Truth and illusion in the price

[richardw]

World's smartest woman on the stock price, from: http://www.ft.com/cms/s/2/54787700-48ca-11de-8870-00144feabdc0.html Question: What is your understanding of the financial crisis? - Eric Kaufmann, Princeton, New Jersey, US Answer: Two parts: First, an economy based on growth is bound to falter now and then. A whole sector could collapse. It's a house of cards. Eventually, it must morph into a system that functions on stability, or it will fail - meaning a fall large enough to cause an unstoppable breakdown and widespread hardship. Second, the impression is widespread that a vast amount of wealth has been lost in the current disruption. This is a misconception. Instead, investors have been misled by their brokerage statements due to what I call the Cheshire multiple, after the vanishing cat in Alice's Adventures in Wonderland by Charles Dodgson (aka Lewis Carroll). Consider the example of stock prices. As we know, our statements indicate the number of our own shares multiplied by the price at which the stock last traded. This is the Cheshire multiple. Some stock somewhere is sold for a higher price, and lo - everyone who owns that stock thinks his or her investment is worth more. This is not wealth; this is illusion. Say that a hard-working pizza-delivery guy decides to buy stock, pays £1 more than the last fellow did, and the float (shares available for trading) for that stock is 50 million shares. Has he just created £50m of wealth? No. Yet a huge number of people think that this figure represents money in the stock market "bank", so to speak, and that this money is available to them unless the stock price goes down. In fact, no such money exists. The sum of all those brokerage statements adds up to the market cap (capitalisation) description and nothing more. Each separate statement indicates only what an investor might expect to receive if a small number of them try to sell the stock at that point. If many investors sell, sellers will outnumber buyers, and the price of the stock will plummet. Understand that this is not simply the phenomenon of rising stock prices. The multiple causes a ballooning effect, instead. It can be *****ed by ordinary activity. For example, say the ageing of a population causes more retirees to begin trading their stock for cash. But because no cache of funds exists to sustain this slow drain, prices start to collapse. Meaning: While each brokerage statement is accurate, the collective amount is not. This fictional aggregate is the "wealth" that ordinary investors believe exists in some form - a misconception fraught with economic danger.

[john_1]

this is why there often great oppertunities in unbunlings and deals of this nature as they will often leave some of this wealth behind in the break up or create more..

[#3]

This argument is a bit thin - point 1 is nothing new - Marx has put that argument forward almost a century ago. Point 2 can easily be pulled apart. The value of your 'statement' is the current price of your stock in the open market which fluctuates according to supply & demand. Wow, now that is perceptive! What does she want to compare it to, cash? Well cash also fluctuates in value, depending on inflation, exchange controls, etc. The intrinsic value of a firm has always been built on NAV and the premium that the market is prepared to pay. Yes the premium may fluctuate, and your net worth can easily be calculated making provisions for such fluctiations - just like traders make provisions for slippage

[richardw]

Well, it's an interesting discussion topic so posted it. But I don't think it's that thin, and since her 228 IQ isn't here to defend it, I'll try to be a very poor substitute!

Firstly, it's not an absolute. I wrote "truth and illusion" because there are both truths and illusions in the price. As you say, the price is usually denominated in another currency, which itself has a variable value. But the value of a currency usually moves a lot less than the value of a stock, so you should be able to generally trust the value of *most* currencies more than individual stocks.

Also, she's not saying that it's supply and demand. She's saying that the market cap of a stock is a very illusory number, because to get it we extrapolate the current price to show a value of all held stocks. So the full-market losses that have been widely reported are similarly illusory.

It's not supremely unique thinking, or claimed to be. The name "cheshire multiplier" directly hints at the economic multiplier concept of how banks create money out of thin air.