November 29, 2011

A Rational View of Share Prices

Belated Happy Thanksgiving!

After breaking for a week as an act of giving thanks, we’re back. Karen and I joined 88,622 others in Aggieland at Kyle Field in College Station for the A&M football game last Thursday versus the Texas Longhorns. Disappointing outcome, great Thanksgiving.

There’s something special about Texas. People passing you on the street say hi and the kids say yes ma’am and yes sir. There’s a lot of what Kenny Chesney calls “the good stuff.” What may be the world’s greatest college bar, the Dixie Chicken, sits on the main College Station drag like an Old West saloon. Batwing doors, even.

Speaking of swinging doors, gyrations in markets make it awfully hard to use your stock price to measure investor sentiment (wasn’t that the idea behind exchanges?). In fact, there’s inherent contradiction between the way markets behave now and how the IR profession cultivates holders.

IR folks typically seek buy-and-hold money that does not trade. Yet executives frequently ask about the stock price. The news rushing at us round the clock tries to explain market behavior in rational terms. Yet stock prices are set by the latest fleeting bid or offer. Nine of ten times, those prices are not rational.

We advise clients to track Rational Price – our measure for the level at which thoughtful investment behavior jostles through the batwing doors of the market to compete with the din in there and stamp a price on your stock. It doesn’t happen often, frankly. About half the client base has had no new Rational Price since about Nov 4. The time between has mostly been about fear and greed vacillating around the euro.

One lesson: If you want rational money setting price, target investors with shorter horizons who’ll shoulder the batwing doors more frequently. If you’d like to hear more about rationally quantifying market behavior, send me an email and ask for our white paper on Measuring IR in Modern Markets.

Speaking of markets, we’ll wrap with a word on them. We warned clients that investors were shifting from equities to derivatives with options expirations Nov 16-18. We saw the biggest use of VIX S&P 500 volatility futures since August. The cause? The euro.

You remember a year ago we were talking about the potential demise of the euro? In a Wall Street Journal article Monday, ICAP Corporates, the biggest “wholesale counterparty” broker helping investors swap this for that globally, said it’s running tests for the return of the Greek drachma and maybe other national currencies.

The implication for IR? Trading is global. We track its impact on clients large and small. A euro-zone fracture would bring into question valuation mechanisms for entire global markets. Right now, it’s all relative. In 1999-2000, the euro’s creation coincided with a significant devaluation of the dollar and a huge bubble in stocks.

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