Cognitive Dissonance on Wall Street
I have been writing about brown shoots for too long to recount - perhaps since the term green shoots was created by some bull with calls on the S+P - and I have been astounded by the number of analysts, pundits and whatever who bought the argument. Congress is expected to re-write the laws of math but no one else. So why were so many people surprised on Thursday with the unemployment data?
This Thursday's unemployment report should not have been a surprise. I will not waste your time recounting numbers you can see or have seen elsewhere. But the sharp selloff means a) a lot of traders got in on the wrong side of the trade and ran in a hurry and b) there is still a historically high amount of cognitive dissonance on Wall Street. Cognitive dissonance may, in fact, explain the entire rally and is, if you like behavioral psychology, is central to understanding the behavior of markets that fly in the face of economic reality.
To quote part of the Wikipedia definition (a good one, to be found at http://en.wikipedia.org/wiki/Cognitive_dissonance), "Cognitive dissonance is an uncomfortable feeling caused by holding two contradictory ideas simultaneously. The "ideas" or "cognitions" in question may include attitudes and beliefs, and also the awareness of one's behavior. The theory of cognitive dissonance proposes that people have a motivational drive to reduce dissonance by changing their attitudes, beliefs, and behaviors, or by justifying or rationalizing their attitudes, beliefs, and behaviors."
Sounds like the Street to me.
Wall Street does one thing quite well - math, usually reserved for bonus calculations, commissions, fees but occasionally used for analyses - and it knows the consumer is dead and getting deader, suppressing business behavior and employment. But it wants to go long - it longs to go long - and this tension is cognitive dissonance. It removes the tension by reconciling these two ideas with what it really wants--for the market to go up. Otherwise intelligent people go on TV and tell people things are fine with green shoots everywhere - I am not talking about screaming anchors who have traded ideology for intelligence like Larry Kudlow, nor am I referring to corrupted reporters now always optimistic as if they had a patriotic duty to be so - perhaps it is ratings? I am talking about money managers who are mostly long and want to stay that way. They are now telling people to "invest in the second derivative" - a decline in the rate of decline - and their reasoning "green shoots." So if you are going to willfully deceive yourself and resolve cognitive dissonance, you might as well pull some sucker along for the ride.
This optimism extends to individual market segments and companies. In the good old days, pre Bear Stearns, when housing starts hit one million per year it was a "bottom" and time to buy the home builders. We are down to half of that rate with no rebound in sight but pundits are talking up the companies, most of them kept alive by billions in tax rebates that end this year. Not one investment bank, not to mention a major money center bank, has earnings power remotely approaching their capability five years ago but the stocks have risen sharply based on accounting metrics the Street knows are on paper, not the real world. Not to mention all of the money center banks cannot exist without Fed guarantees of their bonds. And within this group, look at Citigroup - worthless balance sheet, some great businesses, but having no real shareholder value and if and when forced to properly (I don't mean legally, what they do with their books is legal) account for assets, they are wroth nothing. And how about GM trading above a buck?
There is another variant to this optimism - honest optimism based on a mis-reading of data. My favorite TV analyst, Ron Insana, a brilliant and painfully honest man, not quite fully pulled back into all of CNBC's mantras about green shoots, thinks we have hit bottom in the market with the overwhelming reason being the amount of liquidity the Fed has injected into world markets. Yet, if you look at the circulation of "new money" - its velocity - how much it circulates - against what the Fed has metaphorically printed you can see the money supply may have actually declined in the past year. No kidding. And even if I am partially wrong, where is the liquidity? It is now showing up in margin accounts of hedge funds or trading desks - it is sitting in bank mattresses, ready to be used to balance out future losses.
So there is optimism from cognitive dissonance, know one thing, think another, reconcile this by sticking with a belief even if you know the belief is wrong. Or you are getting it wrong because you are using historical norms to analyze something far less than normal - today's economy and markets.
I am not complaining - well, I guess I am, sort of, since I live on fundamentals even though I only recommend options position in my service, ChangeWave Shorts - but a day of at least partial reckoning is coming. Either a blow up or a slide that defeats even the hardiest if bulls. And even if I am wrong, based on the history I am trying hard not to use, the economy will inhibit corporate profits and at best keep the market going sideways for several to many years. Even Congress cannot change how the market value corporate profits - and the market is way overpriced based on the next 2-12 quarters of economic and profit growth.
The bottom line? Whatever trades you make, they need to be in the face of an economy that is not bottoming and when it does, facing a recovery that could take as much as a decade. And, seriously, take a look at Citi as a short - if they are forced to move their off balance sheet assets on their books, well, lots and lots of these. Check out page 21 of the town hall presentation they half for employees last November. And if you are long Citi, have a drink before you get to that page, and that can be found at http://74.125.47.132/search?q=cache:xSvJ_3VrNX8J:www.citigroup.com/citi/fin/data/p081117a.pdf+citigroup+november+2008+town+hall+meeting+pdf&cd=1&hl=en&ct=clnk&gl=us&client=firefox-a
