Investment banks might have CIPA.
Congenital Insensitivity to Pain with Anhidrosis, or CIPA, is a genetic condition that stops its subjects from feeling pain. In laymen's terms, the subject's body cannot communicate "pain" signals to his or her brain. It's an extremely rare phenomenon, afflicting only 17 people in the US.
Yet, as rare as this condition is for individuals, investment banks seem to have it in spades. In the last month, corporate heads at Goldman Sachs (GS), Lehman Brothers (LEH), and Morgan Stanley (MS) have all come out saying "the worst is over" for the financial crisis. As with CIPA, these corporate heads don't seem to be receiving "pain" signals from their corporate bodies.
On April 8th, Morgan Stanley's CEO John Mack announced that we are in "maybe the top of the ninth," regarding the subprime credit collapse. Yet, a mere three weeks later, Morgan Stanley analysts— the guys who actually study the markets—published a report telling clients to "sell the rally" in financial stocks. They added, "we think we are only in the third inning of the credit cycle and expect this cycle to be worse that (the slump) in 1990-91."
Morgan Stanley isn't alone with this affliction. Lehman Brothers' CEO Richard Fuld announced that "the worst is over" a mere couple of weeks after Lehman analysts cut their estimates for banks in 1Q08. Merrill Lynch's (MER) CEO joined the "worst is over" crowd a mere month before his firm wrote down another $6 billion and announced it would be cutting 4,000 jobs.
Genetic conditions aside, these guys haven't got a clue how bad things are going to be. They're salesmen, not market forecasters. If you don't believe me, have look at their recent forecasts going back to the beginning of the financial crisis. Last July, investment banks estimated losses from subprime mortgages would total $100 billion. Within a month it had quickly doubled to $200 billion. By November estimates had risen to $400 billion. Now, even Goldman Sachs has posited $1 trillion.
It's amazing to me that investors take what investment bank CEOs say seriously, even though they've been spectacularly wrong for most of the financial crisis. It's even more incredible when you consider that these guys are risking nothing making these claims. After all, if they're wrong and things get catastrophic, they'll cash out with severance packages worth hundreds of millions of dollars— just like Chuck Prince and Stan O' Neal. Yet investors are buying it just as they have numerous times in the past.
Since the financial crisis started last July, financial stocks have staged 12 rallies of 5% or more. Every time, investors bought thinking the worst was over. And every time, the sector plunged again. Altogether, it's down 28% since that time.
Folks, the worst will be behind us when CEOs are no longer saying these kinds of things; when rallies are viewed with suspicion instead of enthusiastic exclamations that the bull market is back on track; when fund managers are genuinely bearish— a recent Barron's survey showed 87% of fund managers expect to be net buyers over the next three to six months— THEN the worst will be over.
Until then, any exclamation of "worst" is just wishful thinking. And while the heads of these organizations may not feel any pain, their bodies are bracing for more trouble. For those of us who won't make millions from getting it wrong, I suggest selling financials into this latest rally. You'll be glad you did in the coming months.
Disclosure: No positions.