According to the efficient market hypothesis markets are effectively perfect in their ability to price a stock at the right level of value.
The price at any one time is magically always right. It doesn’t matter that the price swings around wildly, this is just a reflection of an underlying rapidly changing reality.
Because all of the known information from the past is included in the price at all times, the price tomorrow will depend on new unexpected events.
As such changes of price will be random.
This seems correct because prices are very random and you can check that yourself by trawling though historic data to find movements from the past affecting movements in price later.
This is of course what hedge funds do all day long. Try to find ways of trading the future with certainty by seeing if there are tip off in the past. It seems there are many to be found because all this trading effort in itself destroys any predicting links that can be found.
That’s what keeps the market random and perfect.
The time series are not totally random, so the market is not perfectly perfect, but it is fair to say they are very random indeed and the level of perfection in the market can be estimated to be high.
So how can it be that US valuations of tech companies can be so mad?
Twitter is floating at a $10 billion valuation. That’s bonkers.
Facebook (NASDAQ:FB) at $100 billion market cap, that’s approximately $100 a head per user. How does that come to pass when you consider the average Facebook accounts content? Think of all your friends Facebooks, do any of them look worth $100 to you? Talk about spinning Gold from Straw.
It is really not hard to end up scratching your head over the valuations of the likes of Zynga (Nasdaq:ZGNA) and Groupon (Nasdaq:GRPN). Even the market caps of monster companies like Amazon are hard to frame in anything but the blue sky talk of the dotcom bubble. Imagine they were valued like a Walmart.
But wait, why fight it?
This madness is not going away. Its baked into US investor behaviour.
Perhaps if there were more outlets for wild optimism coupled with crazy gambling in the US then the picture would be different. However there aren’t betting shops on street corners or Casino’s in every town.
Manic tech valuations are going nowhere and if you want to short high flying tech stocks you have to be prepared to be torn to shreds.
I would like to think that sanity will break out. However it is not going to happen and there is a single chart to prove it.
As the old speculator once said, “all you have to know is whether it is going up or down, the rest is just detail.”
So look at this. It’s the long term chart of the Nasdaq in a quarterly timeframe.
Which way is this chart going? That’s rhetorical of course.
There is no way I’m going to short anything on this index.
What is more the chart looks like it is only just getting started on its skyward projection.
Let me reframe the same chart so you can consider drawing in the next few years.
The prospect is appetising.
So lets not fight the tape. Nasdaq is going up a long way over the next few years and its going to be the same old tech companies driving the process.
So should investors buy Twitter at $10 billion market cap at the IPO?
It is very tempting but it’s a wide eyed gamble. So if you enjoy that kind of thing why not. The markets going up a long way, so how can a Twitter style internet darling fail?
Myself I’ll save my money for a trip to Vegas or to add to my sedate positions like lead broker to Twitter the 11 p/e Goldman Sachs (NYSE:GS)