Aswath Damodaran 36
Are Markets short term? Some evidence that they are
not..
! There are hundreds of start-up and small firms, with no earnings
expected in the near future, that raise money on financial markets. Why
would a myopic market that cares only about short term earnings attach
high prices to these firms?
! If the evidence suggests anything, it is that markets do not value current
earnings and cashflows enough and value future earnings and cashflows
too much. After all, studies suggest that low PE stocks are under priced
relative to high PE stocks
! The market response to research and development and investment
expenditure is generally positive.
None of these pieces of evidence is conclusive proof that markets are long term,
but the evidence does add up to markets being much more long term than
they are given credit for. There is little evidence, outside of anecdotal
evidence, that markets are short term.
The best support for markets comes from looking at how well they do relative to
expert prognosticators:
1. Forward currency rates are better predictors of expected currency rates in
the future than economic forecasters.
2. Orange juice futures markets seem to predict the weather in Florida better
than weather forecasters.
3. The Iowa Election Market has predicted election results better than political
pundits.
It is true that there are many short term investors and analysts in the market, but
the real question is whether the market price is able to get past their short
term considerations and focus on the long term. Sometimes, it does not but
surprisingly often, it does.
