Traders' Increasing Tolerance for Risk
Yesterday, one of my friends asked why the markets continue to climb. My first response was "more people are buying than selling".
After a quick grin, I explained that there has been a shift in risk tolerance. If we look at some of the stocks that have rallied since March - Citigroup (C), Ford (F), Temple-Inland (TIN) - it's apparent that traders are bidding up the call option on these companies' long-term viability.
In some cases, there is reason to think current shareholders will eventually end up alright (after ignoring opportunity cost). Housing and the economy will eventually recover. On the other hand, shareholders of both Citigroup and Ford still could see their holdings diluted practically out of existence.
Though I remain cautious, I acknowledge the risk of being too conservative. In our portfolio committee meetings, we have looked at stocks lately that we wouldn't have even considered in February. Our desire not to chase performance has kept us out of some stocks, but we are actively looking. The recent addition of Digital Fast Channel (DGIT) reflects this acknowledgement that we need to have greater allocation to stocks likely to benefit from a potential economic recovery.
I still expect another pullback in the markets, though I'm starting to feel like a weatherman who is calling for rain in the middle of a drought. General Motors (GM) and the big banks worry me. GM shareholders are likely to get wiped out. I have no idea what Tim Geithner's exit strategy is for TARP and I don't think he knows either. The fact that the date for releasing the stress test results is being pushed back only serves to reduce the already low confidence in their validity.
On the other hand, the economic data continues to point towards a slower pace of deterioration, which is good. I'm also seeing an improvement in the ratio of positive to negative estimate revisions. Profit forecasts are still being cut, but there is a growing number of positive revisions.
Therefore, there is an argument to be made for being less conservative. I get that.
