My day job is to lead a team of people who analyse and invest in financial market assets on behalf of clients. It’s mostly stocks and bonds.
Portfolio managers tend to seek to identify assets that will command higher prices some time in the future and/or deliver a predictable set of future cash flows. We talk about ‘valuation’ in the strictly financial sense quite a lot. Keynes, writing about financial valuation, likened it to a contest in which to win, contestants needed to guess which photo most other contestants would identify as the most beautiful (rather than applying their own individual tastes). I think this is right, but sort of brushes over the epistemological nature of the contest as lived.
Portfolio managers focus of earnings, inflation, non-farm payrolls, Fibonacci retracements, or whatever else that rocks their boat when assessing financial value. In so doing, they are asserting some internal model as to how the world should think about valuing assets.
Every time the internal model works (eg, stock jumps when earnings surge/ beat) another little positive reinforcement loop is completed. Confidence rises that the internal model as to how portfolio managers think things should be is a close approximation to how things are.
But every now and then a thing comes along to remind us how all financial valuations actually work. This year three things came along: NFTs, cryptocurrencies, and meme stocks.
I have zero professional experience of the art market. Beeple’s mega-Christies sale got the world’s attention. It brought attention not only to digital art but also NFT’s more generally and got folks asking how such valuations might be possible. For me this question carries an easy (if perhaps banal) answer.
The price paid, like that of any artwork, indicated not its extraordinary artistic worth but rather that (usually) at least two people of substantial financial means reckoned that the art in question is worth more to them individually than some chunk of their financial wealth. Art’s financial value is plutocratically determined. One person thinks a painting is worth $1m? Nada. Two people with plenty of financial muscle think it’s worth $1m? It’s worth $1m.
Is the easy answer to NFT/ fine art valuation an easy answer to cryptocurrency valuation? I think so.
Bitcoin/ Dogecoin/ etc have been around for a while. But 2021 saw their collective financial value boom to around c$2.4tn. I don’t encounter people getting mad that a Duchamp Readymade might be inappropriately valued in the context of it’s likely future cash flows: we all know its future cash flows don’t exist.1 But plenty are enraged by substantial financial valuation being attached to either crypto in general or a particular piece of contemporary art.2 And I think people get cross for largely similar reasons.3
While folks scratch around to try to consider valuation frameworks for cryptocurrencies along the lines used to value currencies or commodities, I am more persuaded that the appropriate valuation framework to apply to them is – like NFTs – that of contemporary art.
What about Meme stock valuations? Just like art and crypto their valuations too are also plutocratically determined. The performance of stocks like GameStop and AMC generated the same challenges to the financial world’s established epistemology of financial value as those posed by crypto. The reason why it felt different was that it was done on home turf.
In asset management the idea of active management in a state of market inefficiency is based on the notion that by scraping together good insights, information and analysis it is possible to generate super-normal risk-adjusted returns. I buy into this in a big way. But it is predicated on the notion that others are employing broadly the same mental model around what should command financial value. After all, if you’re looking for super-normal risk-adjusted returns, there’s no point (as a small investor in public markets) identifying awesome firms that will deliver strong and above consensus results if they are going to be subject to a multi-year or multi-decade valuation death spiral (because no-one else reckons that strong and above consensus earnings should translate into higher financial value). Firms that satisfy the model tend to be ascribed a higher financial valuation, while those that don’t may find themselves less able to attract financing upon which their business may depend.
For all the hate out there amongst conventional folk for Chamath Palihapitiya – sometimes characterised as a mega-rich tech bro with political ambitions, punting what is for him spare change into the GME trade in a bid to buy a constituency – I thought that this interview with him by CNBC’s Scott Wapner addressed the issue more clearly than I have seen elsewhere (emphasis mine):
Palihapitiya: …the fact that they shouldn’t be allowed to exist because all of a sudden like because we decide that they should be obliterated into the ground
Wapner: No, they should be allowed to exist. They should be allowed to exist at whatever price their stock should be value at based on what their earnings are and this stock was like seventeen eighteen dollars not that long ago.
Palihapitiya: Who says that? Who says that? Do you want to make the same argument about Tesla? It’s gone 10x in a few months. You don’t know what it’s worth – let’s be honest okay?
Wapner: You don’t think that Tesla’s growth prospects…?
Palihapitiya: Scott – I have my own model for the company. I’m allowed to underwrite however I want to own it. Everybody who bought that stock is also underwriting how they want to own it. And the point is – just because you’re wrong, doesn’t mean you get to change the rules. Especially when when you were wrong you got bailed out the last time. That’s not fair.
The conventional philosophy of security valuation informs a lot of real world decisions as to how resources are allocated. In demonstrating that the financial valuations of firms (just like cryptocurrencies and contemporary art) are plutocratically determined, the Redditters reminded us that those with financial power get to determine financial value.
The strong relationship between financial valuations and fundamentals exist only to the extent that fundamentalists are the ones holding financial power.
1 I mean, sure you could put together a business plan to acquire a top notch art collection, build a private museum, employ staff, charge entry, and make oodles of money. But I’m unconvinced that such plans underpin the art market.
2 It’s not just the financial valuation that gets people cross of course. People also get cross about the facilitation of criminality that is perceived to be engendered, scope for mis-selling they pose to the unsuspecting given an almost total absence of regulation, and jaw-dropping environmental damage attached to proof of work. Labelling these as differences will likely be contested.
3. I think that the reasons that people get cross about the financial value attached to contemporary art falls into five broad categories:
- Resource allocation: when people who have the resources to drop millions on art do so rather than something else (eg, solving world hunger);
- FOMO: when people pay large for someone else’s art, and completely overlook their own artwork (category reserved for artists, although also maybe also dealers and collectors who don’t own the stuff commanding the sky high prices);
- My money! When public money is spent on something that someone doesn’t like (Carl Andre’s Equivalent VIII – ‘those bricks in the Tate’ – is still probably the most famous example);
- Culture Wars: owing to the exclusionary and condescending culture that grows up in the industry that springs from these high prices.
- Money & Value ontology: when monetary value – which so often is deployed as a proxy for actual value – has been assigned to something that someone sees as valueless (and this proxying is, to be fair, the conceit which underpins the allocation of scarce resources in a market economy).
It appears to me that these are analogous to the reasons people get cross about crypto asset financial valuations.