The Price of Everything, The Value of Nothing
Posted by Larry Doyle on August 23, 2010 12:23 PM |
What is something worth? Very simply whatever somebody is willing to pay for it, correct? While regulations or the lack thereof have a big impact on overall levels of returns and compensation, all other things being equal, I do not begrudge those who take risk, work hard, and reap rewards. I applaud them. I view that process as the essence of capitalism.
Does this line of thinking still work in our Uncle Sam economy circa 2010? One of the overriding themes highlighted in Observations on My Afternoon in New York City addressed the topic of market valuations. I wrote:
4. Investors do not want to sell what they currently own because they do not know what they might purchase to replace it. Investors do not want to allocate more capital because they are concerned about market valuations in general.
I should have been even more pointedly specific in writing this statement. While I do believe many people in the market today are concerned about the overall level of the market, the point I was trying to get across is that people do not trust or believe the individual values of investments at current prices. Why is this the case and how does this happen?
Very simply, as The Wall Street Journal addresses in writing Government Clouds Value of Investments:
What is anything worth?
That might sound like an utterance from the book of Ecclesiastes or the title of a freshman philosophy paper. But it is a valid question for any investor right now. Gauging the true worth of stocks, bonds and real estate is extremely difficult at a time when their prices are so heavily influenced by the actions, or perceived inaction, of governments and central banks.
On a far bigger scale, take the 10-year Treasury note, a cornerstone for pricing so many other securities. While the Fed’s monetary-policy stance has always had an impact on government bonds, its moves have much more sway when the economy’s future hinges on monetary stimulus. Just over a month ago, Fed Chairman Ben Bernanke said the economic outlook was “unusually uncertain.” Since then, the 10-year note has rallied. The drumbeat is growing louder for the Fed to balloon its balance sheet further by purchasing more assets. But that would only increase its presence in important asset markets, further distorting them.
Of course, there is supposed to be a happy ending. The fiscal and monetary stimulus is meant to bring the private economy to the point where it is self-sustaining. But it is just as likely that the government remains entrenched. Government entities will likely back some 90% of new mortgages for the foreseeable future. And if, miraculously, that backing returned to precrisis levels, it would still be huge. From 1990 to 2006, 54% of all new mortgages had effective taxpayer guarantees, according to data from Inside Mortgage Finance.
Some will take comfort from the fact that it would have been a good bet to buy shares in 2002, when there was huge doubt about the economy and loud calls for the Fed to do more. The S&P 500 rose 67% from the end of 2002 to the end of 2007.
The problem is, anyone unlucky enough to buy the S&P 500 at the end of 2003 would be down today. That underlines the fact that timing is everything. And even more so in markets beholden to aggressive government action. Today’s winners will arguably be those who correctly guess the Fed’s appetite for shock and awe.
To paraphrase Oscar Wilde: Right now, investors know the price of everything but the value of nothing.
Against this backdrop, should we really be surprised that to an ever increasing extent investors have exited the markets? When Uncle Sam is compelled to step in for investors who lack confidence and feel unprotected, we have a decidedly different marketplace.
Wall Street is now reaping what it sowed for far too long.
I have no affiliation or business interest with any entity referenced in this commentary. As President of Greenwich Investment Management, an SEC regulated privately held registered investment adviser, I am merely a proponent of real transparency within our markets, including our financial regulators, so that investor confidence and investor protection can be achieved.