Revisiting Investing

I originally started blogging in 2006 under the name “Investor Sentiment”‎ (all posts are still available) which recorded  my thoughts and feelings of the general market, long before the financial crisis came on the horizon. The focus was to answer some fundamental questions about success with regard to money: Why do the rich get richer, while the poor get poorer? How is the real money made in a mad world like today? If everyone has all the answers, why isn’t everyone rich?

Pages could probably be written in attempt to answer these questions. But in short: Because it takes money to make money. By understanding the fundamentals of wealth and investing. Because most people fail to act when the time warrants so.

Market Trends

We seem to be at a sudden turning point in what I consider a secular bear market. You see there are two timeframes, which often last years, and sometime decades. When stocks as an asset class rise exponentially, and when stocks don’t really do much.

The 1980s and 90s were much like the first. Rising stocks, good economy, enormous profits. The second scenario is what we’re experiencing since 2001. If you look back, the market is only a few points higher than it was at its January 2000 peak of 11,723. That’s a long time to earn a measly 5% (not including dividends of course, but we won’t even get into adjusting for inflation).

In these large super-cycles however, we do find smaller ups and downs, and this is how most traders make their money. As a matter of fact, some only make money when things get really volatile (wild).

From the beginning of the real estate debacle in 2007 until 2008, we saw a crash in fiscal assets and then a quick rise, sending markets to almost 85% gains, and some stocks (financials) to gains in the 100s of percents.

Passive Style

I consider myself a passive investor, as oppose to an enterprising one. I don’t like sitting in front of double screens all day (6 for some), and I don’t believe that there are many great opportunities in any given time frame. There are times however when there are so many opportunities, that it simply becomes a matter of choosing the best risk reward option.

There are two types when it comes to financial investment. Those who seek opportunities and follow the markets, and those who really don’t care much about what Mr. Market is doing but is able to notice when the bells start a ringin’.

I feel like I used to be part of the first category, but graduated towards the second. Investing is an art of sloth, Warren Buffett once said. It never was my thinking that made the big money for me, it always was my sitting, said the legendary Jesse Livermore.

Pareto’s Principle states that for many events, roughly 80% of the effects come from 20% of the causes. If such is the case, we may infer that 80% of the profits are a result of 20% of the trades. (You may even take this a step further and argue that 99% of the profits result from just 1% of the trades).

I take this opportunity, as an outsider, to offer an objective viewpoint of the financial landscape.

Where We Stand and Opportunities Ahead

Markets fell 2.2% today. Ironic, since the old mantra goes “Sell in May and Go Away!”.

We know that healthy markets climb steadily upward. The more worry or doubt as to a market upward rise, the healthier the rally. The greater the excitement and mayhem, the greater the inevitable disappointment.

300 point moves on the Dow are rarely positive, regardless of whether they are up or down. Corporate profits remain at unsustainable levels, with companies firing on all cylinders trying to stave off any hint of recession. And dividends remain at historical lows. While there were eras (pre-1950) when the average company on the S&P 500 offered a generous 10% yield, today the most generous dividend from a Dow company is 5.45%. Finally, market conditions seem overly ambitious almost completely downplaying the economic condition. Tomorrow’s profits don’t come from yesterday’s market reports.

Let’s hear what Mr. Market had to say about today’s action:

“We need to find real yield and real returns on these assets… The dividend yields on these stocks look awesome relative to all the other investment vehicles out there” – Peter Yastrow, market strategist.

This is the general consensus of the investing community. And that should work out, that is until the Fed starts raising interest rates to catch up with the quantitive easing of capital. (This does not mean that the Dollar will drop, on the contrary, raising rates may be the only thing that the Fed can try that will do so). When this happens, the interest rate, from both the government and banks, will far exceed that of most equity dividends.

Then questions of QE2 (QE3?) and another real estate meltdown come to mind. If you’ve ever jumped from paycheck to paycheck, from interest payment to interest payment, you know how it feels to be in a bind. The money has got to come from somewhere, and where that is, is very important. The American consumer was in bad condition before the rout, so what could we expect now? Usually when you’re on the verge of collapse you’ll reach into the coffers and start liquidating things you never thought you would – old savings accounts, long-term investments, retirement money, childrens’ college funds, family heirlooms – everything and anything in your power to hunker down and not go bust.

That cash may be coming from rising assets, like stocks. But if markets continue to fall, it will turn into a death spiral. Because when that cash flow depletes, it’s all over, and that’s where I think the American consumer is now. They’ve already dug into their essentials. When that’s empty, so is their financial stamina and the greatest consumer-driven anti-recessionary buying binge since WWII.

The Way of Markets

In the event that real rates remain negative (i.e. the rate of inflation continues to rise faster than the rate of return on investment), money will continue to flow to where it is treated best – namely, gold, commodities, unfinanced real estate, and government securities.

You see, the issue with data and financial projections is that they are just that: yesterday’s data and a projection based on yesterday’s data. But when surprises emerge, similar to what happened today, you get a rout. It is obvious then that investment of any kind must be based on more than just data, but a general understanding of the wide dynamic at play (why we use mega-data or history as a guide) and the depth of the perception (much like seeing that the cash on the balance sheet is worth more than the supposed market cap).

The market must be watched closely over the next few days for signs are market irrationality. A recovery from today’s carnage should be expected and then a bumpy ride down. If this does occur (I imagine volatility going nuts with a few daily 250+ point swings) then an equity shorting opportunity may be incumbent.

How To Play This Move

Shorting with Funds: There are a number of funds you can use to short the general market: Ideally are the SDOW (Dow), SQQQ (Nasdaq) and SPXU (S&P) each of which offers you 3x leverage on market losses (and 3x the loss if markets rise). You can find a full list here:

Shorting with Options: Another way would be to buy options on market losses for a few months out. These options could be sold once in-the-money. An option is basically insurance against possible events. In this case, a falling market and a tapped out American consumer.

Always remember to cut your losses and let your winners run!

Disclosure: I own no open positions, long or short. I do own some metals which I do not intend on selling at any price.


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