Positive Thinking vs Skepticism in the Markets

Today we have an an interesting guest commentary from Jack McHugh. 

I found it thought provoking, and thought you would too. Call it The Power of Positive Thinking, Market Edition.

"It makes sense to approach life with a positive frame of mind.
Positive thinking lightens the load at work, makes the goals in
life feel easier to achieve, and allows both friends & family to
more often enjoy your company. Even family pets know the difference
between a smile and a scowl.

But when it comes to investing, I’ve
always tried to be a little more demanding, even skeptical. As a
result, some may mistake the tone or subject matter of these
commentaries as more properly belonging to a sourpuss of the Doubting
Thomas school of economic thought than to one who looks forward to each
and every day. I humbly disagree, and as evidence I offer up more than
just my usually sunny disposition: I always maintain net long
positions in my personal portfolio (hedged to various degrees, yes, but
always net long). 

These scribblings are mostly about risk management,
and as such, I will always be on the lookout for the next problem, the
dangers which may not be clear and present, and the events which can
otherwise harm the returns of investors — especially those trusting
souls who believe in things like the "Greenspan/Bernanke put". I
subscribe to the adage: "Be trustworthy to all and optimistic in all
your dealings, excepting those of a financial nature."

The
trusting and the skeptical have been doing battle all year, and the
stark contrast offered by the market action on Friday and today
are only the latest examples. That AIG has sprung a second and massive
leak of red ink in as many quarters (which prompted its former Chairman
to claim the company is "in crisis" — see below) was the news that sat
so poorly with Mr. Market on Friday. Today looked like it would fare
little better when Fed Ex announced yet another shortfall over the
weekend and MBIA served up another loss this morning (also below).
Market participants would have none of it, and after an opening dip,
they powered stocks higher almost all day. Not even a
prediction from one of their heroes, Jamie Dimon, that the "recession
is just starting" could deter the optimists, nor could a pronouncement
from the Carlyle Group that "enormous bank losses" still have yet to be
recognized (see below). The rally came, saw, and conquered because of
the final quartet of news items you see posted below. HSBC reported
lower write-downs than had been feared, Apple
announced it was running out of I-Phones, and it was revealed that HPQ
has an amorous interest in EDS. It also helped that some retailers
posted better than expected results, causing many to think a recession
won’t visit these shores (see these charts). 

These " it’s all about the future" thoughts
are nicely summed up by the following quotation:

"The earning power of U.S. corporations continues to improve, and as a result equity prices are likely to move higher,” Kevin Cronin, the Boston-based head of investments at Putnam Investments, which oversees about $173 billion, said in an interview on Bloomberg Television. "The market and the economy will do better as we get through the rest of the year.”  (source: Bloomberg)

 

Mr.
Cronin may give little credit to the power of contracting credit
(earnings during the past two quarters have displayed anything BUT
power by declining), but investors have been on his side of the
argument since the Fed–arranged wedding of Bear Stearns and JP Morgan.  The major averages finished with gains ranging from just over 1% (Dow) to just under 2% (NASDAQ).
The bond market edged lower, and yields edged 2 to 6 bps higher. The
dollar fell a touch, but it didn’t help commodities. Falling energy
prices were the main driver in the 0.6% loss posted by the CRB index.

I find it amusing, but it’s interesting how so many want to ignore a
$5/bbl. uptick in crude oil and then want to celebrate the subsequent
$2/bbl. downticks. 

 

This form of positive thinking, and many others like it, have been on
the march since the middle of the month bearing the same name. Stocks
are more than 10% off their lows and keep rising, despite the thump of
the occasional credit shoe. It’s just this type of thinking that
powers bear market rallies of the type Credit Suisse depicts in their
latest "Global Performance Monitor" (see attached PDF).

Looking at the
CS charts, and seeing just how eager folks are to ignore bad news, it’s
quite possible this market has further to run.

 

The skeptics ask, mostly to themselves these days, why, if the crisis
is over, are companies like AIG still losing big money? Why, if the
CEOs of financial companies are so bullish on their companies’ futures
are they selling dilutive stock at depressed valuations? Only one
spring ago, these far-sighted chieftains were buying back shares at
levels 2 to 3 times higher than current levels.

It’s interesting; Wall Street

CEOs
are talking like bulls and selling like bears, while Wall Street money
managers are talking like bears and buying like bulls. When financial
companies feeling the need to dilute their shareholders just to make
ends meet can link up with the trusting managers of other people’s
money, it’s more than just the perfect match.   It’s the perfect
example of positive thinking at work in today’s markets. 

–Jack McHugh, May 12, 2008

Thanks, Jack — great stuff.