Pessimism Required
Advisors Capital Management
By Charles Lieberman
July 16, 2012
Making sense of Friday’s sharp stock market rally is not easy, certainly
not on the basis of the incoming data. Rather, it seems like the rally
was triggered by the absence of horrific news. There is so much
pessimism rampant that anything not really awful may be received as good
news. If we set the bar sufficiently low, it becomes possible that a
slowdown of growth in China and an investment loss at J.P. Morgan of
$4.4 billion looks like good news. This suggests that it is very
appropriate to be bullishly positioned in stocks. After all, if the
expected dreadful financial collapse does really occur, none of this
will matter anyway (tongue in cheek).
Pessimism is rampant. Growth forecasts for the U.S. economy tend to
focus around 2%, with more people suggesting that the downside is more
likely than any upside. Certainly, there are concerns to justify such a
cautious outlook. Growth is weak despite the Fed’s efforts and
creative policies to stimulate the pace of activity. It isn’t clear
they can do much more to become more effective. Our budget problems are
unlikely to be addressed until after the upcoming election, if then.
Politicians are also in such conflict that getting agreement on any
issue is a major task. Europeans are moving slowly, at best, to manage
their own fiscal crisis that is worsened by unrecognized bank losses and
capital adequacy issues across much of the continent. Conflict in the
Middle East could erupt in any number of locations. Iran’s nuclear
facilities could be attacked, either by Israel or the U.S., Syria is in
civil war with its government committing atrocities against its own
citizens, Hamas shoots into Israel almost daily and Iran supports Shia
minorities against Sunni majorities, fomenting yet more unrest.
So it is clear the domestic economy is not performing very well and the
rest of the world is highly troubled. Such an environment naturally
lends itself to extreme pessimism and this is reflected in the behavior
of investors. Capital continues to flow out of stocks and other risk
assets into the “safest” assets, the bonds of the strongest economies.
So, nations like Germany, France, and the United States pay either
negative or negligible interest rates to borrow. Symmetrically, stocks
are cheap to the point that yields on some stocks exceed the interest
rate those same companies must pay to borrow over three or five year
terms. (So, many firms borrow to buy back their own shares.) While it
is not impossible to disappoint such low expectations for the future, it
is also not difficult to exceed expectations. Any good news, or even
any news that isn’t worse than expected, may be sufficient to provoke
sharp rallies, as occurred on Friday. This kind of response, by itself,
implies that stocks are cheap. It is an important message.
(c) Advisors Capital Management
