The Constant Flow of Kool Aid on Wall Street

One thing we talk about a lot is the constant "hopefuly optimism" on the Street in the face of facts. The truth is almost everything on Wall Street in terms of profits is based on luring in more and more people to make transactions, or at least stopping them from withdrawing so of course there is a bias to constantly sugar coat everything. The problem for those who drink the Kool Aid, is they get left with losses. I was reading an artcile about IndyMac (IMB), the nation's 9th biggest mortgage lender, who is promising PROFITS in 2008! Woo hoo! Unlike Thornburg Mortgage (TMA), IndyMac was full of subprime mortgages and the type of junk that eventually brought down Countrywide (CFC) so it's not exactly the best run company or one with any foresight. But the article highlights a few examples of MANY MANY Kool Aid moments we've enjoyed since last spring.... this is what makes the markets very tough. In Kool Aid moments, people are just wanting to believe any sliver of hope. And you can be intellectually correct, but your position works against you as a herd of Kool Aid drinking lemmings runs wild.

We just talked about this last week, when company after company in retail promised "2008 won't be that bad". The same companies who are missing estimates they issued 4-6 weeks ago. So we are to believe they can forecast all the macro effects in the economy by Dec 31, 2008 - when they are failing predicting a month and a half out. True Kool Aid. Just remember, this beverage can be very disastrous to your portfolio. The current Kool Aid is "we'll get through this rough patch but by 2nd half things will be rip roaring" - we hear this from company after company, and government official after government official - I'd like to hear these comments made under a lie detector environment. I think we'd hear a whole different reality. Eventually they will be correct - there WILL be a recovery in "6 months". The question is which 6 months? A few other examples (again of MANY!)

• An extraordinarily tight credit market. Gloomy assessments from economic policy makers about the state of the housing sector. A possible contraction in the nation's economy.
• Faced with those daunting obstacles, struggling mortgage lender IndyMac Bancorp still says it can turn a profit this year. Many analysts are skeptical. "With rapidly rising credit problems and an economic recession looming, we see little reason to be hopeful that earnings pressure will subside for IndyMac over the near term," said RBC Capital Markets analyst Jason Arnold.
• IndyMac, the ninth-biggest mortgage lender in the U.S., lost more than $600 million during a "terrible" 2007. The company expects a big loss in the first three months of 2008, but believes a recovery in the second half will lead a reversion to profitability.
• In the middle of last year, when problems with subprime mortgages became full blown, the company said it expected to remain profitable. It ended up losing more than $6.40 per share. (but let's believe them THIS time)
• At midyear, the company said it expected to remain profitable. In September, with a little more than three weeks remaining in the third quarter, IndyMac predicted it would lose no more than 50 cents per share for the three-month period. It lost more than five times that much. (so they could not forecast 3 weeks forward, but let's believe them THIS time)
• Because of the abrupt and volatile gyrations in the mortgage industry in the past year, many of the market's participants have issued forecasts for a recovery that have proven premature.
• Countrywide Financial Corp. initially predicted it would earn at least $3.80 per share for 2007, and lost more than $2 per share. In the early stages of the subprime crisis, the Calabasas, Calif.-based lender asserted it would be a beneficiary of the shakeout in mortgage lending. (and if you drank that Kool Aid, you lose about 80% of your money)
• Homebuilders were nearly unanimous in late 2006 predicting a rebound in the housing market for 2007. Instead, home sales fell almost 13 percent last year, according to the National Association of Realtors. (and if you drank that Kool Aid, you lose about 80% of your money)
• Executives at Bear Stearns Cos. and Citigroup Inc., hit with billions of dollars of mortgage-related writedowns during the summer, adopted a more optimistic tone in October, saying the market had begun to stabilize. November in turn was one of the worst months in Wall Street's history. (this was at the height of the Kool Aid craze because you don't want to "fight the Fed"!)
• Throughout much of last year, Federal Reserve Chairman Ben Bernanke repeatedly stated he believed the subprime crisis would remain "largely contained," (oh Ben.... I assume he meant contained on planet Earth)

Lesson: Don't drink the Kool Aid

Long Thornburg Mortgage in fund and personal account