Markets face ‘irrational pessimism’

March 09, 2009
Author: Rachel Beck; The Associated Press

NEW YORK – March 9, 2009 – You’ve heard of “irrational exuberance,” right? That’s the expression Alan Greenspan coined more than a decade ago when he warned that investors could be bidding stock prices too high. His worry was that escalating asset values were trumping reality.

These days, the opposite seems to be the case. Call it “irrational pessimism,” a fear that stock prices are headed in only one direction – lower and lower – because asset values and profits seem certain to fall.

Caught in the vortex of this new hopelessness are once-pristine blue chip stocks like General Electric Co., whose share price has plunged 45 percent in the last month to below $7 a share. Investors have become increasingly worried that losses at its financing arm could put a crippling dent in the conglomerate’s capital base.

But before buying into the notion that all is lost, it’s worth remembering that stock indexes today are almost exactly where they were in 1996 when then-Federal Reserve Chairman Greenspan issued his warning.

Investors ignored him then, pushing stocks higher for more than three years until the Internet stock bubble burst in 2000. Now, a growing number of market experts are saying the time may be near when the Cassandras of doom should also be ignored.

“You can get to emotional extremes in both directions of the market,” said Hugh Johnson, chairman and chief investment officer of Johnson Illington Advisors. “Savvy investors think in those terms and they know how to get that to work in their favor.”

By that, he points to the short-sellers who are playing a big role in what the market is doing today. They make money betting stocks will drop, and have set the tone in this current decline, which began after the market reached record highs in October 2007.

Peter Sorrentino, senior portfolio manager at Huntington Asset Advisors, takes that one step farther. “The shorts are staging raids on our companies,” he said. “For the last two years, the best bet you could make on the market was against it.”

Sorrentino knows that because his firm owns 6.4 million shares of GE, and he can’t understand why the stock is trading where it is given that parts of the Fairfield, Connecticut-based company by his count are worth a lot more than where its shares are trading now.

He’s convinced the shorts have made it tough for anyone in the market – at GE and beyond – to think positively because they could get burned. Therefore, investors have decided it is easier to follow than fight them, even if a company’s finances say something else.

A case study of GE illustrates how this may be playing out. Even though GE is in many different businesses from jet engines to entertainment to lending, investors seem to be focused entirely on its finance arm, GE Capital. Once a major profit generator for the company, now there are worries that it is short on liquidity and could post big losses.

GE’s CFO Keith Sherin went on GE-owned CNBC Thursday to get the message out that there was no “time bomb” brewing at the unit, which he said would be profitable in the current quarter, had ample capital and had set aside money to cover any of its losses.

That followed lots of other efforts in recent days from the executive suite – insider stock purchases, video statements from CEO Jeffrey Immelt and other spin – to shift investors’ thinking about such gloom.

“GE put out a press release (Wednesday), citing all the good things it is doing to drive away the demons, but Jeffrey Immelt is no Harry Potter,” said Kathleen Shanley, an analyst at the bond research firm Gimme Credit.

That investors haven’t responded positively may be due to the fact that 1.5 percent of GE shares are out on loan to short sellers, nearly double the level at the start of the year, according to Data Explorers, a short-selling data research firm based in New York.

The shorts’ efforts have then been backed by nervous individual investors who now have reason to sell since GE announced plans Feb. 27 to cut its dividend for the first time since 1938 to save $9 billion a year. GE will pay shareholders a 10-cents-a-share dividend beginning in the third quarter, 68 percent lower than the company’s original plan of 31 cents.

All that selling is putting fund managers on edge, especially foreigners like sovereign wealth funds that had counted on GE as a safe investment. Of particular concern is whether GE’s triple-A credit rating could be in jeopardy if its finance arm lacks capital.

And then adding to the downside pressure is what is going on in the credit-default swaps and options markets. Investors are taking out additional insurance to protect themselves in case GE defaults on its debt, and then they are hedging that with the purchase of put options, which gives them the right to sell shares at a specific price. Some investors in recent days bet the stock would fall to $2.50 by June.

All that shows how GE’s stock has been ravaged by “irrational pessimism” – fed by the shorts but potentially without much to back it up.

Analysts at Deutsche Bank said Thursday that they valued GE’s industrial arm at $12 a share – almost double where the stock currently trades.

Sorrentino goes even higher, putting the industrial business at $20 a share. Add to that, he says, its NBC Universal entertainment division, which could fetch somewhere around $4 to $6 a share, and around $7 to $9 a share for its medical systems business.

The negative environment in the overall market is driving away prospective buyers, said Darin Newsom, senior analyst at the Omaha, Nebraska-based market information company DTN. “Right now no one wants to support this market,” he said.

That may be driven by fear instead of reason.