix announcement
Source: Bloomberg.

This article talks about the current decline in Netflix subscribers and how it has affected not only their stocks, but also created a fear among analysts and investors in the entertainment streaming industry, as well as impacted other companies’ stocks such as Disney, Warner Bros, etc.

Reaction of market to event

Disney shares fell by 6% after the news. Disney is a competitor, which means that normally it could have benefitted from a cut in Netflix (its competitor) stocks. But this did not seem to happen. Instead, investors feared that Disney might also suffer from a slower growth in earnings like Netflix, which resultantly affected Disney’s stocks negatively. By the end of April, Disney stocks fell by 19%, and, according to S&P Global Market Intelligence, down roughly 40% from its peak last fall.

It is said that one of the main reasons for Netflix big decline in returns and subscribers was content, especially since other entertainment such as HBO are gaining the exclusivity over shows such as Game of Thrones or Sex in the City. Therefore, Netflix plays on offering new Netflix Original content to more attract customers. However, Disney should do good after this as it has a deep content library of franchises that it can leverage to produce hit shows, so in the long-term its growth and revenues should not seem to be very affected by Netflix.

Figure 2. Impact of Netflix announcement on Walt Disney stock price.
Impact of Netflix announcement on Walt Disney stock price
Source: Bloomberg.

Link with market efficiency

The efficient market hypothesis states that the market cannot be beaten because it incorporates all information into current share prices, so stocks trade at the fairest value. There are three types of market efficiency that we must know of. First, weak efficiency, where all information contained in past stock market data (prices and transaction volumes) is already reflected in today’s price. Then, we have semi-strong efficiency which in addition to the information contained in historical stock market data, all public information (company accounts, analyst reports, etc.) is already reflected in today’s price. Finally, strong efficiency where all information, public as well as private, is already reflected in today’s price.

I believe this is an example of a semi-strong efficiency as company accounts and reports as well as historical data are included in the price. Disney’s price was subject and result of Netflix public accounts.

Justification of your choice of the event and the firm

I, myself, am a subscriber for both of these entertainment streaming services, so when I heard the news, I was actually surprised about the power and influence that these have on one another. Especially since I believe that both have completely different content which interest me. From a very young age, I’ve been a fan of Disney and their content, which is what made me subscribe to Disney +, while I became a subscriber for Netflix because it was “a trend” back in time and everyone was speaking about all the content available. After reading this news, I also agreed that Netflix has decreased in terms of content and quality, which is why I use more Disney plus, another reason why I was surprised by the news.

Why should you be interested in this post?

Netflix and Disney are two of the most know streaming companies in the world. It’s important to be aware of the impacts that companies from the same industry have on one another, especially to be able to avoid, fight or tackle if news like these were to happen again.

Useful resources

Netflix

Disney+

Why Disney Stock fell 19& in April

Stocks fall after shocking drop in Netflix subscribers

About the author

The article was written in December 2022 by Ines ILLES MEJIAS (ESSEC Business School, Global BBA, 2020-2024).

Why is Apple’s new iPhone 14 release line failing in the first few months?

Why is Apple’s new iPhone 14 release line failing in the first few months?

Aastha DAS

In this article, Aastha DAS (ESSEC Business School, Bachelor’s in Business Administration, Exchange Student from Northeastern University) discusses events about Apple’s products, their impact on Apple’s share price and the link with market efficiency.

Brief reminder of the facts

On Tuesday October 18th, 2022, Apple stocks saw a downturn after the announcement of the limit of one of its iPhone suppliers for the newly released iPhone 14 Plus due to demand issues.

Figure 1. Event about Apple.
Event about Apple
Source: Bloomberg.

With the new release, Apple took a large risk with eliminating certain failing lines like the “mini” model. Within the iPhone 14 range, the largest changes and upgrades were to the “Pro” models in hopes of diversifying its product line while pricing remained consistent in appropriate increases, as done in the past. Unfortunately, this has been highly unsuccessful with many reports revealing how the sales of the “iPhone 14” line have been subpar of expectations.

Impact on company

This is concerning for the company since Apple had increased its sales projections in the few weeks prior to the iPhone 14 family release in September as it does annually and many of its suppliers had already started making preparations for a 7% boost in orders after the release. This incident had direct financial consequences on the company as the stock immediately dropped by $4 from $145. There are mixed reports on consumers’ preferences to buy either the iPhone 14 Plus or iPhone 14 as preferences between the features and affordability of the two vary greatly. It is difficult for the company to gauge the fluctuations in demand, especially as the new iPhone 14 has not been doing as well as anticipated. This can also be attributed to the decrease in global demand because of surging inflation and the impending recession and war in Ukraine. The smartphone market is projected to decrease by 6.5% this year, 2022. Following an official announcement in a press release from Apple, the stock price immediately dropped in regard to the production halt for the iPhone 14 Plus at one of the plants in China. Apple shares fell 3.9% on the New York stock Exchange (NYSE) on Wednesday morning to $145.90. The shares are additionally also down about 18% this year in 2022, compared to a 23% drop in the S&P 500 Index. Still, many professionals state they are not surprised about this due to more preference toward the more premium models of the iPhone 14 family. The share price quickly leveled out but it revealed how volatile the stock is to the market and each decision they make.

Figure 2. Event about Apple.
Apple share price
Source: Google Finance.

Relations to market efficiency

Market efficiency involves a market where the current price of a stock/security quickly reflects information of that security and/or its respective company in a wholly rational manner.

There are many ways to evaluate a market’s efficiency, even as novice market watchers, starting with reevaluating the lag in the time that information is released regarding a security to when it is reflected in the security’s price. The changes in price are usually a product of announcements that are novel and unexpected which can be compared to the press release by Apple to limit the supply chain of its iPhone 14 production as this is uncommon for the company to do, so soon after the company’s fall release, as it does annually. It also relates to a company’s share price in relation to its earnings per share outcomes and the share price growing following the EPS, in an efficient market, as EPS growth reveals positive growth for long-term investors, and it is still optimistic to observe that Apple has managed to grow EPS by 28%/year over the past three years. This restores faith in the stock as though it has proven to be volatile, it regulates itself and has clearly been on the rise in a long-term perspective, revealing sustainable growth. A real positive is seen with Apple’s similar EBIT margins to 2021 as revenue grew by 12% to $388B USD.

At this point in time, the Apple security can be seen as semi-strong efficiency. This can be attributed to how public Apple is with there being much historical market data and public information like company accounts, hundreds of reports on the renowned company which regularly are reflected in the company’s stock price.

Figure 3. Apple financial statistics.
Apple financial statistics
Source: Forbes Digital Covers.

Why did I choose this event?

I chose this event as a financial event of Apple’s stock taking a downturn dip because it reveals much about the smartphone and personal electronics market despite being a quite small event in the trajectory of its iPhone releases. This shows how smartphones will also suffer from raising inflation and the Ukrainian-Russia war despite popular demand and so-called need for smartphones like the iPhone. I am also an avid consumer of Apple products and find it interesting how emotional many stakeholders are based on how they react to even the smallest aspects of its product line. It reveals how despite the rationality of the market being beneficial, human beings chose to act on fear and precautionary measures to ensure that they will be safer rather than opting in favor of risk, within reason.

Why should you be interested in this topic?

There are many reasons why it is important to stay on top of the regular markets and this article discusses a company which is regularly changing in the markets. As a SimTrade student, or anyone interested in financial markets, market efficiency is a key aspect to refer to when making financial decisions and trading. It is worthwhile to consider companies with strong efficiency and those which do not, allowing a broader outlook into how they might function. It is necessary to see if there is a possibility of beating the market because any information available to a trader is already involved in the market price so it is difficult to beat it for the higher returns.

Useful resources

SimTrade course Market information

Yahoo! Finance (October 25, 2022) Here’s Why We Think Apple (NASDAQ:AAPL) Is Well Worth Watching

Apple Newsroom (November 6, 2022) Update on supply of iPhone 14 Pro and iPhone 14 Pro Max

Bloomberg (September 28, 2022) Apple Ditches iPhone Production Increase After Demand Falters

Related posts on the SimTrade blog

   ▶ Aamey MEHTA Market efficiency: the case study of Yes bank in India

   ▶ Henri VANDECASTEELE inancial markets are not accounting enough for the Ukraine-Russia conflict

About the author

The article was written in December 2022 by Aastha DAS (ESSEC Business School, Bachelor’s in Business Administration, Exchange Student from Northeastern University).

Market efficiency: the case study of Yes bank in India

Market efficiency: the case study of Yes bank in India

Aamey MEHTA

In this article, Aamey MEHTA (ESSEC Business School, Master in Finance, Singapore campus, 2022-2023) explains the key financial concept of market efficiency.

What is Market Efficiency?

An informationally efficient market is a market in which the current price of a security fully, rationally, and quickly reflects all information of that security

We can measure the efficiency of a market by observing the lag between the time that information is received to the time that the security’s price reflects this information. If there is a large lag, then traders can make use of this information to generate positive returns. For efficient markets the price of a security should not be affected by information that is already expected. The changes in price should be due to new information, i.e., information that was unexpected. For example: if a company’s earning is expected to be $10M (market consensus) and their earnings are $10M, this should not cause a change in the company’s price. However, if the earnings were $20M or $5M, then the shock news will cause the stock price to move upwards or downwards.

Market efficiency and investment styles

In a perfectly efficient market investors should use a passive investment strategy. This is because in such a market it is not possible to beat the market. In efficient markets investors can expect the market value of an assets to be equal to its intrinsic value. Using an active strategy will result in underperformance compared to the market due to transaction costs. However, if the market is inefficient, then active investment strategies can result in a profit for the investor.

What factors affect market efficiency?

Generally, markets are neither perfectly efficient or inefficient. The degree of efficiency depends on the following factors: the number of market participants, the availability of Information, and impediments to trading.

Number of market participants

The higher the number of market participants the more efficient the market is. Market participants include investors, traders, analysts, and people who follow the market. The number of participants can vary over time and across countries. Some countries prevent foreigners from trading on their markets which reduces market efficiency.

Availability of Information

The more information that is available to the investors, more efficient the market is. The easier and cheaper it is to access the information the more efficient the market will be. The access to information should not favor one group over another and should be equally available to all participants. If participants have access to material nonpublic information about the firm they should not trade on this information as this would constitute insider trading which is illegal. In developed markets there is abundance of information, and the markets are efficient. Example: New York Stock Exchange. In less developed markets the availability of information is lower and hence markets are less efficient. Example: the forwards market.

Impediments to trading

Arbitrage refers to buying an asset in one market and simultaneously selling it in another market at a higher price. This buying and selling will continue till price in both the markets are the same and arbitrage is no longer possible. Impediments to trading such as high transaction costs will restrict arbitrage opportunities and allow for some mispricing of assets.

Short selling prevents assets from being overvalued and hence short selling improves market efficiency. Restrictions on short selling, such as inability to borrow stock cheaply will reduce efficiency.

Transaction and information costs

If the cost of gathering information, analysis and trading is more than the cost of trading misvalued assets markets will be inefficient. If after deducting costs, there is no risk adjusted returns to be made from trading based on publicly available information then the markets are said to be efficient.

Types of market efficiency

Weak form of market efficiency

This form of market efficiency states that current security prices fully reflect all currently available security market data. Thus, past price and volume information will have no predictive power over the future direction of security prices because price changes will be independent from one period to the next.

Semi-strong form of market efficiency

This form holds that security prices rapidly adjust without bias to the arrival of new public information. Current security prices fully reflect all publicly available information. This form says that security prices include all past security market and non-market information available to the public. Examples: Information on the financials reports published by the company, news about the company.

Strong form of market efficiency

This form states that security prices fully reflect all information from both public and private sources. The strong form includes all types of information: past security market information, public and private (insider) information. This means that no group of investors has monopolistic access to information relevant to the formation of prices and no one should be able to generate positive risk adjusted returns.

What do we know about the efficiency of the market?

Fama

Fama, in his paper Efficient Market Hypothesis defined a market to be “informationally efficient” if prices at each moment incorporate all available information about future values.

The efficient market hypothesis states:

  • Current prices incorporate all available information and expectations.
  • Current prices are the best approximation of intrinsic value.
  • Price changes are due to unforeseen events.
  • “Mispricings” do occur but not in predictable patterns that can lead to consistent outperformance.

The efficient market hypothesis does not state:

  • All investors are rational.
  • Prices are always right.
  • Prices should be stable.
  • Professional money managers can’t earn higher than market returns.

The Grossman-Stiglitz paradox

This paradox was proposed by Stanford Grossman and Joseph Stiglitz. They argue that perfectly informationally efficient markets are an impossibility since, if prices perfectly reflected available information, there is no profit to gathering information, in which case there would be little reason to trade and markets would eventually collapse.

Investors that purchase index funds or ETFs benefit at the expense of investors who pay for financial services either indirectly or directly via investing in actively managed funds.

Case study: yes bank

Yes Bank is an Indian Bank founded in 2004 by Rana Kapoor and Ashok Kapur, headquartered in Mumbai, India.

Yes bank is a private sector bank. In March 2020, Yes Bank faced a historical crisis. There are various reasons that led Yes bank to this crisis, they are, there were a large number of bad loans given by banks and depositors have withdrawn large numbers of amounts from the bank. There was no balance between the loan sheet and the depositors’ sheet. RBI put a 30 days moratorium on Yes Bank to save it.
A major effect of the yes bank crisis was that there was a big chance that other financial institutions could collapse. But the Reserve Bank of India took initiative and saved Yes Bank from major collapse.

In May 2020 shares of Yes Bank Ltd. fell as much as 84.65 percent intraday to Rs 5.65 apiece—the lowest on record—but pared some of the losses to traded 51.63 percent lower at Rs 17.80. The S&P BSE Sensex fell 1,450 points and NSE Nifty 50 slipped below 10,900. This, after the Reserve Bank of India on Thursday evening superseded the board of the lender and imposed curbs on its operations for a month.

stock chart of yes bank
Logo of Wells Fargo
Source: internet.

Useful resources

Academic resources

Fama E. (1970) Efficient Capital Markets: A Review of Theory and Empirical Work, Journal of Finance, 25,383-417.

Fama E. (1991) Efficient Capital Markets: II Journal of Finance, 46, 1575-617.

Grossman S.J. and J.E. Stiglitz (1980) On the Impossibility of Informationally Efficient Markets The American Economic Review, 70, 393-408.

Business resources

Yes bank

Related posts on the SimTrade blog

   ▶ Youssef LOURAOUI Passive Investing

   ▶ Youssef LOURAOUI Active Investing

   ▶ Akshit GUPTA Portfolio manager – Job description

About the author

The article was written in November 2022 by Aamey MEHTA (ESSEC Business School, Master in Finance, Singapore campus, 2022-2023)

Charging Bull on Wall Street

Charging Bull on Wall Street

Nakul Panjabi

In this article, Nakul PANJABI (ESSEC Business School, Grande Ecole Program – Master in Management, 2021-2024) talks about the Charging Bull sculpture displayed on Wall Street.

About the Charging Bull sculpture

In mid of December 1989, a bronze sculpture of a bull in its charging position was dropped outside of the New York Stock Exchange. The Bull is a symbol of booming stock prices. Arturo Di Modica, an Italian-American artist, was responsible for this stunt. During the economically depressive period of late 80s, he intended to encourage optimism and hope for a prosperous future among the American Citizens. Anticlimactically, the sculpture was removed just after few hours but was placed just two blocks away from its original place.

Charging Bull sculpture on Wall Street.
Charging Bull sculpture on Wall Street
Source: Arturo Di Modica.

Although the Charging Bull has already become a global symbol for an upward stock price movements and prosperity, understanding the basics of Bull and Bear markets can be useful for Investment Management. Bull market represents the time period where asset and security prices are rising, and it reflects the heightened investor confidence in the financial markets. Conversely, Bear market represents a downward movement in security prices and an increased investor pessimism. The terminology evolves from the behaviour of the animals. Bull market derives its name from the upward attacking technique of a bull and the bear market from the downward attacking technique of a bear.

Price trends

Generally, fundamental investing deals with the fundamental value of the security rather than the movement of its price. However, it does not mean that price movements are completely irrelevant in investment decisions of an individual. It is useful to know whether the market is bullish or bearish. If the security is currently overvalued according to your fundamental analysis, then the ideal action would be to sell the security while it is overvalued. But if the price is expected to rise even higher in the near future, then the rational behaviour would be to sell the Security later at that higher price and to sell it now if the price is expected to dip. Judging the market trends is an important skill to maximise returns on investment.

The price trend approach and market efficiency

Classifying a market as bull or bear derives from studying the trends in prices of assets. The method to identify patterns in price movements and forecasting the direction of price using past market data is known as technical analysis’. Profiting from technical analysis requires the market to be inefficient. It simply means that the current stock price does not reflect all the information represented in the past price points as well as all the public and private information in the market. However, it is widely assumed that developed markets are usually efficient in the semi-strong sense. This means that the prices of the assets reflect all the information from past price points and all the information publicly available. Theoretically, in such a situation an investor cannot benefit (have abnormal returns) by using technical or fundamental analysis.

However, this does not mean that studying price trends is completely useless. In markets which are inefficient, using technical analysis might be even more profitable than fundamental analysis. Generally, the developing economies such as Africa have inefficient markets. In those markets analyzing the past price points might give a reasonable edge to forecast short-term asset prices. Using fundamental analysis can also be tricky in this case. If a stock is undervalued, then the rational behavior would be to buy the stock and wait for its price to increase. However, since the market is inefficient, it is very uncertain when the prices will reflect the public information and, consequently, whether the investor will make a profit or not. In such a case, technical analysis might still work as it relies on market sentiment.

Why should I be interested in this post?

The Charging Bull sculpture on Wall Street is part of the financial culture of every business school student. It is a must see when you visit New York City.

Bull and bear markets are terms that have to be well understood by every investor in financial markets.

Related posts on the SimTrade blog

   ▶ Nakul PANJABI Art as a financial asset class

   ▶ Akshit GUPTA The animals of finance

   ▶ Jayati WALIA Trend Analysis and Trading Signals

   ▶ Jayati WALIA Moving averages

   ▶ Jayati WALIA Brownian Motion in Finance

Useful resources

Wikipedia Arturo Di Modica.

Antoine Bourdon (22/10/2021) Mort d’Arturo Di Modica, sculpteur du célèbre Charging Bull de Wall Street à New York Connaissances des arts.

About the author

The article was written in November 2022 by Nakul PANJABI (ESSEC Business School, Grande Ecole Program – Master in Management, 2021-2024).

The impact of the Russian invasion of Ukraine on Shell

The impact of the Russian invasion of Ukraine on Shell

 Talia HAMMOUD

In this article, Talia HAMMOUD (The George Washington University, BBA, 2019-2023) discusses the impact of the Russian invasion on Shell, a large multinational oil company.

What is Shell?

Shell PLC is a British publicly traded multinational oil and gas company headquartered at in London, United Kingdom. It is one of the largest energy and petrochemical companies in the world, supplying all over the world.

What happened?

The relationship between Ukraine and Russia was tense since Ukraine gained its independence from the USSR in 1991. Since then, Russia annexed Crimea claiming it belonged to them as well as massing soldiers on the Ukraine-Russia border in 2021. On the 24th of February 2022, Russia invaded Ukraine, starting a full-blown war in Eastern Europe. In an effort to condemn Russia, many multinational companies announced they would withdraw or completely halt operations in the country.

Shell announced plans to withdraw from Russian oil just as people close to the matter say a plan is in the works by the Biden administration to ban Russian oil imports into the U.S. Due to this withdrawal, Shell announced that it anticipates account charges from $4 billion to $5 billion in its first quarter of 2022. This move caused American depositary shares of Shell to rise by 2.7% Tuesday, 8th March.

Stock market reaction

When it was first revealed that Shell was still buying discounted Russian oil after other oil companies announced their withdrawal on March 4th, Shell’s market shares plummeted by 5.73%. This shows that the market is efficient and was informed of Shell’s decision as many condemned them for still supporting Russia. There was increased market pressure for Shell to cut ties with all Russian oil suppliers. On March 8th, Shell apologized and announce its withdrawal from Russia as well as stopping all oil purchases from there. Thus, the market increased by 1.05% on March 8th.

Evolution of Shell stock market share price
hell stock market share price
Source: CNBC

Why this is important?

Firstly, it shows how volatile the oil market is as short-term demand for energy responds much faster to changes in growth than to price changes, especially due to the current Russian invasion of Ukraine, and how an act of war can impact millions around the world due to price increases of oil. This inherently impacts a big oil company such as Shell. However, I think that the market stocks rose in support of Shell withdrawing from Russian contracts and territories even though it is very costly as shown by the almost $5 billion in accounting costs for the first quarter. I think that this is an efficient market as stocks began to rise right before the announcement of this withdrawal was revealed showing that people were expecting Shell and other big oil companies to withdraw from Russia due to immense public pressure to condemn the Russian invasion of Ukraine.

Market efficiency

The market is quite efficient as the stock chart reflects all relevant information about Shell and its actions. For example, the announcement of Shells withdrawal in Russia is reflected in the market price of the day it was announced.

Key concepts

American depositary shares (ADS)

American depositary shares (ADS) are shares in foreign companies that are held in American depositary banks and can be traded in the U.S and on major exchanges. Shell Plc has an ADS facility managed by JPMorgan Chase Bank. Each American depositary share is equal to two Shell ordinary shares.

Market efficiency

Market efficiency refers to the degree how which many market prices reflect all relevant information available. If a market is efficient, it means all traders are well-informed and all the information available is reflected in the price of shares.

Volatility

Volatility represents the rate at which the price of a stock increases or decreases over a particular period. Higher stock price volatility often means higher risk and helps an investor to estimate the fluctuations that may happen in the future.

Useful resources

CNBC Shell PLC share price

Wall Street Journal Shell, BP to Withdraw From Russian Oil, Gas

Shell (March 8th, 2022) Shell announces intent to withdraw from Russian oil and gas

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About the author

The article was written in August 2022 by Talia HAMMOUD (The George Washington University, BBA, 2019-2023).

Peloton’s uphill battle with the world’s return to order

Peloton’s uphill battle with the world’s return to order

Photo William ANTHONY

In this article, William ANTHONY (ESSEC Business School, Global Bachelor of Business Administration, Exchange Student from the University of Bath, 2021-2022) discusses the market reaction to Peloton’s quarterly results.

Description of the firm

Peloton is an American company which produces exercise equipment and media streaming. Its best-seller ‘Gen 3 Peloton bike’ is available in the US, UK, Germany, Australia, and parts of Canada. With significant increases in sales during the COVID pandemic, Peloton became a public company via IPO on September 26th, 2019. At the time of writing, the company is currently valued at $16.85Bn (Market Capitalization as of 07/11/2021).

Peloton logo

Source: Peloton.

Description of the event

Peloton reported weakening sales on the 4th of November 2021 and a larger loss than expected for its first fiscal quarter. As consumers begin to return to gyms, a step closer to a pre-pandemic environment, John Foley, Peloton CEO, admits to ongoing “supply chain constraints” and “demand uncertainty amidst re-opening economies”. The fall in demand growth for Peloton’s exercise equipment has subsequently lowered the demand for its subscription-based products which has also contributed to lower profit margins.

My explanation of the market reaction to the event

The weaker than expected sales growth report led to a decrease in Peloton’s share price by nearly 40% from $86 to $60 as illustrated in Figure 1 below. In their fiscal first quarter, Peloton’s loss per share was expected at $1.07 but was instead $1.25; revenue was expected at $810.7 million but was instead $805.2 million. Despite a surge of 148% in sales and marketing expenses to $284.3 million, which represents around 35% of Peloton’s revenue, the firm was still unable to show strong growth figures coming out of the Covid-19 pandemic. This is extremely worrying and underlines Peloton’s “challenged visibility” (John Foley, 2021).

CNBC’s Jim Cramer advised his audience to sell Peloton on the next bounce after what he called a “disastrous” quarterly result. When looking at gyms like Planet Fitness Inc which have increased by nearly 20% in the last 5 days in share price, I believe there is reason for worry for Peloton shareholders. The lack of direction from Peloton management regarding a post-pandemic market and ongoing supply chain challenges leaves Peloton with a ‘sell’ market consensus and for me justifies its cliff-diving share price.

Figure 1. Peloton stock chart.

Peloton stock chart

Source: Google Finance.

Justification of my choice of the event and the firm

I chose this event because it is very recent, it is also a great example of how news regarding stagnant growth can negatively affect a company’s share price. In this example, one of the top fitness companies in the world that gained massive momentum over the global COVID pandemic, saw all its shareholders lose up to 40% of their investment in one single after-hours trading session. Here we have witnessed how ruthless the market can be in just a couple of hours.

My thoughts on the market efficiency

Eugene Fama distinguishes three levels of informational market efficiency:

  • Weak efficiency: all information contained in past stock market data (prices and transaction volumes) is already reflected in today’s price.
  • Semi-strong efficiency: in addition to the information contained in historical stock market data, all public information (company accounts, analyst reports, etc.) is already reflected in today’s price.
  • Strong efficiency: all information, public as well as private, is already reflected in today’s price.

I believe in Peloton’s case that the market has shown itself to have semi-strong efficiency. Within hours of private information being made public, the company share price reflected an adjusted rate relating to the newly released quarterly report information. As a result of the market incorporating the news into the price with such rapidity, the market was hard to ‘beat’ due to shareholders willingness to sell their shares.

Useful resources

Academic references

Fama E. (1970) « Efficient Capital Markets: A Review of Theory and Empirical Work » Journal of Finance, 25, pp. 383-417.

Fama E. (1991) « Efficient Capital Markets: II » Journal of Finance, 46, pp. 1575-617.

Business

Peloton’s website

Peloton’s financial results

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About the author

The article was written in November 2021 by William ANTHONY (ESSEC Business School, Global Bachelor of Business Administration, Exchange Student from the University of Bath, 2021-2022).