We’re more than half way there. The Australian market has now dropped from 6,853 on 1 November 2008 to 3,332 yesterday — a drop of 51.3 percent. Stephen Mayne noted that the declining share market has led to “the greatest destruction of wealth since World War Two.” The previously impenetrable bank sector, despite maintaining a fee gouging oligopoly and a preposterous taxpayer funded guarantee has been decimated. Even BHP, our supposedly resilient, diversified miner has fallen by more than 57 percent.
However, one man’s sharemarket crash is another’s correction. While the media is quick to point to the billions ‘lost’ in the stock-market (or in the case of the United States, “trillions”), in reality, that money was never lost — it never really existed. The true value of shares, like any asset, is based upon the present value of all future cash flows — while share market investors (or Mr Market, according to Benjamin Graham) will make an estimate of the value of various assets — that is all it is — a best guess by a faceless throng. A stock market crash is in effect, a mass re-estimation of the value of various assets.
Dan Denning, writing in the Daily Reckoning, provided an apt analogy when he compared the stock market revaluation to what happens in the real world, noting that financial assets aren’t all that different to real property. Denning stated yesterday that:
Cash Converters helps people turn lazy assets (guitars, mobiles, stereos, old harmonicas) into cash. And what is that but the liquidation of the consumer spending boom? Of course, most stuff isn’t worth as much people think it is. When you own something, you tend to think it’s worth more than everyone else.
The pawn store analogy makes more sense than many explanations proffered by various experts as to why share prices are so much lower now, than in November 2007. Last year, investors put a price on assets which were in hindsight, far higher than their intrinsic value. Investors thought their assets (which in this case, were shares in companies like BHP, NAB or Macquarie Bank) were more valuable than they really were. A bit like people who think that wooden chest of drawers they inherited from their grandmother is mahogany, when it actually is a dark coloured pine.
Investors valued companies based on significant future earnings growth (notwithstanding an impending slowdown in economic growth, the key driver of company earnings). Media companies, often the first to suffer in an economic slowdown were trading on price-earnings multiples of 20 or more. Even our miners, who have spent more than a century disappointing investors, were trading on forward multiples of 10 or more. Many infrastructure companies were valued by the market at billions of dollar but didn’t even have PE ratios — they had no real “E” — their alleged earnings came from arbitrarily revaluing assets, while dividends were paid from bank loans or shareholders own funds.
Many investors, whose portfolios are now valued at less than half of what they were a year ago may not agree, but wealth has not been “lost” in the share-market correction. Rather, illusory gains which had been falsely created by the mirage of bullish expectations and over-leverage have been removed. (Of course, like any good bust, the market will almost certainly over-correct, allowing for shrewd investors to earn extraordinary rates of return when profits start rising.)
Everybody loves a boom — money is cheap, jobs are plentiful and life is good. But for society, booms exacerbate inequality and allow spivs and conmen to prosper, ultimately causing an inefficient distribution of resources. Over the last decade, billions of dollars have been skimmed by investment banks and property trusts which should have been invested in other areas. Managers of companies such as Babcock & Brown, MFS, Allco/Rubicon, ABC Learning and Centro absconded with millions of dollars in cash, while banks, shareholders and taxpayers footed the bill.
Like a drug-fuelled party, a boom may seem like fun at the time, but it is not until the smoke clears, that you can see the mess. A share market crash is economic Darwinism — the weak, the greedy and the incompetent are found out, while fools (and others who were simply too trusting) will be soon parted with their money. Not that there’s anything wrong with that.