The rise of exchange traded funds and passive investing has delivered enormous benefits to investors through lower costs, greater transparency and broad diversification. Photo by Getty Images

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One 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.

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We 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.

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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.

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Looking 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.

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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.

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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.

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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.