Fundamentals don’t matter. That’s been true for some time.
Before last year’s sell-off, the broad stock market was overvalued. By many measures, it was overvalued at the March 2020 bottom. Now at new highs, major stock market averages are again overvalued.
In the long run, fundamentals matter. But in the short run, how investors feel about stocks is more important.
Rather than calling this factor “feelings,” analysts refer to it as sentiment.
When sentiment is optimistic, stock prices trade above their fundamental fair value. Fair values exceed stock prices when sentiment is pessimistic.
Right now, investors are optimistic. They’re buying stocks that do well in a strong economy. And they’re ignoring stocks that could prosper in a recession.
A Luxury Stock at All-Time Highs
LVMH Moët Hennessy (OTC: LVMUY) is an example of optimism in action. This company owns Louis Vuitton and other luxury brands. The stock is at all-time highs. However, fundamentals are still recovering.
Cash flow from operations (CFO) remains below its pre-pandemic peak. In the chart below, CFO is shown by the purple bars. The blue line shows the price of the stock.
LVMH Moët Hennessy’s CFO 2000 to 2020
(Source: Standard & Poor’s.)
CFO is a measure of a company’s operations. It offers more insight into management’s effectiveness than earnings.
That’s because earnings are affected by accounting decisions. CFO reflects sales and the cost of operations. Accountants can’t easily create cash flow.
The stock’s all-time high shows that traders expect strong demand for high-priced purses, champagne and other luxury items.
On the other hand, traders are less enthusiastic about stores that shoppers frequent in recessions.
The next chart shows Walmart (NYSE: WMT). Its CFO is at all-time highs while the stock is about 9% below its highs.
Walmart’s CFO 2000 to 2020
(Source: Standard & Poor’s.)
Walmart’s CFO increased even as the economy shut down. Groceries and Walmart’s everyday low prices were in demand last year. Stores are likely to deliver increased CFO whether the economy expands or contracts.
In the past, LVMH has been among the weakest stocks as recessions end. This reflects the fact that consumers defer nonessential expenses — such as LVMH’s entire product line — in economic contractions.
This time is different.
When LVMH outperforms Walmart, investors are optimistic. But if optimism declines for any reason, so will stocks.
Fundamentals may matter in the long run, but for the short term, keep your eye on investor sentiment — it’s sure to tell you which way the market is headed.
Regards,
Editor, One Trade