Investing on Hope

There is a sentiment out in Wall Street land today, lead of course by the UBS write-down, that hope is in the air. The news is all over the major publishers today;

"Stocks started off the second quarter with a rally on Tuesday as investors weighed a fresh round of mortgage-related write-offs at UBS and Deutsche Bank, two of the world’s largest financial institutions.

But despite the discouraging numbers — $19 billion in write-downs at UBS and nearly $4 billion at Deutsche in the first quarter alone — investors hoped that the bad news could signal the last of Wall Street’s subprime woes.

As reported in the NY Times article Shares Surge on Bank Write-Downs

“It’s psychological,” said Richard Sparks, a senior analyst at Schaeffer’s Investment Research. “When a company comes out and writes down more, it leads people to believe that they’re being forthright.”

“We’re hoping that we are closer to the end than the beginning,” he added."

The market in turn saw a flight from treasuries into the financials today as a result of the write-downs. The Relatively Good News in the article:

"A closely watched manufacturing report, prepared by the private Institute for Supply Management, ticked up last month, though business is still shrinking within the industry. The gauge of manufacturing activity edged up slightly to a reading of 48.6 in March from 48.3 in February, slightly better than expected. Any reading below 50 is seen as a sign of contraction.

Elevated export orders continue to offset flagging domestic demand, but manufacturers are feeling the effects of inflation: a gauge of prices paid for production materials reached its highest level in nearly 6 years.

Spending on construction projects also improved, as overall spending fell 0.3 percent in February after declining 1 percent in January, the Commerce Department said on Tuesday. Government-financed building is increasing even as private residential construction remains in a slump.

Investors were also buoyed by a drop in commodity prices, which have reached record levels in recent weeks. The declines in prices for oil, gold and wheat could translate to cheaper prices for consumers.

Crude oil has fallen for three consecutive days; it dropped by $0.41 on Tuesday to just under $102 a barrel. Gasoline prices were also trading lower. Gold, which becomes more expensive in times of crisis, declined to $888 a troy ounce after reaching $1000 just two weeks ago."

Better than expected does not imply strong fundamentals. Hope is a hell of a thing to invest on; better save it for the tracks. I already outlined why we are not going to see an upturn any time soon in Why is Market Cheerleading so Prevalent? Besides, investors and traders have already hoped before that the write-downs were all but over back in Q4 2007. David Gaffen of Marketbeat explains this conundrum Behind the Write-down Rally:

"With Tuesday’s 300-point increase in the Dow Jones Industrial Average, investors are engaging in a familiar game — buying shares of equities, particularly financial stocks, on the hope that the worst news has been accounted for in current share valuations....

...Several earnings-related releases produced rallies in the financial-services sector. On Oct. 1, 2007, Citigroup Inc. shares gained 2.2% after the company announced a $5.9 billion write-down on its subprime-mortgage exposure. A few days later, on Oct. 5, Merrill Lynch & Co. Inc. admitted to a $5.5 billion write-down — sparking a 2.5% rally in Merrill stock. And about a month later, on Nov. 8, Morgan Stanley shares gained 4.9% after the company announced a $3.7 billion loss on sub-prime exposure.

“Everybody said, ‘this is the kitchen sink quarter,’ and it turned out not to be,” says David Joy, chief market strategist at RiverSource Investments, a unit of AmeriPrise Financial. “Now we’re getting the same sort of sentiment here, and it remains to be seen whether this is truly the kitchen-sink quarter. There’s some optimism that it will be.”

Until housing prices return to normal price levels vs. housing rents and inventory in the housing market has decreased significantly I wouldn't get your hopes up too much because those are the sources of our economic burdens now and the they must be unwound before a market bottom can be realized. Furthermore, analysts and traders better also hope corporate profits improve, because the BEA Q4 GDP & Corporate Profits news release was fugly!

"Domestic profits of financial corporations decreased $74.4 billion in the
fourth quarter,compared with a decrease of $32.5 billion in the third.
Domestic profits of nonfinancial corporations decreased $34.3 billion in the
fourth quarter, compared with a decrease of $14.4 billion in the third."
That is simply astounding, non-financial profits are declining faster than
financial profits!