Thursday, 20 November 2008

The rights and wrongs of markets

As I have said before, equity market people are a funny bunch, jumping around all the time, trying to second-guess each other (sometimes to the point of vacuity), while others even tend towards obsessive mysticism.

One trend of the equity market in recent years has been denial. This denial often took the form that rising share prices (and then commodity prices) were unconnected to high levels of liquidity (credit), and so ignoring the idea that a decline in liquidity would lead to a fall in share prices (for instance: when debt is no longer there for private equity buyouts, there is no ‘bid premium’ for companies that might be bought out).

It is interesting now to see many equity investors waking up to what's happening in the credit markets, and some making very similar mistakes. Now they are mistakenly ascribing powers of foresight onto the credit markets, trying to pin significance onto indicators that have little wider meaning, often so divorced from the real world as to only tell a story about the indicator itself. (But analysts need something to write and theorise about!)

There is only a little truth in the myth that credit markets know more than equity markets (a point debated in the link immediately above). The truth is that credit markets have different sources of information and research to those that focus on shares. Credit market news tends not be mediated through bank analysts and PR-driven national newspaper articles. Instead, it tends to be internal, or provided by specialist news organisations that have two-way information exchanges with market participants. The latter pair of reasons help explain how the credit markets could have deluded themselves so much ahead of the crash.

Overall, I do not think that the credit markets provide 'better' information than the equity markets, or vice versa. It is, however, interesting to see that the equity market, which is deeper and more liquid than the credit market, can be just as wrong as the credit market, but in its own distinctive way.

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