In the following example, let's eliminate depreciation for the sake of argument.
Cartel Computers (CC) purchases and ships $1 m in computer manufacturing equipment to Indonesia. In partnership with an Indonesian firm a company is set up which issues stock in the local currency. The CC in combination with local capital take controlling interests. Their shares are not traded, but prices, of course, are set at the margin by the shareholders that are doing their thing. The firm exports computers for the world market and with the rupee at par $1=100r earns an annual profit of 15%.
After two or three years a currency crisis devalues the rupee 50% for reasons which are exogenous to the activity of this firm. It continues to earn 15%. Because it is one of the established equities in the local market international traders take short positions in the stock and speculate against the national currency, so the stock declines as well, in spite of reasonable earnings (just like a lot of performing bonds have taken hits in recent days, as well as performing stocks in the US).
Due to the combined stock and rupee depression the dollar valuation of the firm has fallen 75%. Inside that firm is $1,000,000 worth of equipment currently valued at $250,000.
However, neither CC nor the domestic controlling interests put the firm up for sale for controlling interests (this is why Korea has balked at some of the equity transfer proposals to manage the currency collapse). They know that the firm is worth more than the pricng mechanism is saying it is worth.
Now, the question is, how does CC look at its investment in this firm. It is no different, than say, Ford or GM with a factory in Europe when the relevant currency goes down 20%. The fact of the matter is if the firm is making profits in local terms it's not necessarily the case that you want to get rid of it if you are losing money on the exchange. Maybe you just want to take your local money and reinvest it locally (like a tariff, currency falls can encourage local investment). Because you know two things. One, the firm is viable as a local enterprise, and two, as an international firm, it is an asset because it is making something you know you can sell for more elsewhere (note that the currency falls have not resulted in huge crashes in prices here. Most of the price crashes have come from our export sector. In fact Asian firms are trying to keep US prices high to compensate lost sales in Asia).
So if someone offers to come in and "buy this firm" at 25% of par, which happens to be today's price, it amounts to a fraud, and everyone involved knows it. CC may be forced tow rite down the value of its asset on its American books. But it's not the case that this firm can be bought for the nominal stock market price. And CC knows that at a minimum it can yank the productive machinery out of Indonesia and haul it back here, where it will be worth $1,000,000. And arguably if that's what the physical capital is worth in the US that's what the firm should in fact carry on its books. So this Indonesian company, in spite of stock prices, won't be for sale. If you want to say, well, the reason is there's overcapacity in computers and hence the assets aren't in fact worth anything, well, it really makes no difference. In the universe of overcapacity all firms are undervalued but some number of those firms in fact have a higher intrinsic value because a year or two down the line they'll be back on their feet. And people know this.
So the point is that the stock market valuation can be rejected by major players.
Now, in the closed-end universe, I think there may be something linked to this kind of divergence. Ownership of a % of the underlying physical capital is secured through stock ownership but the "real value" might be more closely approximated by the $ valuation of the assets, in spite of teh currency fluctuations. Yes, you could go to Indonesia and buy the same stuff cheaper or presumably have a broker do it for you. But once you do that you are in the rupee universe. It is possibly the case--in my confused thinking?--that the relative stability of the dollar valuation in a closed end fund is analagous to the CC company which, knowing that the underlying value of the physical capital is $1m and that the market valuation is a quarter that, refuses to sell at the price. The company can't be bought at that price nor can it be replaced with another company at that price. Speculative forces have caused it be undervalued.
Something also must be added, about the weirdnes of how we value things by marking them to market. I have had shared in two analogous funds, one closed-end, the other open. They both hold the same kinds of assets. One is trading at a premium and the other is trading 10% below July levels. Because its value is set every day by tallying the sale of assets that have plunged in their trade among professionals, it directly reflects liquidity in junk. But the other trades at a premium. Why should this be?
The answer, I think, is that prices are set at the margin by whoever is happening to sell--usually speculators--but there is another is acting rationally by discounting current fluctuations. Some people are in stocks for the 20 year period. They hold no matter what today's price is. If those people are in a closed end fund and continue to hold, it will stabilize the value of that fund even if the market prices underlying assets differently--because 20 year people and day traders are two different birds. In the case of LND, a 7.5% annual return with another 1.5% annual dividend, in a fund that has a 15 or 20 year history, looks pretty good when some funds are offering 4%.
Anyhow perhaps I am mising something but I don't think it is as stragithforward as JBOD (offline) and Rosser have made out. But I could be wrong. I've been wrong before.
-- Gregory P. Nowell Associate Professor Department of Political Science, Milne 100 State University of New York 135 Western Ave. Albany, New York 12222
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