The Only Thing We Have To Fear Is ...
July 31, 2008
Just about everyone has some sort of fear, rational or not, and I’ll start right off by sharing my biggie: confined spaces. I have no memory of a dark closet incident, and I’m pretty positive I’ve never fallen down a well. Yet the idea of finding myself locked up in a prison cell or, worse yet, buried alive, terrifies me. Even the blanket tucked too tightly under the mattress fills me with inexplicable anxiety and causes much kicking and pulling until I pronounce it sufficiently loose.
Of course, prison and live interment are pretty horrifying, no doubt about it. But the chances of these things actually happening to me don’t exactly leap off the charts. So, realistically speaking, how rational is my fear?
This is an important question for investors right now, and not always an easy one to answer. Clearly, the current U.S. economy offers much to be afraid of—people fear the dollar will collapse, that inflation will rise, that growth will fall, that a major bank will fail, that the Fed has made a policy mistake, that Fannie Mae and Freddie Mac might overly stretch the government’s balance sheet, that house prices will continue to fall. And so on and so on.
When considering the high yield market, though, one can’t ignore a few other facts: Spreads don’t look half bad and defaults haven’t materialized at the rate previously expected. Not to mention the fact that most investors we’ve talked to believe the market has already priced defaults into current spreads.
So should high yield investors be scared? Perhaps “cautious” is a better word—and yes, they probably should proceed with caution. But the key is analyzing each fear case by case. Investors we’ve spoken to recently have all stressed the need for case-by-case analysis. Don’t discount an entire sector, even one that under current conditions calls for underweighting, they say, because you just might find yourself on the wrong end of a short bet.
So while some fears do have basis in reality—a bank robber, for example, probably should fear prison—blanket fear (like fear of tucked-in blankets) is pretty much always irrational.
By the way, I asked my colleagues in the office to tell me about their fears, give me one rational and one irrational, I said, and it wasn’t always easy to tell the difference. Sharks, reptiles, walking near giant mechanical cranes? All of these things can cause harm under very specific circumstances, can’t they? One person responded, “Marriage and heights—which one is irrational?” Good question. Better take it on a case by case basis.
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