Totally distorted market

Trillions of dollars in paper wealth were wiped off global markets on Thursday as investors stampeded out of equity markets, triggering a big plunge in prices.

Analysts readily offered a clear-cut explanation for the panic: the latest reading of a leading indicator showed the mainland's manufacturing sector unexpectedly contracting, and US Federal Reserve Chairman Ben Bernanke suggested the US Fed could start tapering its quantitative easing soon.

What has been barely talked about is the fact that market volatility and market crashes (in their worst scenario) are destined to happen in a totally distorted market.

Monetary authorities themselves are one of the perpetrators of market distortion in the sense that they have been fueling asset price bubbles in recent years with full-blown money-printing operations in their bid to keep interest rates at near zero levels, and create positive wealth effects to help shore up their sagging economies.

Unscrupulous stock issuers are another culprit of market distortion. They have made the stock market a handy cash cow, and have been deceiving investors with inflated earnings made possible by creative accounting.

As a result, the equity market has deviated from its original function of serving as a platform for entrepreneurs to acquire surplus cash from individuals for productive activities, and as a platform for investors to share profits from productive collaboration with entrepreneurs. Instead, it has become a venue for zero-sum games.

Given such distortions, stock valuations have become meaningless, and the price performance of a specific stock is no longer an indicator of the real value of the relevant company and the dividends it pays. Instead, prices are driven by expectations about market liquidity and themes.

In the absence of reliable valuation benchmarks for determining the true value of stocks, prices are like floating sand, and investors must keep themselves on high alert for any sign of negative developments. Volatility will be here to stay so long as the market keeps deviating from its original function and monetary authorities continue to print money.

The author is a current affairs commentator.

(HK Edition 05/24/2013 page1)