Price variability, volatility, market movement. Whatever term you use to describe it, large fluctuations in security prices have recently become even larger. When measured by the CBOE Market Volatility Index (the “VIX”), market volatility is at a ten-year high (excluding the days immediately after Russia invaded Ukraine). For example, TravelCenters of America, Inc. (TA) recently released its Q3 earnings and was down over 20% the same day. The 20% decline was despite the company meaningfully growing revenue and earnings and our research team finding no material change to the business’s fundamentals, forecasted medium-to-long-term earnings, or breakdown of our investment thesis.
You might ask, and our research team asks itself, the following questions: (1) has there been a change in the way market participants trade over time, and (2) if so, should it affect our investment strategy?
The answer to the first question has yet to be decisively concluded. The University of Chicago, in a February 2022 article[1], stated that we see an increase in price variability when money is taken out of the financial markets. The result of money (and the people who manage that money) leaving the market is there are fewer points of view that are inputted and changes in security prices become less frequent and further apart. A competing theory is that ESG considerations and restrictive fund mandates tend to obscure true price discovery and cause security prices to diverge further from their true” or “intrinsic value. One more theory is that today’s market participants have access to information instantaneously as it is released, and some have algorithms that process information or react to others’ trades instantly. These immediate reactions to price movement often exacerbate trading in either direction and result in prices that become more distant or disassociated from the true value of the business. While there are many theories as to why market volatility occurs generally and has increased recently, our research team does not subscribe to any singular theory and believes it is likely that multiple factors contribute to price movements. Accordingly, we remain aware of the biases of our fellow market participants and make investment decisions with them in mind, even if our own investment philosophy differs.
The answer to the second question may come as a surprise to those who are unfamiliar with MIAM’s investment philosophy. Our research team welcomes volatility. This is because larger movements away from the intrinsic or underlying value of a security create a wider window in which we can buy at a depressed price or sell at a price above intrinsic value. The greater the volatility, the greater the opportunity. Of course, there is more nuance than that statement implies, but the precept remains true. And while volatility can cause quarter-to-quarter or intra-quarter prices to reflect subpar investment results, a long-term horizon allows sufficient time for an investment thesis to play out and market value to align with intrinsic value. At times, it can be tough to tolerate elevated volatility, particularly when the security price implies that a company is on the brink of financial or operational ruin (regardless of whether that is the reality). However, the combination of our rigorous fundamental research process in each portfolio company and our long-term vantage point is why we confidently maintain high levels of conviction in our portfolio holdings, even in times like today when broad market sentiment negatively affects short-term investment performance.
As always, feel free to reach out to MIAM if you would like to learn more or discuss a particular company or idea.
Sincerely,
The MIAM Research Team
[1]Emily Lambert. Why Are Financial Markets So Volatile?, https://www.chicagobooth.edu/review/why-are-financial-markets-so-volatile#:~:text=With%20so%20much%20money%20essentially,%2C%20leading%20to%20volatile%20markets.%E2%80%9D. Accessed October 31, 2022.
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