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."

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)


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

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.


AIG Should Postpone Annual Meeting, Greenberg Says

FedEx Lowers Profit Outlook, Cites Higher Fuel Costs

MBIA Posts Loss of $2.4 Billion as CDO Slump Deepens

Carlyle’s Rubenstein Says `Enormous’ Bank Losses Unrecognized
HSBC Sets Aside $3.2 Billion for More Bad U.S. Loans

Apple Says IPhone Is Sold Out at Its Internet Store

Electronic Data Jumps on Report of Hewlett-Packard Buyout Offer

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What's been said:

Discussions found on the web:
  1. Douglas Watts commented on May 14

    From today’s Portland, Maine Press-Herald:

    Taxpayers’ plans more survival than stimulus

    A survey finds that most Mainers will skip the extras and use their rebates to pay down debt or will save it for a rainy day.

    Only 17 percent of Maine residents plan to spend their government economic stimulus checks on discretionary purchases such as trips, clothing and furniture, a new statewide survey has found.

    One-third of Mainers surveyed expect to pay bills, notably for heating oil, electricity and gasoline. Another one-third said they’ll save the money for a rainy day. The results suggest that many Maine residents are nursing a painful financial hangover from record energy prices, and that many more expect hard times ahead.

    “This is catch-up money, not stimulus money,” said Curtis Mildner, president of the Market Decisions research firm, which conducted the survey of 404 Mainers. “This is a picture of people hanging on.”


  2. bluestatedon commented on May 14

    The seeming disconnect between the equity markets and reality on the ground in places like Maine and Michigan is not without historical precedent, as there were some tremendous market advances in the depths of the Great Depression.

  3. ipodius commented on May 14

    Great analysis. As I sit here looking at my software that says the DOW should be hovering somewhere around 11200 (given my estimate of forward earnings and other adjustments that I’d tell you about, but then I’d have to kill you :) I wonder, what in the heck is going on in the equity markets? So this reinforces the feeling that no matter what today’s data says, people are looking past the problems to the future, and not wanting to miss the upside.

    The practical and realistic side of me thinks that this downturn is going to last at least 2Qs and perhaps a little longer, and when I look at what earnings have to swing to the upside to justify these prices all I can think is that this is beyond positive thinking, and runs smack into denying reality. You know, there’s one thing to being a team player. There’s quite another im thinking positively about the future, but resognizing that you’re now in a ditch and have to get out for the future to be rosy. It seems Mr Market is in the bottom of the ditch, but dreaming of the day he’s running free now. So play the game accordingly.

  4. DownSouth commented on May 14

    “The big bull operators knew…their American public. It could not resist the appeal of a surging market. It had an altogether normal desire to get rich quick, and it was ready to believe anything about the golden future of American business. If stocks started upward the public would buy, no matter what the forecasters said, no matter how obscure was the business prospect. They were right. The public bought.”–Frederick Lewis Allen, “Only Yesterday”


  5. bruce commented on May 14

    Positive thinking??

    Inflation increased .7% last month…How??

    Well if the core was actually .2%, they overlooked the fact that wages fell .5%…my math tells me at the very least the average wage earner lost .7% of the month before…

    any criticism of this analysis??

    Bruce in Tennessee

  6. sergtat commented on May 14

    The answer is simple: market manipulation by FED and hedge funds. Market never goes down on bad news, lately. At the end of the day there is always some rumor pucked by a talking head on CNBC and the market “suddenly” goes up.

  7. catman commented on May 14

    Bravo Jack. The basic point came early, and Im sure it wasnt lost on this readership. Your personal portfolio must be run like a classic hedge fund, holding and hedging an inventory, in addition to any personal tastes running to day, forex, option, or bond trading. He also speaks to being careful about your info inputs in light of the need for a reasonable level of conviction when the market is in a counter trend to your point of view.

  8. mhm commented on May 14

    Sorry, but “positive thinking” doesn’t cut it. You can put sheep and wolf together and both will think positively in absolute opposite directions. One is deluded…

  9. Jason G. commented on May 14

    I balance skepticism and optimism by being skeptical about everything in the markets, news, economy, etc., but being optimistic that I will survive and prevail despite the underlying mistrust.

    I also believe this is a bear market rally, and every bear market has a different flavor. Maybe a few individual stocks will buck the downtrend… maybe there’s solace in gold or commodities… maybe I can buy at a discount when panic embraces those around me… and with the proper risk controls in place, I can even survive when I’m wrong about any of the above.

  10. dblwyo commented on May 14

    Anybody live enough out West to know how you can see big thunderstorms coming for miles across the prairies? Back in the day for those who remember the Big Thompson flood we got the gust fronts early and then a lull of calmness but looking out late that night you could see the darkest, biggest clouds stretching N-S across the whole Western horizon. Just shot thru with lightening. Never seen anything like it…until now metaphorically.
    Everybody hyped up the R-word in Dec/Jan/Feb and when it didn’t happen right then “we’re” all celebrating. Dimon was the first public figure to get it right. The economy has a lag structure and we’re just starting to tip over but we are past the worst of the credit crisis where market breakdowns threatened catastrophe. By the way El-Arrian supports that view as well.We may get some more bear rally but we’re just headed for the Valley…you know the I will fear no evil valley because my mis-reading of the scriptures comforts me one…

  11. BDS commented on May 14

    Optimism and pessimism are two sides of the same coin, offering a distorted view of the world, and keeping one in bondage to ignorance.

    Dispassionate reason sets us free.

  12. The Financial Philosopher commented on May 14

    The only problem with arguments on both sides of the bull/bear/growth/recession debate lies with the attempt at making a prediction in the first place. As Mr. McHugh implies, it is logical to be “net long.” Prudent risk management demands this behavior.

    “Those who have knowledge, don’t predict. Those who predict, don’t have knowledge.” ~
    Lao Tzu

    “If a man will begin with certainties, he shall end in doubts; but if he will be content to begin with doubts, he shall end in certainties.” ~ Francis Bacon

    “There is only one side to the stock market; and it is not the bull side or the bear side, but the right side.” ~ Jesse Livermore

  13. VennData commented on May 14

    A comical set piece on the WSJ opinion page today, “Whole Stole the American Spirit?” by Zachery Karabell lamenting the lack of “hum” the US has versus China or Dubai.

    He claims “This isn’t a Democrat-Republican divide”

    The GOP’s recent talking point was that liberals aren’t as happy as conservatives based on an academic study (Oh suddenly they LIKE academia.)

    This is how the right wing media machine gives your two ways to chew. Two logically inconsistent beliefs to which you can proscribe your own set of feelings of the moment.

    Last month it was how Bush, Paulson Lazear et al didn’t want to play the ‘blame game’ but just fix ‘the problem(s)’… then last week Bush was out blaming Democrats re. the subprime crisis, the oil crisis etc.

    Endless, emotionally manipulative sophistry.

  14. Matt M. commented on May 14

    Wow …does the Financial Philosopher nail it with those quotes. Traders/Investors ….both bullish and bearish should print them out and tape them on their station. The TBP comment section could learn alot from those quotes….. a ton of folks very, very sure of their opinions!

  15. Mich(^IXIC1881) commented on May 14

    RE: The TBP comment section could learn alot from those quotes…..

    Those quotes sounds all good and dandy but what do they mean really?

    If somebody tells me “Those who have knowledge, don’t predict. Those who predict, don’t have knowledge.” If I don’t predict where the markets are going I would either sit on the sideline or have a perfect hedge. If the hedge is really perfect, that means whatever amount I make on longs will be lost on shorts. If it is not a perfect long, then I am still predicting a direction.

    Forget the stock market, all of us predict everyday. The day we sign the papers to buy a car or house we predict that we will be able to earn enough to pay our debit.

    Or this:
    “If a man will begin with certainties, he shall end in doubts; but if he will be content to begin with doubts, he shall end in certainties.” It all sounds good but what is a man without any convictions (perceived certainties) in life… Doubt paralyzes people. Every success story of entrepreneurs I read about all have the common theme of “everybody including my close circle doubted my dream and goals, but in my mind I was certain that it would be a success”

    Or this:
    “There is only one side to the stock market; and it is not the bull side or the bear side, but the right side.”

    This is most useless saying I have ever heard off… Including Jesse, nobody is always bull or bear all the time, but at any point in time, you have to be convinced of a trend or else you shouldn’t be in the market at all…

    Anyway, as the wise man said “If you understand, things are just as they are… If you do not understand, things are just as they are….”, right?

  16. flenerman commented on May 15

    Please, where can one find more musings from Mr. McHugh?


    BR: I believe he is institutional only research

  17. Matt M. commented on May 15


    The quotes are very relevant to trading. Traders lose money when they hold their opinion too highly and can not fathom the other side of the trade. The quote about the “right side” is so dead on that you should read it every day. There are very good reasons folks wash-out of the trading game…..the biggest is failure to overcome ego and “knowing” that the market is wrong and you are right. There is a reason that only 2% of traders can make a living trading. Your reponse (in all its bravado) tells me that you have alot of work to do.

  18. Robert Mooney commented on May 19

    Cycles occur always and everywhere and do not necessarily converge across economies.

    Remember the definitions of Company Reports we saw after Arthur Anderson.

    EBIAT – earnings before irregularities and tampering
    CEO – Chief Embezzlement Officer
    CFO – Corporate Fraud Officer
    EPS – Eventual Prison Sentence
    NAV – Normal Anderson valuation

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