The Big Question: Is the stock market becoming too short term?

Interview with Metropolis, Jennison and Veritas

In our latest Big Question, Simon Denison-Smith, Thomas Davis and Andy Headley explore how quarterly reporting, passive investing, and retail participation affect short-term market behaviour, long-term investing, and opportunities for active stock pickers.

Simon Denison-Smith
I think this question comes from Donald Trump's proposal that US companies should move to six monthly reporting. And the real question is, does quarterly reporting result in management being obsessively short-term focused to the detriment of long term shareholder returns? We don't really see evidence of that in jurisdictions where they're already at six monthly reporting, like in the UK, for example. On the flip side, you see companies that have very long-term orientations who actually report even more frequently. So something like Ryanair in our portfolio reports passenger numbers on a monthly basis. So it really comes down to individual management teams and whether they're short term and long term. What we really like is seeing management teams that have significant ownership of their businesses, and that's something that we really encourage as well.

Thomas Davis 
I have to say the short answer is no. The companies we own strive to create and articulate medium- to long-term business plans that they believe will create value over time, despite that quarterly treadmill of earnings and guidance. Companies have been operating on the quarterly basis quarterly timetable for decades and it's difficult to argue that long-term value creation has been noticeably impacted in any adverse way. Quarterly earnings and guidance can actually be helpful guideposts reflecting progress towards a business plan. At the same time, progress needs to be recognised as something that can ebb and flow with the pace of business. Companies are rarely moving in a straight, consistent line over time, so small adjustments in guidance should be viewed in proper context and measured against the broader competitive environment. In our strategies, we focus on business fundamentals first and foremost with each earnings report. Looking at whether execution's on track, whether market share is improving, whether profitable growth remains an achievable outcome over time.

Andy Headley
I actually don't really think that quarterly earnings and guidance are having a material impact on valuations. I think if we look at countries that don't do full quarterly earnings like France, there doesn't seem to be any difference between those countries and the way the stocks react versus countries that do full quarterly earnings. And so I don't really think that quarterly earnings and guidance is having a really big impact. In fact, if anything, I'm a proponent of more disclosure.

Simon Denison-Smith
There’s no empirical evidence that suggests that passive investing or algorithmic trading has resulted in greater volatility. But there is a logic to the idea that passive investing might have a role here. Passive investing is essentially a momentum trade. So as money flows into passive funds, more of it's being allocated to stocks that are going up and away from stocks that are going down, and that could create more volatility. With algo trading it's actually quite interesting: we've seen examples in earnings calls where share prices have moved very quickly on the basis of a single answer from a question by the CEO and what we've noticed is that sometimes there's no new information in that answer. It's just the tone that's being interpreted. We think algo traders are using large language models to pass CEO and CFO words to drive their trading. Our preference is to keep our eyes on the horizon and to think about whether or not that sentiment is really affected the overall long-term thesis for our stocks and if it hasn't, then it's a great buying opportunity.

Thomas Davis
We believe that the proliferation of passive vehicles and algorithmic trading certainly does seem to have a distortionary effect on markets, at least over short periods of time. Passive investing has moved well beyond the initial concept of simply replicating an index with either a mutual fund or an ETF. Sector and style ETFs, leveraged ETFs, thematic ETFs, and tradable stock baskets that are created by various brokerage firms and then algorithmic variations on almost any of these vehicles create ways to rapidly trade both large and small segments of the equity markets, irrespective of individual company fundamentals. So that leads us to think that the markets can be distorted from time to time as a result of these new vehicles.

Andy Headley
The data we have indicates that passive and algorithmic trading are having a big impact on equity markets and valuations. From what we can see algorithmic trading represents something between 60 and 75% of all trading volume on the major exchanges, and passives are another 20 to 30% of trading volume. Now, clearly these ways of investing are largely value agnostic. The investors don't care about closing the gap between share price and intrinsic value and I think what this means is, as a consequence of them having such high market share, that we'll see greater disparity between share prices and actual intrinsic values, and we'll see those differences persist for much longer.

Simon Denison-Smith
So there is evidence that active retail investors trade more frequently and have shorter hold periods and that's clearly not conducive to a long-term investor mindset. The most extreme example is the rise and fall of meme stocks.

Thomas Davis
Retail participation in the equity markets has clearly increased over the years. It's been helped by lower costs, improved access and easy-to-use platforms. A significant portion of this activity is long term in nature and pretty constructive, particularly through pensions, ISAs and diversified investment funds that encourage discipline savings. But at the same time, we have to acknowledge that some retail activity is more short term in nature. Social media driven narratives, rapid shifts in sentiment can promote trading behaviour that's disconnected from the underlying fundamentals of a business. From our perspective though, the key issue is not so much who owns the stock, it's how it's owned. Long-term value creation ultimately rewards investors who understand the business, can tolerate some volatility along the way and give management strategies time to succeed. While increased retail participation can add some noise to short-term pricing, it does not undermine the long-term investment process. If anything, it just makes markets more dynamic.

Andy Headley
I suspect, although I don't know, that having greater retail participation leads to a shorter-term mindset. I think in general the volume of trading done by retail investors tends to be shorter term and what we've seen over the last 5 to 10 years is really the gamification of retail investing. So we see these US companies like Robin Hood that have really gamified equity trading. Now, there is still a cohort of retail investors that are great long-term-focused investors. But I think that they're outweighed significantly by the shorter-term, more momentum-driven investors, which is leading to a sort of shorter-term time frame rather than a longer-term time frame.

Simon Denison-Smith
We believe it's an opportunity. Benjamin Graham, the father of value investing, describes it beautifully when he wrote that in the short run the market acts as a voting machine, but in the long term, it's a weighing machine. What he meant by that is that in the short term, stock prices react to sentiment and narrative that's often not linked to the fundamentals of the business. For example, the latest tweet by Sam Altman. What we have to do as stock pickers is focus on the fundamentals. It's not that we ignore what the market reaction to it is. There is genuine wisdom in the crowd. But our role as stock pickers is to sift through that noise and identify which information really has an impact on long-term cash flow returns. Because we have a very concentrated portfolio, that judgement is easier because we have a really deep understanding of our businesses and that helps us to trade effectively.

Thomas Davis
We actually see this as both, but ultimately more of an opportunity. Short-term market behaviour can increase volatility, which can be uncomfortable, certainly as it's occurring, and especially when high-quality growth companies experienced sharp price declines driven by temporary concerns or sentiment, rather than underlying fundamentals. However, the same volatility often creates attractive opportunities for long-term investors, such as ourselves. When capital moves quickly based on headlines or algorithms, it can lead to mispricing. For disciplined stock pickers, this creates a chance to buy a strong growth company, a strong business at compelling valuations, or, frankly, to reduce exposure when expectations have become overly optimistic. Our investment approach is built to navigate these conditions. As long as a company's fundamentals remain sound, short-term volatility becomes something to manage rather than to be concerned about. And in that sense, a more short-term market actually can reinforce the value of active stock selection.

Andy Headley 
I'm pretty confident that it's both a risk and an opportunity. A risk in the sense that what we're seeing with this greater participation of both retail but also algorithmic and passive, is we're seeing a greater disparity between intrinsic value and share price, as these investors don't really care about intrinsic value, their value agnostic. So we're seeing a risk because there's a bigger difference and it’s persisting for longer. But the upside is that when this gap closes, there is much greater upside in these companies that you can buy much more cheaply because of the influence of passive, algorithmic and retail investors and their short-term nature.