Financial Foundations Exposed

News reports related to the fluxuations of the stock market are not surprising or inconsistent, but when I stop to consider what they say I find that they are either disturbing or based on faulty assumptions. This holds true whether we are talking about reports of falling or rising stocks and the report on today’s rally is a good example:

U.S. stocks staged the biggest rally in seven decades on a government plan to buy stakes in banks and a Federal Reserve-led push to flood the global financial system with dollars. . . the Dow Jones Industrial Average climbed more than 936 points.

The stocks and stock markets are supposed to give an indication of the value of the companies and economies they relate to. What is it about the plan by the Federal Reserve that makes any company better managed or more successful enough to warrant an 11% increase in value over one day?

The underlying assumption is that the government action is at the root of the deciding factors leading to the investment decisions of professionals and thus it is the hand controlling the puppet of economic production and has the right to interfere in the market as it sees fit. That assumption scares me because if we ever fully accept that premise we open ourselves to more overt government action in the markets. The more blatant the interference we will accept the more arbitrary those actions can safely be until we can find ourselves in an economic 1984 where the government can decide one day that it will give $700 Billion away and buy equity stakes in our financial sector and then the next day it can declare that it has no business interfering with corporate mismanagement and it can’t spare the $700 Billion anyway.

If that assumption is faulty – that government is the driving economic force and the basis for the decisions of investment professionals – then the news reports are misrepresenting the reasons for the rise and fall of stock prices so that we never begin to deal with the real causes of those economic swings, large or small. If professional investors are really deciding that stocks are worth more at the end of the day than they were at the beginning for reasons other than the government intervention then we should be told what indicators are being used to determine that the companies are worth more today than they were yesterday.

4 comments for “Financial Foundations Exposed

  1. October 14, 2008 at 5:16 pm

    Our economy is an incredibly complex thing. Just the financial sector of the economy is incredibly complex. In fact, almost everyone, including the smartest experts, are just guessing when they explain why the market tanked last week and then jumped yesterday. There are more factors at play than any computer model can even consider.

    The MSM and the politicians have been hammering this idea that the bailout is finally starting to kick in. But consider the fact that the government made short selling (attempting to profit from an expected decline in the stock price — essentially acting on the concept that a particular stock’s value is less than the market price currently shows) illegal.

    This temporary ban expired last week. Shorters punished the market for a couple of days. The market overreacted. Then opportunists ran in and purchased what they believed to be underpriced shares, believing that they were more valuable than market prices then showed. That caused a re-correction to compensate for the overcorrection.

    And this was just one factor — a government-caused factor. Many, many other factors were at play. Did the bailout have anything to do with the drop or the jump? (Yes/no/maybe/some?) Certainly. But nobody can tell you with any certainty what effect it had.

    When we think we can manipulate the market to cause it to respond per our wishes, we are fools.

  2. October 14, 2008 at 7:22 pm

    So, it’s the faulty assumption option, I thought that was the case, but I fear how the general ignorance regarding what is really happening will continue to lead voters and members of congress to act.

  3. Carl
    October 15, 2008 at 9:22 am

    The market does not reflect the value of the stocks that make it up. Market price is simply a reflection of what a willing buyer and a willing seller agree to pay in a particular transaction.

    Example: Dot com stocks. Many companies had zero actual value (value being defined simply as assets minus liabilities) but people would buy them because they thought it would go big. The market is simply a reflection of expectations, not actual value.

    Value and market price are related, but value does not cause market price.

  4. October 15, 2008 at 10:10 am

    Market price is, and ought to be a reflection of where the willing buyer and the willing seller meet. I’m fine with that. My problem is how the willing buyer arrives at the price they are willing to pay. My contention is that those who pick their price based on expectations that the price would continue to rise without any consideration for a real change in the value of the company are nothing more than gamblers.

    I won’t pretend that gamblers don’t exist in the market, or even that their numbers among investors are not substantial. I am simply trying to point out that people need to recognize the nature of the fraud they are being sold by the media and the leaders of the financial industry.

    Those who are doing the real business of investing (making calculated decisions about where real value is likely to increase over time) do not base their decisions on an unrealistic string of best-case scenarios.

    The fraud we are being asked to believe that that it is acceptable for the market to be based entirely upon widespread perception rather than underlying value.

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