Weekly Musings 15 (4/17/11)
investing in troubled times
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For those who are new to the Musings: they are basically a glimpse into my notebook, the unfiltered swamp where I organize future themes, sort through the dozens of stories and links submitted by readers, refine my own research and start connecting dots which appear later in the blog or in my books.
Investing in Troubled Times
The Piggy Bank: U.S. dollar, Contrarian Trade
Opening Notes:
First let me apologize to all of you who emailed me the past week. The site logged an unprecedented 84,000 visits last Sunday, about 10 times the daily average--the result of a mention on the social "recommend" site reddit.com--and that, coupled with recent entries on college education costs and hyperinflation generated a crushing wave of email.
Discounting that one-day anomaly, the site traffic has risen to the point that my host is saying I need to move to a dedicated server, which of course costs 10 times more per month....
Investing in Troubled Times
I have been working on my next book, which is titled "An Unconventional Guide to Investing in Hard Times." For what it's worth, I have promised contributors and subscribers a draft of the book. After about a year of work, I thought I was getting close earlier this year but I recently scrapped the draft and rewrote it from scratch.
The "investing guide" space is so crowded, I have struggled with what I can bring that hasn't already been covered in depth in hundreds of other books. I think I have an answer: an unconventional overview of the psychology of speculating/investing (all investments are speculations, unless they're fraudulent, i.e. insider trading), a brief overview of why the next 20 years will be unlike the last 20 years, and a brief explanation of some key tools that might help inform our investing/hedging decisions.
I don't know how the future will unfold, and neither does anyone else. That suggests the primary tool is to remain flexible, curious and open-minded to possibilities.
One reason I decided to write the book--and risk adding another title to a shelf that already stretches to the Moon--is that I find most explorations of investing/trading psychology to be sorely lacking.
For example, a recent approach is to list various cognitive biases, and then leave the reader to figure out the actual process of overcoming them. It seems to me that this is largely a futile program, as is holds out an implicitly false promise: "If you can only eliminate the dozens of cognitive biases that plague the human mind, you would become wealthy from brilliant investing."
Put another way: if only we could become computers, we would trade without bias, and thus be successful.
But is eliminating cognitive biases really the primary obstacle in trading/investing? It's true that "black box" quantitative trading machines skim billions of dollars in profits from high-frequency trades, holding positions for a few minutes at a time, but this is mostly an artifact of a system that enables high-frequency trading. If the political climate shifts and rules change, for example, so that all positions must be held for 24 hours, then what would that do to black-box HFT returns?
This is not to say I have the answer, but there may be value in questioning whether human behavioral psychology is the primary impediment to raking in billions. It seems the really great investing fortunes have been made by humans who made outsized bets in a small number of stocks and happened to be right. Perhaps intuition is more "profitable" than a drive to eradicate cognitive biases.
I am also endeavoring to incorporate some of the things I have learned from Harun I., a frequent contributor whom I often rely on for trading insight. For example, here is Harun's recent description of "guerrilla trading:"
"A few words about advice and opinions. Those that advised people to stay in cash were wrong. If the Dow, even though it is underperforming gold and has serious structural defects, had been purchased in 2009 it would have locked in energy prices at the 2009 level. In other words, it would have proved an effective hedge. If one bought gold there would have been moderate losses ( energy instruments are outperforming gold). If the commodity itself (oil) had been purchased, there would have been a perfect hedge. The charts are purely mathematical and do not deceive. There is no static, one size fits all, answer in a realm that is dynamic, and at times violently so.
The great thing about the market is that it gives its participants the ability to express their opinions. There is a short for every long and vice versa. Only one will be "right". Rather than engage in a debate based on the pretense that I "know" what will happen next is for me a waste of time, instead, take a position in the market with a specific time horizon. Money in my game is just a way of keeping score. So I invite those with strong opinions to express themselves in the market. Their equity curve will tell them if they were right.
So for those capable, use what resources you have to be flexible. Become good at guerrilla tactics. Stay small and nimble and trade only in highly liquid instruments. Hit the market when your edge presents itself, then fade into the jungle with your profits before the market can regroup.
For those with no resources, what can be said? If you run out of ammo in a firefight, unless you find someone to share what they have or someone who no longer needs it, the best you can do is try to survive."
In terms of risk management, the analogy may boil down to: avoid risk (having an opinion in the market) unless you have an edge or a hedge against being wrong.
And of course, my book will explore the question of what constitutes wealth and prosperity. Our culture and economy presume that a million dollars is the answer, but that looks too simplistic to be a satisfactory answer.
The Piggy Bank: U.S. Dollar, Contrarian Trade
Warren Buffett famously said "Try to be fearful when others are greedy and greedy when others are fearful."
This is of course a classic description of contrarianism: the way to reap big profits is to do the opposite of the herd. By what metric do we measure greed and fear? There are various technical tools like the VIX "fear index," but if there were a perfect measure then everybody would be using it, and then of course it would lose its edge.
Another way of saying the same thing is to buy what's completely hated and sell what's over-loved. At this juncture that would suggest selling AAPL (Apple) and buying the U.S. dollar, which is almost universally expected to go to zero.
It reminds me of the sentiment toward gold in 2000. Gold had underperformed for 18 years, while stocks had made dizzying gains in that same time span. Buying gold was for the deranged or sadly deluded. Looking back, selling stocks and buying gold at $300 an ounce in 2000 was a very low-risk and profitable investment. When sentiment is extreme, then that can be taken as a contrarian signal. Nothing is more hated and loathed than the U.S. dollar, which is seen as slipping down a one-way slide to Doom.
This is why I am buying UUP, an ETF that goes up when the USD goes up. This is disclosure, not a recommendation. It could be a wrong "opinion" and the market will inform us soon enough.
This time reminds me of 2007: the global financial situation was obviously precarious, yet stocks remained at elevated levels for another year. Similarly, in 1999 the voices of reason said the stock market bubble was already dangerously inflated, yet it continued inflating for another year. When will the current bubble pop? That is unknowable, but the clock is definitely ticking.
From Left Field
Thanks for reading--
charles
