Thursday, 23 August 2012

Investor Pessimism

Lately, I have been reading a lot about investors, banks and nations preparing for the worst case scenario. It seems that the definition for "worst case scenario" differs from time to time: a Greek exit, a Euro collapse, a banking collapse, a Eurozone collapse and so on. Obviously one has to prepare for such events. What I always thought to be weird is that people always prepare for "worst case scenarios" only after recessions or severe economic blows occur. One should never be worried by pessimism or optimism in the markets. Although they may last long in many cases, they are always alternating. They are both outcomes of human nature, a sort of behaviour that was the same throughout the years.

All of the great investors throughout history understood this. People are always prone to good or bad feelings. A bear market (e.g. a falling index in the stock exchange) occurs when people feel overly pessimistic about the present and the future and a bull market (the exact opposite, a rising index) occurs when people feel overly optimistic about it.

A great example of this is the banking situation nowadays. Banking institutions after expanding rapidly in the last decade (overly optimistic) are now contracting their business operations to operating only at the local level (overly pessimistic). Cross-border lending is steadily declining in the EU reaching 2007 levels in last June. Otmar Issing, a former ECB chief economist states: "Over the long term, the monetary union can't be maintained without private investors,because it would only be artificially kept alive." While this is true and many feel that getting rid of their assets in euros and buying gold or real estate is a great idea, others have gone even further by removing themselves from the monetary zone. 

Many investors are even betting against the euro surviving. John Paulson, who made billions shorting (i.e. selling something now - e.g. a stock or a currency - in hope of buying it later at a lower price and thus profiting with the difference) during the sub-prime lending crisis in the US and the now retired George Soros stated that they are betting against the common currency. 

As for me, I wouldn't worry about bank contraction. Both economies and firms contract and expand as they react to the general feelings of threat or hope for the future. A crisis is a good opportunity for people, firms, economies and states to learn from their mistakes. What I hope is that politicians and policymakers will realize the need for action. Even late action is better than no action, however too late would mean the end of the euro as many investors prophesied.

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