Brexit reduced valuation - not value

A few brief notes on Brexit’s non-rational effect on the stock markets.

The reason to own a stock is access to some kind of future dividend(s). Think about it, no stock would we worth anything if it didn’t pay money back to its owner at some stage. Hence, the stock price should be today’s value of future dividends. But this does not seem to be the case. The day after Brexit, a lot of large companies in Europe declined 5–10% in price. Did future dividends of most companies in Europe decline by 5–10% due to Brexit? Not a chance! Their valuation fell with more than their value did.

Also, trading volume increased. Since every stock needs to be owned by someone, this means money didn’t flow out of the stock market. What happened was more investors traded and/or did more trades than usual. If I move money away from stocks, I do that because I believe other investment options are better given the current state of the markets. Let that sink for a moment. If I sell after the price-decrease, I believe the stock is now priced HIGHER than its future dividends. This also strikes me as odd, I would rather draw the opposite conclusion and refuse to sell (I’m a mathematician). But the market didn’t, and trading volume surged.

The markets consists of humans and machines trading on human emotions. This seems to make for irrational markets, which of course is Ok. If everyone buys into the scheme, it’s no longer a scheme. I will continue on this topic in my next post on stock crashes.

Stay tuned!

/Kristoffer