Pessimistic Investors Are Missing the Boat in 2010, Again

Includes: CAA, DRH, LEN, PHM, XHB
by: Kehong Wen

There is an abundance of pessimism in the current investment crowd, which is well-supported by high unemployment, foreclosure waves, federal deficits, anemic home sales, ... There is little wonder why so many commentators here on Seeking Alpha dwell on the negative side of every piece of economic data. If you go with the wisdom of this crowd, you should be shorting the market in general.

Yet short sellers have been frustrated so far this year. Nothing seems to work. In particular, the homebuilding sector has been one of the top performers of the year so far (simply check Lennar (NYSE:LEN), D.R. Horton (NYSE:DRH), Standard Pacific (SPF), Pulte Homes (NYSE:PHM), or XHB). It is truly frustrating for investors who just cannot see any light in the housing sector, and cannot accept the fact that government support is sometimes necessary and useful.

After a disastrous 2008, investors pulled record amount of money out of equities, and put them into bond funds and/or cash. Despite a roaring "V-shape" recovery in the equity markets in 2009, much narrowed credit spreads and the expected rise in the yield curve, investors continued to pour $89 billion into bond funds in the first quarter of 2010.

PIMCO has been the prime beneficiary of this inflow. Its "new normal" thesis has been well-argued and publicized which has also helped draw money into their bond funds. All this money however may make it extremely hard to keep up with performance, given the potential inflation and potential rise in rates.

Finally, PIMCO warned that bond funds may have seen best days. They have even started to offer stock funds.

One clearly can see at least two different types of herds here: The avoid-equity-at-all-cost crowd that stampeded into bond funds and the pessimism-dwelling short-selling crowd. One would think that the second crowd may be more sophisticated and better informed, yet they may be just one-year behind the curve after investor like John Paulson has already made his killing in 2007-2008 by shorting and started going long into financials in 2009.

The trait of the investment sheep makes them dwell on one direction for too long. Such sheep showed up in force in the last housing boom. And we may be seeing them again in the abundance of extreme pessimism in 2010.

Disclosure: Long global recovery, SPF, LEN