How ETFs, momentum and passive investing are reshaping stock prices

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Photo by Getty ImagesOne of the biggest adjustments investors need to make today is recognizing that stock prices are increasingly driven by narratives and the capital flows they create rather than purely by earnings, cash flow, balance sheets and valuation.THIS CONTENT IS RESERVED FOR SUBSCRIBERS ONLYSubscribe now to read the latest news in your city and across Canada.Exclusive articles from Barbara Shecter, Joe O'Connor, Gabriel Friedman, and others.Daily content from Financial Times, the world's leading global business publication.Unlimited online access to read articles from Financial Post, National Post and 15 news sites across Canada with one account.National Post ePaper, an electronic replica of the print edition to view on any device, share and comment on.Daily puzzles, including the New York Times Crossword.SUBSCRIBE TO UNLOCK MORE ARTICLESSubscribe now to read the latest news in your city and across Canada.Exclusive articles from Barbara Shecter, Joe O'Connor, Gabriel Friedman and others.Daily content from Financial Times, the world's leading global business publication.Unlimited online access to read articles from Financial Post, National Post and 15 news sites across Canada with one account.National Post ePaper, an electronic replica of the print edition to view on any device, share and comment on.Daily puzzles, including the New York Times Crossword.REGISTER / SIGN IN TO UNLOCK MORE ARTICLESCreate an account or sign in to continue with your reading experience.Access articles from across Canada with one account.Share your thoughts and join the conversation in the comments.Enjoy additional articles per month.Get email updates from your favourite authors.THIS ARTICLE IS FREE TO READ REGISTER TO UNLOCK.Create an account or sign in to continue with your reading experience.Access articles from across Canada with one accountShare your thoughts and join the conversation in the commentsEnjoy additional articles per monthGet email updates from your favourite authorsSign In or Create an AccountWe now operate in an environment where billions of dollars in market value can disappear from a company in a matter of hours simply because an exchange-traded fund (ETF) rebalances, a factor model rotates exposure or a widely held investment narrative changes direction. Investors often search for a fundamental explanation when the more immediate driver is the movement of capital itself.This advertisement has not loaded yet, but your article continues below.A recent example was the market’s reaction to announcements surrounding Starlink’s potential entry into the U.S. cellular market. The news triggered sharp selloffs not only among American telecommunications companies but also in Canadian carriers such as BCE Inc., Rogers Communications Inc. and Telus Corp., erasing an estimated $3.5 billion to $4 billion in the combined market value of the Canadian companies in a single day. Canadian telecom operators did not suddenly lose their spectrum lichttps://financialpost.com/tag/valuation/enses, regulatory protections or extensive network infrastructure. The economics of their businesses were largely unchanged. What changed was the narrative surrounding the industry and the capital that immediately flowed in response to it.Canada's best source for investing news, analysis and insight.By signing up you consent to receive the above newsletter from Postmedia Network Inc.A welcome email is on its way. If you don't see it, please check your junk folder.The next issue of Investor will soon be in your inbox.We encountered an issue signing you up. Please try againLooking south of the border, consider Mosaic Co., a company I unfortunately owned personally. In less than a month, the stock has lost roughly one-third of its value following little more than an analyst downgrade and a lack of meaningful company-specific news. Fertilizer prices have remained relatively stable while sulphur, an important feedstock cost for the company, has actually been declining. Concerns surrounding the upcoming quarterly report may explain some of the weakness, but they do not fully explain why roughly 188 million shares changed hands over the past four weeks, equivalent to approximately 60 per cent of the company’s public float, while roughly US$2.2 billion in market value disappeared. At some point investors have to ask whether one of the world’s largest fertilizer producers genuinely became worth billions less or whether a large institution simply hit the sell button and let the algorithms do the rest. Increasingly, those are two very different questions.This advertisement has not loaded yet, but your article continues below.Part of the answer lies in the profound transformation of market structure over the past two decades. The rise of ETFs and passive investing has delivered enormous benefits to investors through lower costs, greater transparency and broad diversification. Yet their success has also changed how prices are determined.Hedge fund manager David Einhorn recently argued that traditional value investing has, in many respects, been defeated. Decades ago, markets were dominated by active managers employing teams of analysts whose job was to identify businesses trading below intrinsic value. Capital was allocated based on assessments of earnings, cash flow, competitive advantages and valuation. Investors bought stocks because they believed the businesses were worth more than the market price.Today, a growing portion of market activity comes from passive funds, quantitative strategies and retail investors influenced by themes and momentum. Many participants are no longer focused on what a business is worth, but rather simply betting on where its share price may go next.This advertisement has not loaded yet.This advertisement has not loaded yet, but your article continues below.Passive funds buy according to index weights, quantitative models respond to momentum, volatility and factor signals and algorithms attempt to anticipate the behaviour of other market participants. In many cases, trading activity has become increasingly detached from traditional fundamental analysis. As money chases momentum or exits crowded positions, prices can become completely disconnected from intrinsic value. The good news is that eventually fundamentals reassert themselves, but investors must often endure significant volatility before that occurs.For active investors, this creates both risk and opportunity. The challenge is distinguishing between a company facing genuine deterioration and one caught in the crossfire of modern market structure. Understanding who owns a stock, how much is held within passive vehicles and where liquidity resides has become almost as important as understanding the business itself.Like it or not, we live in a new investment world where narratives and capital flows can overwhelm fundamentals for extended periods of time. That has been one of the most important lessons of the post-COVID era of quantitative, algorithmic and artificial intelligence-driven markets. As investors, we need to be careful not to chase or give into the latest narrative but to determine what a business is actually worth.This advertisement has not loaded yet, but your article continues below.Whether paying my cell phone bill or fertilizing my garden, I am reminded that stock prices are not always conveying value. More often than many investors realize, they are communicating something far simpler: where the money is flowing. At least for now, anyway.Martin Pelletier, CFA, is the author of Investing Through the Storm and a senior portfolio manager at TriVest Wealth, a team that is part of Wellington-Altus Private Counsel Inc. TriVest provides discretionary risk-managed portfolios, investment audit/oversight and advanced tax, estate and wealth planning. The opinions expressed are not necessarily those of Wellington-Altus._____________________________________________________________If you like this story, sign up for the FP Investor Newsletter.This advertisement has not loaded yet.Notice for the Postmedia NetworkThis website uses cookies to personalize your content (including ads), and allows us to analyze our traffic. Read more about cookies here. By continuing to use our site, you agree to our Terms of Use and Privacy Policy.