California Drowning
(as sung by Peter, Michael and Arnie)
13 July 2009
Sean Russo
SOMEONE once said “life’s not fair”, so why should markets be fair? World equity markets are supposedly approaching “fair value”. I contend markets never trade at fair value. I think it is more reasonable to argue that fair value is simply the line between overvaluation and undervaluation that historians and others draw in afterwards, with perfect hindsight.
Others might also argue, not unreasonably, that at the close of each day or each week the price reflects fair value for that particular point in time.
Take the cycle of the life and now the death of Michael Jackson. A retrospective of the tough school of public opinion marks out various points of undervaluation and overvaluation of his core value, his marketability. When a painter dies they will no longer paint. Future scarcity of the artist’s works and past observations of the price of the works of dead artists suggest the value of those works should increase. I get that, for some artists anyway. I don’t get why the sales of CDs and online downloads of Michael Jackson’s music went through the roof because he died. If you didn’t ever feel compelled to own Thriller in the past, why buy it now because the very talented but weird white/black guy just died?
But ‘getting it’ is not the point and trying too hard to get it, to determine whether something is under or overvalued, is the mistake we make too often in the markets.
Remember Keynes said, “markets can stay irrational for longer than you or I can stay solvent”. Often it doesn’t have to make sense, just observe what is happening and choose your role – participant or observer. The price of “Michael Jackson the asset” is clearly on the trajectory from undervaluation to overvaluation. Who knows where value will settle when the world has read “The Real Story”, all 200 of them?
Personally I am much sadder for the passing of Peter Bernstein earlier in June. He was 90 so he had had a “good innings”, but nonetheless the world of finance is poorer for his passing. At least we can be grateful for the wonderful collection of best selling books that he has written. One in particular which has been described as the definitive book on risk, “Against the Gods” **, is an absolute must read. Particularly for anyone charged with wrestling with the multitudes of risks such as those that exist in exploration and mining.
If you don’t own it go out and buy it. If you have read it in the past, dust it off and read it again or give it to a colleague to read. Not because he’s dead but because it makes enormous sense and its message is really timely in a world that seems to want us to believe that’s its all okay and we are at or near fair value with the worst behind us.
This is the same world that has unemployment over 10% in a quarter of the states in “The United States of America”. One of those states, California is, in its own right, the eighth largest economy in the world; 20 years ago it was the fifth largest. Now it appears that the eighth largest economy in the world must resort to handing out IOUs to its creditors.
“Keep providing your services and we promise to pay – IOU, Arnie”.
That’s right, the punters are being asked to put their “full faith and trust” in Arnie and his crew, no greenbacks available. If only Arnie could just print money like the economies ranked one to seven and nine to 99 (and beyond). Is California the Canary economy?
Bernstein wasn’t against taking risk. On the contrary, he recognised taking risk is an inevitable part of business (and investment). He simply asked that people always ask “what are the consequences of being wrong?” and to “never take a risk that you do not have to take”. These two sentiments are at the core of sensible risk management and the practical use of hedging. Essentially he was saying look after the downside and the upside will look after itself.
If ever there was a time to really understand the consequences of being wrong it must be now. The kind of volatility we have seen and are likely to continue to observe has the potential to continue to drive markets from one extreme of “value” to another and back again. If you attempt to operate in a market like this without appropriate hedging and broader risk management policies and practices, even if your view is ultimately proved right, your business may not survive to see it come to pass (see Keynes comment above). This is the time not for a strong view but a sound plan.
Of course you could choose to go with Michael and try to “beat it, just beat it” and hope the outcome is not “bad, really-really bad”.
**Against the Gods-The Remarkable Story of Risk, Peter L.Bernstein, John Wiley and sons Ltd.