Mark to Myth

Liquid markets should, at least in theory, generate price signals relevant for the fair value of the underlying traded assets. Quantitative easing in a low-interest rates environment led to decoupling assets’ prices from their intrinsic value. While most investors conflate price with value, history shows that markets generate erratic signals. Are the current share prices reflecting the company’s fair value? Is this a mark-to-market or a mark-to myth?

The term “mark to market” describes a set of metrics used to determine the fair value of an asset (or liability) that is subject to fluctuations observable in the market.

A straightforward example is the fair value of a stock portfolio which equates to the sum of each stock’s market prices.
The term “mark-to-myth” was extensively used after the 2008 credit crisis and referred to complex mathematical methods for determining the fair value of illiquid financial instruments.

The current state of financial markets is a fertile ground for “mark to myth”, despite the high liquidity in the leading traded assets. Companies’ valuations based solely on their share price is strongly biased by exogenous factors, independent of their ability to add value to shareholders in the long term.

In 2008, “mark to myth” - based fair value generated premiums related to the lack of liquidity in specific markets. On the contrary, 2022 brings a paradigm shift in the mark-to-myth, whereas assets’ price incorporates a premium generated by the liquidity glut. In all cases, valuations disconnected from fundamentals are not a good sign for investors, even if the market is liquid.
The recent market contraction in tech shares amid strong quarterly earnings is a leading indicator that we are witnessing a market structurally overbought.

Suspending the mark-to-market prices is the most irresponsible thing to do. Accounting does not make corporate earnings or balance sheets more volatile. Accounting just increases the transparency of volatility in earnings. Diane Garnick, American investment manager

Market overview

The latest inflation data came on Thursday, and it does not look good.  The US inflation soared to a fresh 40-year record value, putting more pressure upon the Fed’s representatives to increase interest rates. After the announcement, the stock market dwindled, the leading indices plunging significantly over the past two days.

VIX, the leading volatility index, captured the market turmoil delivering a strong spike after the announcement of inflation data.

Gold prices went in the right direction spiking above USD 1,860, fueled by fears that Fed’s hike may not suffice to curb inflation.

Macro:

Eurozone

While the Fed is struggling with dealing with rampant inflation, European Central Bank’s representatives seemed much more relaxed about this matter. The ECB aims for a 2% inflation in the long run and they say it will go back without any intervention. Philip Lane, the ECB's chief economist said that “Eurozone inflation will return to trend without significant policy tightening by the European Central Bank as pandemic-related bottlenecks in goods as well as labour are resolved”.

Lane’s view may well be an overstatement, but data shows that Eurozone inflation is much lower and more stable than in the US. Moreover, France has even a lower inflation level than the European average. Therefore, the European economy has a higher chance to avoid structural hyper-inflation.

Forex:

USD into nowhere

With higher inflation, the greenback should, at least in theory, lose ground to the Euro. But, in practice, since July 2021, the Euro is depreciating to the US dollar.

The trend is largely counterintuitive, and investors’ propensity for the dollar is solely driven by expectations of a potentially brighter future for the US economy. Nevertheless, if the hike in interest rates throughout 2022 is significant, the EUR/USD rate will follow a more volatile pattern.

Focus:

VIX

Despite a spike in the volatility level amid high inflation figures for January 2022, the leading volatility index is relatively low with respect to the foreseeable turmoil expected in the market. Uncontrolled inflation, dipping tech shares and foreseeable rates hikes are a few of the arguments that would justify a higher volatility level.  

In hindsight, volatility measures the market’s unpredictability, and the current situation indicates that there are not so many unknowns for the key players.

Focus:

Facebook

Facebook’s stock market collapse marks the end of an era. Facebook pioneered social media and changed the life of an entire generation. Gen Xers were and still are Facebook’s main user segment. Newer generations, including Gen Z, seem less attracted by Facebook and prefer TikTok, Instagram or Twitch. The net drop in both new and active users marks the end of Mark’s supremacy in the world of social media. By pivoting to Meta, Facebook aimed to a strategic turnaround, but as we speak, the market is still reluctant about this endeavour.

Market outlook

The Dow Jones Index returned on the descending pattern initiated in January and ended the week into negative territory, below 34,800. The next move to watch is the Fed’s rates hike that could amplify the current trend.

Bitcoin ended the week above USD 42,000, after a bumpy ride caused by turmoil in the stock market. Bitcoin follows a pattern correlated to the stock market, which exposes the leading cryptocurrency to systemic risk. The interest rate hike could generate new price corrections, and Bitcoin could test the USD 30,000 level over the next month.

The Gold ounce ended the week above USD 1,850 amid a strong rally fueled by the new inflation data. The foreseeable market contraction and the inflationary context are good arguments for a rally in gold prices.