Sentiment Extremes
By Paul Lamont
Sept 30, 2010
September’s rally prodded the investment herd back into chasing yield and investment returns. According to the American Association of Individual Investors, the herd has had the largest swing in bearishness to bullishness in 6 years. Likewise, small time futures traders (tradefutures.com) are as bullish as they were at the April 26th high (83% bullish). According to the Investment Company Institute, individual investors reduced cash levels.
Simultaneously, institutional money moved into taxable government money market funds (i.e. Treasury Bills, Short-term Federal Loans, etc.). The smart money managers are increasing their no yield positions. With insider selling to buying reaching a 1,411 to 1 ratio, corporate insiders clearly agree with institutional money managers. We side with them as well. Preservation of principal is paramount.
“When the price of a stock can be influenced by a “herd” on Wall Street with prices set at the margin by the most emotional person, or the greediest person, or the most depressed person, it is hard to argue that the market always prices rationally.” - Warren Buffett. “The Superinvestors of Graham and Doddsville.” Hermes, the Columbia Business School Magazine, 1984.
More Bond Trouble
Last month, we described investors ill-advised move into bond funds. In summary, if the historical comparison to the Depression continues to be accurate, these investments will be less than ideal. Already buyer’s remorse should be setting in. As the Wall Street Journal reports:
“For years, the fund industry and research firms such as Morningstar Inc. have assessed the safety of bond funds by analyzing their holdings' underlying credit quality. Now, amid concerns that the measurement could understate the risk that the bonds will blow up, Morningstar has changed its methodology to count lower-rated bonds more heavily. The move—which took effect Sept. 1—means that more than half of the domestic taxable bond funds tracked by Morningstar saw their so-called average credit-quality ratings fall under the new methodology.
In some cases, people who thought they were investing in an investment-grade bond fund may find themselves in a portfolio whose credit risk is more like a junk-bond fund, says John Rekenthaler, Morningstar's vice president of research.”
Investors see a nice coupon of X% a year stamped on a bond, but things change:
“In 1928, the American Gas & Electric Company sold an issue of 100 year 5 percent bonds to the public at 101, yielding 4.95 per cent. Four years later, in the depth of the depression, the bonds sold as low as 62.5 with a yield of 8 per cent.” - The Intelligent Investor. Benjamin Graham, 1945.
Instead of chasing returns which frequently disappoint, investors should search for value.
The U.S. Dollar
Just as in November of 2007, (‘Traders Bullish On Everything’) the percentage of traders bullish on the U.S. dollar is again down to 5%. Remember what a surprise it was to most that the U.S. Dollar rallied through the Financial Crisis of 2008? True value is found in defeatism and widespread pessimism. To give another example, there are fewer investors bullish on the dollar now than at the start of this year. The dollar rallied for the first five months of this year.
More Than Just Tumbling Dice
As we quoted Mick Jagger last month; “Songwriting and playing is a mood… you get the feel of one particular period of time.” We commented on The Rolling Stones when they topped the charts in May with their re-release of 1972’s Exile on Main St. Now Mick and Keith are back with last week’s re-release of “Ladies and Gentlemen: The Rolling Stones” a DVD of their 1972 tour through the U.S. As the Wall Street Journal describes, the DVD displays a tour with “the rock ‘n’ roll outlaws at the peak of their powers.” After 1972, “It was never quite the same again for the Stones…’Ladies and Gentlemen’ is the soundtrack to the last act.” With bullish sentiment towards the S&P500 at its peak (same as the April 26th high), our December of 2009 advice to investors; “leave the party when the Rolling Stones arrive” is still appropriate. The soundtrack to the last act is playing.
What’s Next?
In February, we stated “it is Spain and Ireland that are even more important to European bank balance sheets.” Specifically, “the risk is that a large European bank failure will generate another wave of financial crisis around the world such as happened in late 1930 and early 1931.”
With investors excited about the Euro (96% bullish!), Ireland and Spain are set to disappoint. On Sept 30th, Ireland’s Finance Minister Brian Lenihan, while assuring us that “The Irish banking system is at rock bottom today,” increased his country’s bank bailouts to $50B Euros. He also denied the possibility of a double-dip recession, even with Irish growth at -1.2% in the second quarter.
On the same day, Spain was also in the news with a downgrade of its debt. Looking at our Bloomberg chart from February, this downgrade will cause writedowns in French and German banks.
When these two countries are cited as the reasons for Panic, governments in Europe will find that their banking problems are bigger than their capacity to bailout. In June, we cited a Bank of International Settlements report:
"Events coming out of Greece highlight the possibility that highly indebted governments may not be able to act as a buyer of last resort to save banks in a crisis. That is, in late 2008 and early 2009, governments provided the backstop when banks began to fail. But if the debts of the government itself become unmarketable, any future bailout of the banking system would have to rely on external help."
“The government’s failure to protect the nation from the pitfalls of speculation was the single most important lesson to come out of the calamitous events of the South Sea.” – Edward Chancellor, Devil Take the Hindmost: A History of Financial Speculation. 1999.
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