Why the sharemarket makes no sense in the short term


Sometimes the world just doesn't make sense

Some would argue that the sharemarket makes no sense in the long term either but that is an argument easily dismissed through 4 or 5 years of intensive discussion, research, correspondence, argument and analysis. So for the moment, let’s just say that it does make sense in the long term but there is room to argue that it does not in the short term.

Here’s an example of why.

Gunns is a high profile timber company – domestically famous for tearing up old-growth forest and chipping 100 year old trees to make annual statements for superannuation funds that can be thrown in the bin when returns aren’t what was expected. They can’t seem to cut a win out of anything that they do, and the shareprice reflects that. Here is Gunn’s shareprice for the last 5 years.

Gunns Shareprice chart for 5 years

You can see the huge devaluation applied to Gunns' assets.

If we look at the last 12 months, we can see a huge drop in the shareprice, and therefore the company market capitalisation, or market valuation.

Share price chart for Gunns Ltd for one year

Ouch! You can see the incredible drop in valuation for the business in the last 80 days

The announcements from the company don’t really suggest that the business valuation should halve… At least, not from any logical long term look at the business. There was an announcement on the 10th March 2011 confirming government approval for a pulp mill, which caused a lot of shares to be bought and sold but this didn’t halve the value of the company, and the price rapidly recovered to its pre-announcement level.

What you do see when you trawl through the various ASX announcements, is a huge amount of trading by the major shareholders. And a couple of notices about changes in shareholding, which upon reading, seem to suggest that an awful lof of shares trades were actually borrowed. Let’s call that “shorting”, and assume that it is folk borrowing share to sell in the hope that the price will fall and they will buy back for less money – handing back the borrowed shares and pocketing the price difference as a handy short-term profit.

This wouldn’t necessarily work in a company where the current strategy, outlook and management were all mature and publicly known. However, Gunns has been trying to get the finance for its pulp mill and trying to deal with its old-growth forest felling issues, and changes in management and… You get the drift.

One of those reports suggests that lots and lots of shares had been borrowed for this purpose (selling short). Market analysts tend to report and think about such trading activities as being helpful for “price discovery” (ie, testing for any weakness in the company), market liquidity (the number of shares available to buy or sell on a given day) and such clever things. Many argue that it makes no difference to the long term value of the company – in fact, it cannot affect the company long term outlook. The GFC made a mockery of such flippancy, as loan covenants were breached and technical defaults resulted in devastating impacts on individual companies.

In this case, the number of shares available to be sold short were far more than the amount traded on a given day. In other words, the people selling short have sufficient capacity to move markets. Who cares, you might say? Well, you can bet that folk selling at the reduced levels on fears that the company was going under, would care quite a bit.

To me, this is what constitutes an uninformed market. In other words, lack of adequate disclosure. Of course, legislators, market participants and the shorters themselves would disagree with me, for the reasons mentioned earlier. So my opinion is rather worthless. Feel free to ignore it should you wish to do so, and consider this note as nothing more than the rantings of a misinformed and undereducated observer.

And what has happened today?

Gunns Ltd shareprice during 1st June 2011

You can see the huge change in price at 10 o'clock... Would the folk selling shares they didn't own be deciding to buy them back now?

The shareprice is up 25% – interestingly enough for those who care about such things, the change occurred right on 10 o’clock… which lines up with the timing of yesterdays’ sharp price movements in BHP and the major banks. Am i beginning to sound like a conspiracy theorist..?

Anyway, today the company released an announcement on the broad strategy, confirming amongst other things, an intention to stop felling of native forest and to go it on their own for the pulp mill financing and a slew of other initiatives that were probably on the go anyway but by making the announcement, the  company keeps the market informed, and you’d think that at least part of that announcement objective was to stamp on any potential for speculation that the company was about to fail.

Another anouncement today was from the “value” fund manager Dimensional. These folk have a very strong track record of buying companies when they think they are undervalued, and have enough global clout that they would be a welcome addition to a company register – especially given their preference to be long term players.

So, was the disclosure in all this fair and reasonable? The company did what it could to inform the market when it appeared that the market was failing to appreciate where it is headed. Those that have faith in the long term potential were able to gain entry at what are historically very low prices. The shorters were able to buy back the shares and hand them back to whoever they borrowed them from. The price is highly likely to recover over time so any shorting that may have taken place -and i’m not sayin’ that it did (misquote from the movie Shrek) – hasn’t negatively impacted the long term shareholder.

That is NOT a recommendation, so don’t act on it and suggest that i’ve recommended that you do!!! Remember, this site DOES NOT provide personal advice, as it cannot take into account your personal financial position, goals and objectives or tolerance of risk…

Has anyone lost? Well… if you sold your shares at 32c without looking at or knowing any of the above then you have certainly lost out. Is this a case of poor disclosure? It’s not my lot to suggest that it is – i’m just raising a few issues here. However, you cannot just look at an ASX trading board and know how much of the day’s trade was selling or buying by folk who have borrowed the shares. To me, this is a failure to keep the market participants informed. There is no legislative requirement that this be disclosed other than something somewhere that says you must disclose this within a few days or some such thing. Not much use to those who traded a few days before, is it?

And so we can ponder just a few of the arcane issues that can have a massive impact on the shareprice of a company on a given day. When taken as a whole, the sharemarket movements usually make quite a bit of sense when viewed in the context of news on the economy, interest rates, currency and government policy. However, there is less and less sense when you begin to consider individual companies over short terms, as major initiatives and speculative plays can be taking place that you and i are completely unaware of.

Just sharing a few thoughts.

Feel free to investigate and castigate me for any errors, omissions or misstatements. All of this is nothing more than my sharing what have been some very superficial and brief peeks into the large price movements in just one company. You must not use it as the basis of a personal buying, selling or hold decision – that should only be done after either you or some far-sighted and appropriately qualified individual has taken the the time for a full analysis, and done so in the context of your overall financial objectives.

Phew – it sometimes feels like disclaimers take longer than the notes they are intended to cover… Thank goodness for the high female participation in high school typing class, which was a major factor in my learning to type ridiculously well, very early in life. Great preparation for the subsequent flowering of the computer age.


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