Jan

27

Last September 30th, I was highly critical of a fellow spec (no need to name names) who, amidst the S&P downgrade, the ECRI recession call , and a volatile and nasty stock market swoon wrote: "None the less I moved a large part of my 401 K to cash, and the rest in safer stocks today, giving me more than half in cash. This is as conservative a position I have been at including the 2008-2009 period. " With 20:20 hindsight, we should note that this fellow sold the "exact low" — a statistically improbable feat … comparable only with buying the exact low in natgas last week. He never wrote to us about if/when he became less conservative. One presumes that he continues to justify his decision with some rationalization like: "The risks were just too great to ignore." Or "I couldn't take the pain." Or "My wife would never forgive me if I lost everything."

As I wrote at that time, I thought that there is always a risk of things getting worse, but that I was nibbling into weakness — because my disciplined analysis (which has worked for decades) gave the most probable 3-5 year return of high single digits…and that was sufficient grounds to be adding to exposure — not reducing exposure. I'm not giving away any trade secrets when I note that different asset classes behave differently, and my willingness to nibble at stocks during last summer's swoon is not inconsistent with my unwillingness to aggressively buy natural gas futures at its recent 10-year low prices. Now that Mr. Market has risen a cool 21% — and the Dow Jones is back to it's early 2008 levels, I would bless and compliment anyone who wrote that they were thinking about taking some chips off the table — in large measure because the most probable 3-5 year return in the S&P is back towards the low single digits…and there is considerably less palpable fear; there is little or no value in US fixed income; and European headlines are currently in abeyance. I have no clue whether the next 10% will be up or down — but if it's up (and occurs in the next month or two), I'll be taking some chips off the table too. Everyone makes mistakes. Only fools make the exact same mistake twice. Learn from your mistakes, and you'll be a better trader and a better person too.

A Repentant Man Who Did Not Use a Cane writes in: 

I will own this mistake. I have learned from it.

I have thought of that post often, and my macro call's results have been worse than you infer: Because of a new process for transfers, I did not complete the transaction on the 30th. I was not aware of it until Monday, I did not get my confirm and the transaction actually was completed at the close of the 4th.

The S&P was 1131.42, 1099.23 and 1123.95 respectively on those days.

Rather than tell how my account has performed since then let me tell what I believe I learned.

Early on in my history of on this list, I told my one exception to the cane rule:

"When there is a liquidity crisis all bets are off". This worked during the 08 meltdown. I suffered some pretty big hits, but there were more coming once the banks were begging for cash after Lehman. However, it did not work in September because there was no crisis. Being unleveraged I should have stuck closely to the rule, I incorrectly believed that I could have saved a lot of power by anticipating the crisis rather than getting out once it happened. Now, I still believe that if you are a leveraged trader, not going all in with a liquidity crisis forecasted is a prudent thing to do. You may miss a big gain, but your chances of blowing up has increased beyond what is predictable by the historical numbers. If you want to turn to the scientific method during these periods, it would appear that there is significant parallel to what can happen in the chaos of population growth. That is if one resource is depleted you must adapt rather than use the same old tricks.

Now the converse side of the liquidity crisis rule is once the creators of money flood the market with liquidity, then this is the time to pull out the canes again.

I will leave it the everyone to shred this or to educate me further…before the market does.

Gary Rogan writes: 

Rocky, the point about selling low seems pretty clear. Are you saying though that you have some evidence that when the expected return falls below low single digits one should "take some chips off the table"? Clearly both points are of the "is motherhood good? is apple pie good?" variety, especially the first one, but much as many people recommend buying low, a lot fewer recommend "going to cash" when the Fed model or whatever is pointing to low expected returns for their core portfolio, if that's what you are talking about. 


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