Question : After reading the above articles 1 and 2, who do you think is driving markets - short-term or long-term investors?

Below is Article 1

Do fundamentals01' emotionsdrive the stock market? There's never been a better time to be a behaviorist. During four decades, the academic theory thatnancial markets accurately reflect a stock's underlying value was all but unassailable. But lately, the view that investors can fundamentally change a market's course through irrational decisions has been moving into the mainstream. With the exuberance of the highetech stock bubble and the crash of the late 19905 still fresh in investors' memories, adherents of the behaviorist school are finding it easier than ever to spread the beliefthat markets can be something less than efcient in immediately distilling new information and that investors, driven by emotion, can indeed lead markets awry. Some behaviorists would even assert that stock markets lead lives of their own, detached from economic growth and business profitability. A number of nance scholars and practitioners have argued that stock markets are not efficientithat is, that they don't necessarily reflect economic fundamentals.1 According to this point of view, signicant and lasting deviations from the intrinsic value of a companfs share price occur in market valuations. The argument is more than academic. In the 19805 the rise of stock market index funds, which now hold some $1 trillion in assets, was caused in large part bythe conviction among investors that efficientemarket theories were valuable. And current debates in the United States and elsewhere about privatizing Social Security and other retirement systems may hinge on assumptions about how investors are likely to handle their retirement options. We agree that behavioral finance offers some valuable insightsichief among them the idea that markets are not always right, since rational investors can't always correct for mispricing by irrational ones. But for managers, the critical question is how often these deviations arise and whether they are so frequent and signicant that they should affect the process of financial decision making. In fact, signlficant deviations from intrinsic value are rare, and markets usually revert rapidly to share prices commensurate with economic fundamentals. Therefore, managers should continue to use the triedeandetrue analysis of a company's discounted cash flow to make their valuation decisions. When markets deviate Behavioralenance theory holds that markets might fail to reflect economic fundamentals under three conditions. When all three apply, the theory predicts that pricing biases in financial markets can be both signicant and persistent. irrational behavior, Investors behave irrationally when they don't correctly process all the available information while forming their expectations of a company's future performance. Some investors, for example, attach too much importance to recent events and results, an error that leads them to overprice companies with strong recent performance. Others are excessively consen/ative and underprice stocks of companies that have released positive news. 4 Systematic patterns of behavior. Even if individual investors decided to buy or sell without consulting economic fundamentals, the impact on share prices would still be limited. Only when their irrational behavior is also systematic (that is, when large groups of investors share particular patterns of behavior) should persistent price deviations occur. Hence behavioral, finance theory argues that patterns of overcondence, overreaction, and overrepresentation are common to many investors and that such groups can be large enough to prevent a company/s share price from reflecting underlying economic fundamentalsiat least for some stocks, some of the time. Limits to arbitrage in nancial markets, When investors assume that a company' s recent strong performance alone is an indication of future performance, they may start bidding forshares and drive up the price. Some investors might expect a company that surprises the market in one quarter to go on exceeding expectations. As long as enough other investors notice this myopic overpricing and respond by takingshort positions, the share price will fall in line with its underlying indicators. This sort of arbitrage doesn't always occur, however. In practice, the costs, complexity, and risls involved in setting up a short position can be too high for Individual investors. If, for example, the share price doesn't return to its fundamental value while they can still hold on to a short positionithe socalled noise-trader riskithey may have to sell their holdings at a loss. Momean and other matters Two welleknown patterns of stock market deviations have received considerable attention in academic studies duringthe past decade: longeterm reversals in share prices and shorteterm momentum. First, consider the phenomenon of reversalihigh-performing stocks of the past few years typically become lowperforming stocks of the next few. Behavioral nance argues that this effect is caused by an overreaction on the part of investors: when they put too much weight on a company's recent performance, the share price becomes inflated. As additional information becomes available, investors adjust ; their expectations and a reversal occurs. The same behavior could explain low returns after an initial public offering (IPO), seasoned offerings, a new listing, and so on. Presumably, such companies had a history of strong performance, which was why they went public in the rst place. Momentum, on the other hand, occurs when positive returns for stocks over the past few months are followed by several more months of positive returns. Behavioral-nance theory suggests that this trend results from systematic underreaction: overconservative investors underestimate the true impact ofearnings, divestitures, and share repurchases, for example, so stock prices don't instantaneously react to good or bad news. But academics are still debating whether irrational investors alone can be blamed for the long, termrreversal and shortetermemomentum patterns in returns. Some believe that longeterm reversals result merely from incorrect measurements of a stock's risk premium, because investors ignore the risks associated with a companfs size and marketitocapital ratio.2 These statistics could be a proxy for liquidity and distress risk. Similarly, irrational investors don't necessarily drive shortiterm momentum in share price returns. Prots from these patterns are relatively limited after transaction costs have been deducted. Thus, small momentum biases could exist even if all investors were rational. Furthermore, behavioral nance still cannot explain why investors overreact under some conditions (such as IP05) and underreact in others (such as earnings announcements}. Since there is no systematic way to predict how markeE will respond, some have concluded that this is a further indication of their accuracy.a Persistent misprici g in carve-outs and dual-listed companies Two well-documented types of market deviationithe mispricing of carve-outs and of dual- listed companiesiare used to support behavioralifinance theory. The classic example is the pricing of 3Com and Palm after the latteHs carveout in March 2000. In anticipation of a full spin-off within nine months, 3Com oated 5 percent of its Palm subsidiary. Almost immediately, Palm's market capitalization was higher than the entire market value of 3Com, implying that 3Com's other businesses had a negative value. Given the size and protability of the rest of 3Com's businesses, this result would clearly indicate mispricing. Why did rational investors fail to exploit the anomaly by going short on Palm's shares and long on 3Com's? The reason was that the number of available Palm shares was extremely small after the carve-out: 3Com still held 95 percent of them. As a result, it was extremely difcu It to establish a short positi n, which would have required borrowing shares from a Palm shareholder. During the months following the carve-out, the mispricing gradually became less pronounced as the supply of shares through short sales increased steadily. Yet while many investors and analysts knew about the price difference, it persisted for two monthsiuntil the Internal Revenue Service formally bpproved the carveiout's taxifree status in early May 2002. At that point, a significant part of the uncertainty around the spin-off was removed and the price discrepancy disappeared. This correction suggests that at least part of the mispricing was caused by the risk that the spinoff wouldn't occur. Additional cases of mispricing between parent companies and their carved-out subsidiaries are well documentedfL In general, these cases involve difculties setting up short positions to exploit the price differences, which persist until the spinoff takes place or is abandoned. In all cases, the mispricing was corrected within several months. A second classic example of investors deviating from fundamentals is the price disparity between the shares of the same company traded on two different exchanges. Consider the case of Royal Dutch Petroleum and "Shell\" Transport and Trading, which are traded on the Amsterdam and London stock markets, respectively. Since these twin shares are entitled to a #fixed 6040 portion of the dividends of Royal Dutch/Shell, you would expect their share prices to remain in this fixed ratio. Over long periods, however, they have not. In fact, prolonged periods of mispricing can be found for several similar twinishare structures, such as Unilever (Exhibit 1). This phenomenon occurs because large groups of investors prefer (and are prepared to pay a premium for) one of the twin shares. Rational investors typically do not take positions to exploit the opportunity for arbitrage. Thus in the case of Royal Dutch/Shell, a price differential of as much as 30 percent has persisted at times. Why? The opportunity to arbitrage dualilisted stocls is actually quite unpredictable and potentially costly. Because of noisetrader risk, even a large gap between share prices is no guarantee that those prices will converge in the near term. Does this indict the market for mispricing? We don't think so. In recent years, the price differences for Royal Dutch/Shell and other twinishare stocks have all become smaller. Furthermore, some of these share structures (and price differences) disappeared because the corporations formally merged, a development that underlines the significance of noiseitrader risk: as soon as a formal date was set for definitive price convergence, arbitrageurs stepped in to correct any discrepancy. This pattern provides additional evidence that mispricing occurs only under special circu mstancesand is by no means a common or longilasting phenomenon. Markets and fundamentals: The bubble of the 1990! Do markets reect economic fundamentals? We believe so. Long-term returns on capital and growth have been remarkably consistent for the past 35 years, in spite of some deep recessions and periods of very strong economic growth. The median return on equity for all US companies has been a very stable 12 to 15 percent, and longiterm GDP growth forthe US economy in real terms has been about 3 percent a year since 1945.5 We also estimate that the inflation, adjusted cost of equity since 1965 has been fairly stable, at about 7 percent.6 We used this information to estimate the intrinsic PIE ratios for the US and UK stock markets and then compared them with the actual values.7 This analysis has led us to three important conclusions. The rst is that US and UK stock markets, by and large, have been fairly priced, hovering near their intrinsic P/E ratios. This figure was typically around 15, with the exception of the highiinflation years ofthe late 19705 and early 19805, when it was closer to 10 (Exhibit 2). Second, the late 1970s and late 19905 produced significant deviations from intrinsic valuations. In the late 19705, when investors were obsessed with high shortiterm inflation rates, the market was probably undervalued; longiterm real GDP growth and returns on equity indicate that it shouldn't have bottomed out at PIE levels of around 7. The other welliknown deviation occurred in the late 1990s, when the market reached a PIE ratio of around 307a level that couldn't be justied by 3 percent longiterm real GDP growth or by 13 percent returns on book equity. TDon't Blame Stock Markets for Peri] of ShortTermism The Business Roundtable, a prestigious organisation of the CEOs of the largest American companies, last week urged large public companies to stop telling investors what senior executives expect quarterly earnings will be Their effort arises from the widespread belief that the scourge of marketdriven short, tennism is seriously damaging the American economy Ending this quarterly eaniings advice would help. Respected business leaders like Jamie [hum and Warren Buffetl have promoted the idea under the headline that \"ShortrTen'nism is Harming the Economy\". The adVIce on forgoing advance projections of quarterly earnings is sensible as such efforts largely waste managerial time~the earnings will be announced soon enough. But the thinking behind the advice, that marketednven shortetermism is seriously banning the American economy, is unsound. Critiquing short, tennism is now an idea whose time has come and, for many, its severity is so obvious that the idea needs no support. Like the recent at1acks on open trade, basic marketplace advantages do not seem as advantageous, even to market leaders like the Business Roundtable, as they once did Shortetermism driven by stock markets is said to come from rapid trading in American equities and stockholder actiwsts at hedge funds pressuring executives for immediate results and cash, pushing executives to take shortcuts. Three ways of stock market shortrterm degradation of the economy are regularly repeated and Widely accepted Without question. First, shorteterm stock markets punish companies that do research and development, R&D expense comes now, pay-otfs in better products come years later. Diminished R&D compromises the economy's future. Second, companies are draining their cash by buying their own stock back at a torrid pace to keep cash, hungry investors satised With the cash gone, the companies' capacity to perform deteriorates Third, the US, which more heaVIly depends on stock markets than most of the rest of the developed world, is investing shockingly less in capital equipment, fadories and new businesses than its peer nations. But none of these three core shorteterm ideas is true R&D spending is rising in the US The Department of Commerce's data are clear and unambiguous. Yes, stock buybacks are ukhundreds of billions of dollars of stock has been bought back in recentyears. One might mistakenly think cash is therefore draining out. But it isn't, because large US companies simultaneously also increased their net longeterm borrowing by hundreds of billions of dollars Cash isn't draining out when one combines the two. Cash out to buy stock; cash in by borrowmg more. Too much debt, even at today's bargainebasement interest rates, is not always for the best. But it isn't a shorteterm, quarterly problem and it's not draining cash. Recommended Equityearnings Investors deliver harsh verdicts on earnings calls Capital spending on new machinery and equipment is down in the USunambiguously. But, capital spending is down across the entire developed world It's down in countries like the UK that also depend strongly on stock markets and it's down in Germany, Japan and the rest of the developed world, including the countries that do not depend on stock markets as much as the US. Something else is happeningmore efCIent use of existing equipment due to better IT, postindustnal economies using less heavy capital than before and movement of basic manufacturing to China and elsewhere The developed world's capital spending decline deserves understanding but if such spending is falling both in nations oriented to stock markets and those not so oriented, then looking to markets as a central explanation is a deadrend that leads to irrelevant or even damaging policy solutions Why is theeconomywide data so inconsistent with such widespread belief in market-driven short-tennism? One reason is that we're mm more venture capital rms now do the R&D in some sectors better than the big public companies Second, many public companies have kept researching and investing but the problem cases get headlines and political attention Third, and in my View most importantly, tedtnology is moving faster than ever. Product cycles are shortening. Hardewon skills for employees and companies are displaced faster than ever, thereby disorienting, disrupting and angering those who worked hard for skills that the next technological shift undermines, hitting them hard. Something broader may be going on. Some executiveslike many in the Business Roundtable membershipmay exaggerate shonrtermism because it justies executives, riot shareholders, always having the nal word And for many citizens and political leaders, shortetermism has become a catchrall complaint against Wall Street and the large public company. Real problems like neglecting employees' welfare, environmental degradation and the disruption resulting from increasing speed of technological change are too otten labelled as marketdriven shortrtennism. These are real problems. But they are