Elon Musk explains how stock markets predict the future

the stock market is very good at predicting what will happen in the future this is the statement that i made in my last video and unsurprisingly i received a lot of comments from people questioning how can this be true when the stock market jumps around so violently and we see stock market bubbles and crashes clearly these things show us that the stock market is anything but accurate well in this video i'm going to teach you one of the most important investing lessons you will ever learn and my good friend elon musk is here to help explain [Music] hello and welcome back to the channel for those of you that are new here hi my name is james i am a financial planner and this is a place where you can learn to make smarter financial decisions so what do i mean by the stock market is good at predicting the future i know you're probably sitting there thinking how can this be possible it didn't predict this inflation or a recession and it certainly didn't predict coronavirus so what the hell are you saying well let me bring in our good friend mr musk to help explain things as you may be aware elon has recently made an ill-fated attempt to buy twitter between january and march of 2021 musk quietly started building a stake in twitter and we now know that by march 14th this stake had grown to 9.2 percent of the company and over the following weeks musk tweeted a series of suspicious polls about the future of twitter and how he would improve it and on the 4th of april musk's stake in twitter became public via a securities filing and the stock rocketed by 27 to over 50 on anticipation of a buyout offer over the following days there was then a back and forth about whether elon would join twitter's board and then finally on april the 14th elon made an offer to take twitter private for 54.20 per share which is a 40 premium above where the twitter stock was trading at before elon got involved now with perfect hindsight we know exactly how this unfolds from here but what do you think that the stock market is predicting at this point well elon's just made a bid for twitter for 54.20 per share so why hasn't the stock price jumped up to exactly that level well the market must be anticipating that this is not a done deal it must think that there is still a significant chance that this deal won't go through and it was right to assume so because twitter was not on board with this offer and on april 15th the day after elon made his bid twitter adopts a poison pill in an attempt to prevent a hostile takeover so at this point we have two potential outcomes either elon buys twitter for 54.20 per share or the deal falls apart and the stock falls back to where it was before this all started with hindsight we now know that elon did not buy twitter and we could look back now and say that the stock market got it wrong but did it back then no one could have known for certain whether the deal would go through or not there was a chance that the deal would go through there was also a chance that it wouldn't so at this point in time on april 18th the stock market is weighing in the chances of each of these two events occurring so if you bought twitter on that day for 48.45 and the deal did come off you would have made a 5.75 profit but if it didn't and the price dropped back to 38 you would be set to lose 10 dollars so i hope you're starting to see that the market is not predicting that a or b will definitely happen it's evaluating the probabilities of each possible outcome to arrive at a price that represents these known risks so based on the fact that there is a 5.75 upside and a 10 downside we might assume that at this point the market is suggesting that there is a better chance of the deal coming off than there is it falling apart and as we see over the following days as twitter engages in talks with elon the stock price rises as the chances of the deal going through increase and then they finally peak after twitter accepts his offer you'll notice that price never gets quite as high as 54.20 because the market still thinks that there is a chance that the deal could unravel as it did quite quickly now looking back in hindsight we know that this deal has not happened and you might think that well that means the stock market got it wrong but that's unfair because at that time no one could read elon's mind and the market was simply acting on all of the information that was available at that time so when i say the stock market is good at predicting the future i don't mean that it's telling us that a or b will definitely happen because no one knows that instead it's assessing all of the facts and information that we have available to us right now to weigh the likelihood of each potential future outcome to arrive at a price that represents these risks i like to use buyout examples to illustrate this because in these situations there are two very clear potential outcomes as another example let's look at activision in january microsoft entered into a deal to buy activision for 95 dollars per share on this announcement activision stock shot up to 82.31 per share which is telling us the market is still forecasting that there is a good chance that this deal will not go ahead and as we can see over the following months we've seen the stock price decline as the anticipated risk of the deal falling apart has increased again because we have two clear outcomes it's easy to see how the market is pricing in future risks outside of these buyout scenarios stocks have many many more potential future outcomes and as a result it's harder to see this process in action but the market is continually assessing each of these outcomes to arrive at a price that represents those known risks at the moment there is a risk of prolonged inflation recession and maybe even a war i know this you know this everyone knows this so the stock market will already be pricing in these risks so now we understand that the market is forwards looking and rapidly pricing in new information but is it any good is it accurate in 1970 eugene farmer developed a model called the efficient market hypothesis which put forth a framework to assess how efficient markets are or how good are they at pricing in new information and weighing the risks of the future in this he theorized that stock prices adjust rapidly to new information as it becomes available and that a stock's price reflects the fair value of that company at that time it also stated that markets priced in new information so rapidly and accurately that it should not be possible for an investor to consistently identify undervalued or overvalued stocks and make a profit from it other than through luck and stock prices move in a random unpredictable manner as new information arises this is a theory that was further popularized in burton malkiel's book a random walk down wall street now that's a pretty big statement if this is true it would mean that all stock picking and market timing is futile just think about it there is a trillion dollar active management industry that is based on the premise that it is possible to beat the market and this theory clearly flies straight in the face of that now eugene farmer actually went on to win a nobel prize for this theory and his other commitments to the field of finance however this theory has been the source of fierce debate ever since it was published primarily because it assumes that all information about stocks and the economy is rapidly available to everyone and that investors are rational well as a financial advisor i can tell you that investors are anything but rational in fact there is now an entire field of study that is dedicated to the research of irrational investors it's called behavioral finance and suggests that investors are instead driven by fear and greed that leads to stock market bubbles and other market inefficiencies the debate about stock market efficiency is still ongoing to me it certainly seems like the markets are rational at times or maybe that's just because of their random nature but as far as you and i are concerned if the market is inefficient and it does miss price stocks at times it's only really relevant if we can predict when it is being inefficient and we can profit from it otherwise we may as well just carry on and behave as if markets are completely accurate all of the time so if the stock market is inefficient and it can be exploited we should see evidence that some investors are able to achieve higher risk adjusted returns than can be simply explained by luck remember we do expect some people to outperform the market over very long periods of time simply by random luck just like in a coin toss that has a 50 50 chance of landing on heads or tails but if we have enough people playing the game some people will end up with getting 10 or even 20 heads in a row but as we know if they keep on playing the game long enough their overall score will revert towards the mean so if the stock market is wildly inefficient and easy to exploit we would expect to see evidence that lots of professional stock pickers are able to beat the market and achieve returns in excess of what can be explained by luck if on the other hand only a handful are able to outperform it would suggest that there are inefficiencies there but they are very very hard to exploit and if there is no evidence of anyone being able to outperform it means that markets are efficient enough that they cannot be exploited as you can imagine a huge amount of research has since been done to test these hypotheses some studies have shown that there is some evidence of outperformance but only in a very small number of highly skilled investors whereas many big seminal papers show that there isn't no evidence of active managers being able to produce any value net of fees so perhaps it's right to assume that the answer lies somewhere between these two that the stock market is mostly efficient but there are some inaccuracies that can be exploited but only by a very very small number of people that are skilled enough to do so and that it typically takes a 20-year track record to be able to identify whether these individuals have actually been able to achieve their returns through skill or just luck so what does this mean for us as investors should we be trying to be in this top 0.0001 of investors or should we just carry on and behave as if markets are completely efficient for this i'd like to paraphrase professor hersh shepherd a pioneer of behavioral finance who has spent his life trying to prove that stock markets are inefficient he says that yes the stock market is inefficient and that theoretically we should be able to exploit these inefficiencies to turn a profit but in practice when trying to stock pick or time the market our behavioral biases get in the way and prevent us from being able to execute properly and that our poor execution typically leaves us with returns that are far worse than the market after costs because of this he concludes that the vast majority of investors should behave as if the stock market is perfectly efficient this is coming from a guy who has spent his life proving that stock markets are irrational and yet he still believes that we should invest as if it is so there it is you and i should be acting as if stock markets are efficient so when you are looking at the price of a stock or an index fund we should assume that that price accurately reflects everything that may happen in the future given what we know right now so the next time you find yourself asking is now a good time to invest you should recognize that that is an impossible question because if it does look like there is an upcoming risk of recession or inflation and that companies may struggle the stock market will already have fallen to reflect this and we'll now be offering you a fair price given the known risks that we face and if it's offering us a fair price then yes now and every time is a good time to invest yes we may look back with hindsight and say that worked or it didn't but there is no amount of research that we could have done at that time to tell us that in advance now whilst you've been watching this you've probably been thinking what about famous investors like warren buffett or peter lynch surely these are examples of people that have been able to out with the market well no most of these famous fund managers outperformance can be explained by a few simple factors and if you want to learn what they are and how you can try and replicate their returns you should watch this video here where i talk about how i invest my own money i'll see you there

Channel: James Shack

Views: 40,272

Keywords: elon musk, twitter, stock market, investing for beginners, twitter deal

Id: UJiS1Z0cu_w

Length: 13min 33sec (813 seconds)

Published: Mon Jul 18 2022