Sentimental Silliness

How flaky can we humans be? Just one week ago, headlines squealed a single note. Credit crisis! Subprime victims! Failing hedge funds! Armageddon! All predicting total systemic fallout from subprime loans gone wild. But today, a cursory review of news sites reveals a curious lack of subprime hysteria. Sure, there's the occasional story, but the big font is reserved for other news today.

Was the credit crunch cured? Nah—we still don't believe there was anything much to the credit crunch in the first place. Likely, a few back-to-back positive days caused editors to feel a tad shamefaced about incessantly banging the doom-and-gloom drum. (No worries, a couple down days, and they'll all be back.)

Why the headline whipsaw? Sentiment moves fast. Think about your own emotions—you can get ecstatic or despondent, but that only lasts for so long, and then you bounce back to your normal mood bandwidth. But the shifts happen fast—that's why markets can be so volatile in the near term. For example, staying so irrationally fearful about bands of bankrupt subprime mortgages wreaking havoc on the economy takes a lot of energy. Eventually, investors are bound to notice that earnings are walloping expectations for Q2, and global GDP is galloping along. Then, BANG, you're over it and onto fretting or exulting something else.

The lightning-swift shifts in short-term sentiment are why you should never, ever try to time short-term moves. You cannot predict what will overwhelm investors next, nor can anyone guess when mood will shift again. (Which is why surviving as a profitable day trader requires an absurd amount of luck, a masochistic god complex, and an understanding or absent spouse, or alternatively, a Faustian deal of some sort.)

Here's just a sampling of today's news that makes it hard to believe, only last week, blood was allegedly pouring down the streets.

What Credit Mess? Subprime Offers Roll On
By Nancy Trejos, MSNBC
https://www.msnbc.msn.com/id/20418461/

This is exactly what we've been saying! And look at this:

Wall Street Cheers Home Sales Gain
By Alexandra Twin, CNNMoney.com

New home sales rose considerably this month instead of falling as expected. Why? First, this credit crunch is over-hyped nonsense. Second, money remains cheap and easy. See?

Rates on 30-Year Mortgage Rates Sink
By Jeannine Aversa, AP
https://www.newsvine.com/_news/2007/08/23/915455-rates-on-30-year-mortgage-rates-sink

Good news isn't confined to the credit markets.

Durables Surprisingly Strong
By Staff, CNNMoney.com

Slight weakness in the housing sector just isn't enough to derail our massive, dynamic economy. Growth in orders for US-manufactured goods was five times higher than expected. Five times!

Why shouldn't you try forecasting short-term and day-to-day swings? Because you end up looking ridiculous with a headline like this:

Bracing For Another Day of Struggle
By the Editorial Staff, CNN Money

Oops. That headline appeared this morning, and the S&P 500 ended today up 1.2%. Awkward. Are we out of the woods yet? Hard to say—1998's correction W-bottomed—first on Russian ruble fears and then the Long Term Capital Management fallout (both too relatively small to have legitimate economic impact). Some other big story could make a late stage surge, spiking risk aversion as markets retest lows (or even head lower).

But even if that happens, so what? Fundamentals remain very attractive for equities this year. Stocks look very cheap relative to other alternatives. Long-term rates are benign, more so now than before recent credit fears crescendoed. Earnings yields remain above bond yields globally, meaning once these credit fears shake out, stock-supply-reducing cash-based M&A activity will pick back up. All in all, the likeliest scenario we see at this point is stocks rallying through the year-end, no matter what goofy fears pop up in the next few weeks.

There's really only one time to make serious portfolio shifts based on sentiment—when investors are nearly universally euphoric, but you perceive some set of little-noticed, hugely negative fundamentals. The same is true in reverse if you've successfully gone defensive in a bear market. Other than that, we're just too flaky.