Benjamin Graham, esteemed mentor of Warren Buffet, first created the parable of Mr. Market – yes, parable, like the ones from the bible, as in the prodigal son or lost sheep. Here’s the story:
Imagine you own a small $1000 share in a private business. One of your partners, named Mr. Market, is very obliging, indeed. Every day, he tells you what he thinks your interest is worth and, furthermore, offers either to buy you out or sell you an additional interest on that basis. Sometimes, Mr. Market's idea of the value of the business appears justified. But, sometimes, he lets his enthusiasm or fears get the better of him and the value he proposes seems to you little short of silly. If you are a prudent investor, will let Mr. Market determine your view of the value of a $1000 interest in the enterprise?The point is to separate Mr. Market’s manic recommendations from common sense. Mr. Market has seen a lot of mood swings since his birth (circa 1950). When prices are high and the market’s up, he's like a kid with ADHD in a candy store, he can't get enough stocks; and when the market’s down he’s downing vodka and antidepressants.
A stock – like anything else in the world – is composed of both value and fluff. The former is the earnings or projected earnings of a company, and the latter is speculation. Together they form its ever fluctuating price. Changing with the price is the P/E ratio, which is almost like a value to fluff ratio, but not quite. The catch, of course, is that you can never really separate speculation from value – and that holds for stocks, or about anything else in the world for that matter.
The government’s drastic reactions to Wall Street reek of Mr. Market’s work. Just like Mr. market, they're acutely attuned to any market activity, and if the market gains for a few days they'll be boasting from Cloud 9, if it drops they'll hit the panic button even harder. Very little true value and long-term solutions will come of it. There has and always will be a strained relation between the government and Wall Street. The government makes money, but Wall Street makes value. Unfortunately we’re now looking a whole lot of the former and very little of the latter.
Media (in order of appearance)
Photo: (1) Cover of Memoirs of the Dean of Wall Street, selected content by Benjamin Graham, 1996; (2) The Return of the Prodigal Son, by Pompeo Batoni, 1773; (3) Emergency Panic Button, 02/21/2008, by carrythebanner (4) Money, by Thomas Hawk, 06/11/2007
Video: (1) MARKET MELTDOWN!!, uploaded by bdoggman, from the CNBC show Mad Money Sphere: Related Content