Monday, January 30, 2012

The Value of an Asset

You don't have to be involved in the investment management business to know that, in the end, an asset is really only worth what someone else will pay for it.

This seems almost too obvious, but I was reminded of this simple rule over the weekend.

There was an article in the New York Times yesterday about an ongoing debate in the classical music world.  Violins and cellos made by such old masters as Stradivarius command huge prices among the great musicians in the world:

Several factors put old Italian instruments on top. Superb wood, perfected design, the highest craftsmanship and special varnish all came together in Cremona and its environs from 1550 to 1750. The sheer number of years being played is a factor. Repeated vibrations have an effect on the wood’s structure, causing cells to break down in a way that produces a more flexible sound, some violin experts say. “By playing an instrument, it opens up its pores,” said the violinist and conductor Pinchas Zukerman, who plays a 1742 Guarnerius del Gesù. “The voice becomes purer and brighter.” 

The prices these instruments can command are daunting.  The piece notes that

...Stéphane Tétreault, an 18-year-old Montrealer who is being loaned the 1707 Countess of Stainlein Stradivarius cello that belonged to Bernard Greenhouse, a founding member of the Beaux Arts Trio, who died last May. The Greenhouse family sold the instrument two weeks ago to an anonymous patron in Montreal for an undisclosed amount, but one said to surpass the previous record of $6 million.

I ran into Richard Ortner, head of the Boston Conservatory, at a benefit concert last night, and had a chance to talk to him about the price of instruments.

Richard emphatically confirmed the facts in the article, noting that string players can often amass debts similar to a home mortgage in order to secure one of the classic string instruments.

By contrast, said Richard with a laugh, players of metal instruments like a flute or horn get off pretty lightly; the top price for a flute, for example, is probably no more than $20,000.

Investing in stocks, in a way, also reflects the basic fact that any particular company is really worth what the collective market wisdom will pay for it.

The Financial Times on Saturday had a good piece about the strong rally in financial stocks that has occurred this month.

As some of my earlier posts noted, the fundamentals for bank stocks really haven't improved all that much from last year. European banks underperformed their American counterparts in 2011, but lately have rebounded sharply.

Investors have been encouraged that the actions by the Fed and the European Central Bank (ECB) will be sufficient to allow the European banks to survive and even prosper.  In particular, the ECB's Long Term Refinancing Operation (LTRO)
injected nearly 1 trillion euro into the banking system last month, which seems to have at least stabilized the financials for now.

So the value of bank stocks at this point can be hazy, but it seems to me that it really can't be argued on fundamentals alone at this point.  Prices are moving higher, and if the goal is to increase the value of your portfolio then you have to at least think hard about the banking group. As the article notes:

...{Thomas Moore, equity manager in Edinburgh, suggests that} investors ignored the power of the LTRO for a month and even now this is a lot of negative feeling about banks around. "There is a lot of pessimism out there. It suggests there is still scope for valuations to re-rate...

Similarly, credit analysts at Citi say: The fact that investors are so reluctant to commit to the rally and the effect of the LTROs makes it all the more likely that it continues for considerably longer than people envisage - or indeed, by more than is warranted by the fundamentals."

So the lesson from the classical music world can be applied to bank stocks:  whether you agree or not, prices are going higher, simply because that is the price that people are willing to pay.