August 17, 2010

Prudential Vice Chair Says Stocks Are Not Trading Chips

Thursday and Friday this week we’re in New Orleans sweating it out and moderating a Rapid Fire panel on hot topics at the NIRI Southwest Regional Conference. Karen and I plan to eat beignets and drink Sazeracs too. Probably after.

Recently Kate Welling at Weeden & Co. interviewed Prudential’s vice-chairman, Mark Grier about being public in 2010. I read it and asked if we could highlight it here. It’s critical knowledge for IROs and public-company execs now.

Prudential (NYSE:PRU) has market capitalization of $26 billion, 38,000 employees, some $700 billion of assets under management. Before the May 6 Flash Crash, Vice-Chairman Grier had lamented to the SEC about the lack of fundamental content in stock prices.

In the interview, Grier said: “What happens when the market’s fundamentals are algorithms and signals and pings and all the stuff that goes on between the machines? What happens when the machine doesn’t know whether it’s buying Prudential or McDonald’s or Continental Airlines? What happens when that is really the way in which stock prices are being determined?”

Grier said, “I believe that this disconnect between company fundamentals and stock prices is a much more serious source of systemic risks than anybody is giving it credit for. The systemic risk – if the markets are materially wrong, if they are broken down, if they are not reflecting fundamentals, and if, as a result, real investors are hunkering down and not participating – could be devastating.”

“Stock prices,” Grier said, “are reflected in corporate accounting statements, in the financials, in earnings, in capital, in mark-to-market valuations, in regulatory capital. Then we have the rating agencies that use them. We have all the headline risks that go along with the market volatility as they affect employees and as they affect clients.”

And what if the whole underpinning construct isn’t fundamentally priced? Grier said, “There’s a basic conflict between using the stock price as our report card and the way in which that price gets set.”

Grier talks about the financial crisis of the past two years. “Instead of reflecting fundamentals,” Grier says, “the market itself became the fundamental. And that’s not the way it’s supposed to work…everybody is scratching their heads trying to figure out what’s going on, and that gets translated into expectations and plans and spending and pretty soon into real behavior. So pretty soon the economy was going through a cycle that was driven by the market itself.”

These are but a few nuggets from Kate Welling’s treasure-trove interview. Read it. Pass it on to your CFOs and CEOs.

We can’t solve the problem until we first understand it. The problem is that the market only marginally reflects what we do every day. Changing it starts with IR professionals getting a grasp on how markets work.

Second, companies need to be involved in setting rules for stock markets. Public companies are the life blood. Yet rules are made by traders, for traders, and companies are silent. Imagine if supply and demand were irrelevant in the grocery store and price-setting power belonged to a cartel selling groceries. And then suppose that economists considered prices to have been set by supply and demand. Could you trust their predictions?

Here’s a challenge, IR professionals: Educate yourself about markets. This interview is a great starting point. Write a letter for your CEO to submit to the SEC, a position statement on our capital markets.

The first step toward change is forming an opinion and expressing it. These are our capital markets, after all.

It’s about time for a Sazerac.

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