Ed Yardeni is President and Chief Investment Strategist of Yardeni Research. He has been a leading commentator on the economy and financial markets for 25 years, and his daily column has been required reading for Pinnacle analysts for years. Yardeni (at least for the time we’ve been reading him) is known for being generally optimistic about financial markets, which is another way of saying he tends to tilt towards being bullish whenever he can. Dr. Ed wears this on his sleeve, and isn’t at all nervous about letting his readers know that being optimistic is a much better way of viewing the world then the opposite, which tends to be downright depressing. Just last week Yardeni referred to bearish analysts as “nattering nabobs of negativism,” which you may recognize as the famous phrase written by William Safire for Vice President Spiro Agnew to deliver at the 1970 California Republican state convention in San Diego. The full quote, referring to the liberal press, was, “In the United States today, we have more than our share of the nattering nabobs of negativism. They have formed their own 4-H Club… hopeless, hysterical hypochondriacs of history.” Last year I actually wrote to Yardeni to take him to task for similar statements about his optimistic world view, letting him know that we didn’t subscribe to his research because we wanted to read an optimistic assessment of the economy, but because we expected an objective analysis of the facts as he sees them. He wrote back assuring me that he does have a realistic world view, but feels that the pessimistic view of the global economy tends to get more attention than it deserves.
Lately I have been wondering about that, and find myself pondering the role of optimism for those whose job it is to actively manage portfolios. (This kind of consideration comes naturally after the stock market has rallied by more than 25% from its lows.) By optimism, I don’t mean an optimistic assessment of current facts and circumstances based on an objective analysis of the data, but rather optimism in the context of generally believing that things will work out for the best. To me, it seems somewhat unpatriotic to not believe that things will be better in the future than they have in the past. In the American experience that has been the case, despite a civil war, a couple of world wars, a great depression, a great inflation, and more recently, a U.S. debt downgrade, the threat of $5 per gallon gas prices, a nuclear meltdown in Japan, a sovereign debt default in Greece, and on and on. In spite of all of that, you could reasonably argue that Americans should be optimistic, if for no other reason than that we have collectively enjoyed the most positive economic experience in the history of the world.
Being financially optimistic also makes sense from the perspective of long-term risk premiums. You will be hard pressed to find a fifteen-year period of buying and holding stocks that doesn’t earn higher returns than owning bonds or cash. In other words, owners almost always receive higher returns for taking risk than lenders over long periods of time, and investors who pessimistically forget this fact run the risk of missing the next secular bull market, which typically begins when pessimism reigns and optimists are ridiculed. I suppose if your investment time horizon is long enough, you can once again reasonably make the case that you should view the glass as half-full, because time has a way of refilling the glass when you aren’t looking.
Finally, when you are in the business of investing other people’s money, being optimistic is a wonderful way of approaching client relationships. Everyone wants to know that no matter how bad things have been in the past and how bad they may feel in the present, that you believe things (whatever those “things” happen to be) will be better in the future. Unless you are managing a fund that shorts the market (which means you make money when prices fall), it is prudent to maintain a sunny disposition when discussing future market returns. After all, we manage risk for a living, and if our clients conclude that there isn’t a good reason to take risk, then we may shortly find ourselves out of business as they find risk-free alternatives for their investable assets.
Nevertheless, the “Lord will provide” and “the glass is half-full” sort of optimism makes me nervous. As a personal philosophy, it produces people with a positive disposition who you want to hang out with and invite to your next dinner party. But as an investment philosophy in a world full of systemic risk, it seems like a wonderful recipe for large losses of principal. Pinnacle ascribes to only one philosophy in decision making, which is that we try to evaluate the facts objectively. We are as optimistic or as pessimistic as our objective analysis allows us to be. And because we don’t believe that we can ever be 100% certain of the results of our analysis, our optimism or pessimism tends to be colored by our knowledge of the opposing view of the world. The net results are diversified portfolios, decisions made by an investment team rather than a single investment guru, a quantitative and qualitative approach to decision making, and a three-part process for determining investment value. As a firm even when we are optimistic (or bullish), we hedge our risk positions with bearish (or pessimistic) assets. The notion that you should always be optimistic only makes sense to me when you think risk assets are absolutely cheap based on many different measures. From that point, optimism will see you through the frightening downdrafts of markets making a final bottom, and allow you to be fully invested when markets finally see their lowest prices. (But again that optimism at the market bottom is based on objectively assessing market valuation, and not arbitrarily clinging to an investment philosophy rooted in optimism.)
Pinnacle’s Chief Investment Strategist Rick Vollaro has nicely described the current bullish case as “a tale of two tales.” Optimists can point to lower risk spreads, abundant liquidity, high productivity, fair market valuation, signs of lower unemployment, the potential for a housing bottom, the possibility of a virtuous economic recovery in the U.S., the fact that the U.S. is experiencing a boom in natural gas production, the apparent effectiveness of our economic sanctions against Iran, the resilience of U.S. consumer spending, the case for secular growth in the emerging markets, and the resilience of U.S. corporate profits, as reasons to be bullish. Each item above meets our test for rational and objective discussions about facts, and yet each can be rebutted by bearish investors with a different perspective about how to view the data. We simply don’t believe that there’s a case to be made for blind optimism, which can be frustrating for those who prefer to view the world through rose colored glasses. Hopefully we’re not and will never be “nattering nabobs of negativism.” However, we’ll continue to try to be like that perennially unloved baseball umpire who “calls them as we sees them.”