Tuesday, July 3, 2007

When Complex Markets Are Not Transparent

The complexity issues described in yesterday’s weekly report are amplified by the fact that so much that occurs in the financial world today is hidden from view. This is especially true for the multi-trillion dollar unregulated money worlds of hedge funds and private equity. For competitive and other reasons, full transparency does not exist and a “trust the experts” mentality rules. I suppose, as long as the results are there, who is to question the 21st century’s version of masters of the universe?

The point of this falls back to one of the three valuation inputs – the discount rate. One might suspect that astute investors would consider adjusting the traditional discount factor for a world so complex and opaque. Yet, most investors, particularly professional investors appear to be content and accept conventional valuation inputs in a most unconventional time.

Investment Strategy Implications

When complex environments are not as transparent as they should be, risk should be higher and, therefore, valuation lower. A further point for my primary argument that stocks should remain undervalued*.

*Note: Undervalued does not mean down. It simply means that wherever fair value is, stocks should not reach that level. For example, if fair value were determined to be 1700 in the S&P 500, equities could rise from present levels. However, my research argues that they should not reach fair value.

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