The Incredible Levitation of Stock Markets

I am not sure that stock prices ever bear much relation to the worldline that will ultimately play out over time, but the recent rally, now aged 55 days and counting, really highlights the fantasy world that typifies equity values (as so much else, but more on that later).  Recall that market indices made their lows on March 6th and the world looked bleak.

At that time, one started to hear that FASB was going to reconsider the application of the Mark-To-Market accounting rules for banks which would relax the requirements to mark their balance sheet assets to a market which did not exist.  The whole Mark-To-Market issue does present a dilemma.  On the one horn, as we have seen, the idea presupposes a market where price discovery is actually happening.  If this price discovery function is impaired, how is one to mark to market?  On the other horn of the dilemma, if you allow the quants to mark the assets to their models, the pressure to tweak the model is too strong to resist so you wind up marking the assets to fantasy levels.

Recall that the stringent Mark-To-Market accounting rules only became active in November 2007.  This marked the top in equities.  Conincidence?  I think not.  Also, according to the timeline published here,  on Monday, March 9th, markets started moving higher.  On Tuesday, March 10th Fed Chairman Bernanke weighed in on the issue of Mark-To-Market Accounting by suggesting that the rules be loosened.  This must have made Steve Forbes happy, as he had been harping on this issue.  According to the Wikipedia article linked above, the FASB made their announcement that the rules would be relaxed on March 16th.  The markets have been rallying since it first caught wind of the change.

Think about this for a minute.  In response to the hiding of problems banks have; by making their financial situation more opaque, markets have rallied 25%?  Moral of story is that people like to live in a fantasy world and damn you if you intrude on their reverie with sordid tales of reality.  Lesson for traders?  Do not be too worried about what reality would dictate, the markets and indeed the world turns on perceptions of reality washed through human minds which crave fantastical stories.

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