The Only Thing We Have To Fear Is ...
July 31, 2008
Just about everyone has some sort of fear, rational or not, and Ill start right off by sharing my biggie: confined spaces. I have no memory of a dark closet incident, and Im pretty positive Ive 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 dont 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 ofpeople 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 governments balance sheet, that house prices will continue to fall. And so on and so on.
When considering the high yield market, though, one cant ignore a few other facts: Spreads dont look half bad and defaults havent materialized at the rate previously expected. Not to mention the fact that most investors weve talked to believe the market has already priced defaults into current spreads.
So should high yield investors be scared? Perhaps cautious is a better wordand yes, they probably should proceed with caution. But the key is analyzing each fear case by case. Investors weve spoken to recently have all stressed the need for case-by-case analysis. Dont 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 realitya bank robber, for example, probably should fear prisonblanket 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 wasnt always easy to tell the difference. Sharks, reptiles, walking near giant mechanical cranes? All of these things can cause harm under very specific circumstances, cant they? One person responded, Marriage and heightswhich one is irrational? Good question. Better take it on a case by case basis.