"HEY RON, JUST WHAT THE HECK IS FAIR VALUE?"
Each weekday morning on the Paul W. Smith Show, I end the Starfire Investment Report with our best guess as to how the U.S. Equity markets will open at 9:30 a.m.
The best available indicator of the direction of the stock market is the price level of the "futures" contracts that are based on the S&P 500, Dow Jones 30 Industrials and Nasdaq 100 stock indexes. Buying a "futures" contract is a leveraged way to bet on the direction of the price of a particular commodity. In this case, the "commodity" is the group of stocks that makes up the particular index. Since the futures contracts trade most of the morning before the stock market opens, looking at the direction of the futures can be a very reliable indicator of the stock market open.
However, simply looking at whether the futures are up or down (as investment reports on some other radio stations are prone to do) can be misleading. Imagine a weather forecaster predicting today's high temperature by telling listeners, "It will be sunnier than it was yesterday." You need a whole lot more information to make an accurate assessment.
The "fair value adjustment" takes into consideration several critical differences between the futures and the market itself. For instance, the futures continue to trade each night after the stock markets close. Accordingly, a major earnings announcement can impact the closing futures level without impacting the closing level of the stock market. Moreover, differences in "carrying costs" between the futures and the underlying indexes must be considered. Depending on these factors, the "bar" we have to jump in order to have a positive indicator each morning might be higher or lower than you might otherwise expect.
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