The Bears Are Back in Town

Fri, Aug 27, 2010

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In addition to the spate of disappointing headline economic numbers this week, there’s been an effusion of bearish sentiment in the news. The doom and gloom first buzzed my radar on Saturday, with the New York Times story, “In Striking Shift, Small Investors Flee Stock Market”.

Investors withdrew a staggering $33.12 billion from domestic stock market mutual funds in the first seven months of this year, according to the Investment Company Institute, the mutual fund industry trade group. Now many are choosing investments they deem safer, like bonds.

If that pace continues, more money will be pulled out of these mutual funds in 2010 than in any year since the 1980s, with the exception of 2008, when the global financial crisis peaked.

Yesterday Paul Krugman reinforced the retail investor’s view in his op-ed, “This Is Not a Recovery”:

…in any sense that matters. And policy makers should be doing everything they can to change that fact.

The small sliver of truth in claims of continuing recovery is the fact that G.D.P. is still rising: we’re not in a classic recession, in which everything goes down. But so what?

The important question is whether growth is fast enough to bring down sky-high unemployment. We need about 2.5 percent growth just to keep unemployment from rising, and much faster growth to bring it significantly down. Yet growth is currently running somewhere between 1 and 2 percent, with a good chance that it will slow even further in the months ahead.

…All of this is obvious. Yet policy makers are in denial.

Krugman’s suggestions, among which were that the Fed can “buy more long-term and private debt; it can push down long-term interest rates by announcing its intention to keep short-term rates low; it can raise its medium-term target for inflation, making it less attractive for businesses to simply sit on their cash,” were answered this morning in Chairman Bernanke’s speech to central bankers. Bernanke advocated buying more Treasury securities and keeping interest rates low for longer than the market currently expects.

The Rich Get…Grumpier

This week Spectrem Group released its latest surveys of wealthy investors’ confidence, and millionaires, in particular, are not happy.

“Millionaires posted their biggest decline in investment confidence in more than a year in August, while affluent investors saw their confidence decline for a third-straight month. The millionaires’ decline is particularly troubling since it suggests millionaires, typically more sophisticated than the broader affluent population, are reverting to a bearish frame of mind,” said George H. Walper, Jr., President of Spectrem Group.

And why are the rich so pessimistic? When the company asked those “affluent” investors (defined as having investable assets topping $500,000) what most influenced their outlook, the leading answer was…no, not the economy, or even unemployment (though they were number three and number two, respectively)—but “the political environment”. Sure, a weak economy and lots of people on the dole are bad, but what we really have to worry about is that there’s a Democrat in the White House and the Republicans don’t have any constructive ideas. And these are the people getting the fat pay checks?

The Pragmatic Capitalist puts the blame for resurgent instability on overly optimistic Wall Street Analysts, for having coaxed investors into buying during a long-term bear market and thus making the bulls vulnerable to another leg down:

The key component holding this market together is the continuing strength of earnings when compared to expectations. The continued optimism in the analyst community leaves the market extremely susceptible to losses at this point in the cycle. Earnings are the linchpin holding it all together which leads me to believe that the market’s greatest threat at current levels could very well be Wall Street itself as analysts continue to forecast robust earnings and macroeconomic growth in an environment that is looking increasingly fragile.

Chris Clair of Reuters HedgeWorld, on the other hand, blames overly optimisitic economists. In Wednesday’s “Alternative Reality” column, Clair asks, “Do people feel even worse about the economy when the numbers badly miss analysts’ forecasts than they would if the numbers were merely reported with no comparison to an estimate? If you ask me what the weather is going to be tomorrow and I say, in my very best George Plimpton, ‘Sunny. Seventy-two.’ and it turns out to be raining and 56, do you feel worse for having your expectations dashed than if you’d simply woken up and seen that it was cloudy and raining?”

His conclusion?

To me, making financial decisions using predictions on jobless numbers or GDP is little removed from using the point spread in the sports section to the same end. It can be fun and interesting, but let’s not put too much emphasis on it. The games are settled on the field, and the economic turbulence will play out independent of economists’ estimates.

Go to the Source

Of course, there’s plenty of blame to go around, and perhaps the most deserving recipient is the guy who actually lost a quarter of your money. Hedge-fund news site FINalternatives reports that some 50 clients have been engaged in a law suit against the Opulent Lite hedge fund managed by the son of a Silicon Valley entrepreneur. The manager, Neil Godbole, apparently pleads incompetence, according to my interpretation of his comments quoted in the story. The investors claim that there was a “systematic and organized family scheme” to cover up losses. I tend toward the more positive view of human nature, but something about this stinks of the baser side.

Now, there are two ways to look at all this. 1) The obvious perspective: It’s the beginning of another major leg down; 2) The contrarian view: Such negative sentiment is indicative of a bottom (intermediate-term, at least).

The technical picture is mixed, with momentum turning up and sentiment indicators still weak. But our income strategies don’t depend on predicting market direction—we buy volatility when it’s low and sell when it’s high, all the time targeting a delta-neutral risk profile. We sometimes gain an edge from a directional bias, but that isn’t a fundamental component of our strategies. In up, down or sideways markets, our strategies are developed to outperform.*

*This is a forward-looking statement, and we caution readers that trading options involves a substantial risk of losses. Past performance is not necessarily indicative of future results.

 

†Home page photo courtesy of Flickr user Tambako the Jaguar under Creative Commons license.

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Jared Woodard specializes in trading volatility as an asset class. With over a decade of experience trading options and other volatility products ... Read More

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