French philosopher Jacque Derrida caused a
plague revolution in literary circles that continues to inaffect academic circles to this day. Termed Deconstructionism, the theory proposed that in literature, and by extension painting and sculpture, there was no such thing as objective value. In short, the worth of a work of art could not be separated from the reader. If the audience determined that the poetry of William Blake, for example, had no relevance to their experience, then it was worthless no matter what anyone else thought. To the extent that deconstructionism led to a reassessment of the dominance of Dead White Males in history, it was entirely healthy. Its wholesale adoption in college English departments, on the other hand, is an ongoing disgrace. I have no problem believing that current IQ testing is inaccurate and unfair for inner city kids because of the context of the questions, but the second this thought leads to Hamlet being crap because a high school student “doesn’t get it”, I have to tap out.
A similar process of Deconstructionism is occurring in asset markets as most conceptions of objective equity and debt values are being tossed out the window. The valuation of investment assets is, of course, a matter of debate. However, for the sake of argument let’s accept that most valuation techniques are variations on the primary theme that a “hard value” can be determined by the present value of future cash flows. This is a blog post and I’m not getting paid, so we’ll keep the discussion of correct discount rate simple, assuming a blend of government rates.
This underlying assumption of this classical valuation technique was that the discount/interest rates were only peripherally related – the economy, as reflected by the discount rate, went a long way in determining the relative value of the cash flow stream of the investable asset. This is the relationship that’s been completely thrown on its head. The Fed and the ECB are determining rate policy in response to credit, not economic conditions, arguably with the sole intention of boosting asset values. History will judge whether this is a good idea or not, but it is clear that rate policy is now largely disconnected from current economic activity. This in turn implies that the validity of current rate policy is arbitrary in the same way that Deconstructionists believe that the value of Shakespeare is arbitrary – dependent on the reaction of the audience or markets.
The preponderance of technical analysis in the current market is an important contributor to this phenomenon. Technicians eschew fundamental analysis in favor of careful measurement of short-term investor behavior. With reference to Graham’s belief that the market was (to paraphrase) “a voting machine in the short term and a weighing machine in the long term”, technicians are fully concentrated on the former. This is not to criticize technicians, far from it – during the past three years ignoring technicals has been a sure path to investor bankruptcy. But, the fact that the vast majority of current trading activity is determined by an investment philosophy that completely fades any concept of intrinsic or objective value, furthers the argument of this post – that the market is operating without the net of accurate asset price valuation.
To attempt to determine the “correct” value of an investable asset in the current market is to ask “how big is a balloon?”, dependent on how much central bank air will be pumped into it. The market today, in light of the ECB’s LTRO program is nuts – being in uncharted waters, I wouldn’t predict market disaster as any more probable than any other scenario. At some point though, equity and debt markets will have to settle into some form of homeostasis where future values are in some way predictable. Until then, we are just gambling on coin tosses and hoping for the best, living in a world where The Di Vinci Code can be considered our highest artistic achievement if enough people agree.