[ The Year in Review ]
The Wall Street Journal said it best when they wrote:
"Investors have just lived through one of the most extraordinary years in stock-market history."
We're all familiar with the statistics (taken from WSJ):
The Dow Jones Industrials declined 6.2%,
The S&P 500 declined 10.2%, and
The Nasdaq Composite fell 39.3%.
With fundamentals in deterioration, the markets, ever optimistic, are looking for the Federal Reserve for relief in the form of an interest rate cut to buoy the market.
Hmm. Some empirical evidence does suggest that the markets tend to go in the direction of the Fed's monetary policy, though the effects aren't immediate. Just look back to the period when interest rates first began to rise. Remember when those enthusiastic traders once said that the bulletproof technology sector was immune to interest rates? The phrase, "Don't fight the Fed," held true again, but it took some time before the markets followed suit. With the rate reduction on the horizon, the bulls are looking at a legitimate reason for optimism, but I remain cautious about that "E" of the P/E.
A wise participant of these boards once mentioned to me that it's liquidity that drives this market. With the benefit of hindsight and living through the experience myself, I would agree with his statement. It just takes time for its effects to work its way through the market. Just think back to the time of the Asian crisis and the subsequent rate reductions and the boom that followed, and more recently, the rate hikes and the bust that followed. It's not all encompassing, I'm sure, but those two points make quite a line for an argument.
So, 1999 was the year for offense, and 2000 was the year for defense. Actually, 2000 gave us the opportunity to play both ends, since the boom continued through the first quarter.
For a moment there, I was fat and happy like the rest, having returned over 67% for those first three months through aggressive trading. While I did manage to get out near the top, I had to learn for effectively the first time how to deal with persistently disastrous market conditions. No longer did the buy-on-the-dip strategy work; that only works in upwardly trending markets, and conditions began to suggest that times were changing.
Still, however, I became tempted by the lower prices and made entries that subsequently whipsawed me. I was in; I was out, and loss after loss continued to add up--I felt through the summer a feeling of displacement, and it showed in my results. Over the next five months, I continued to lose, climaxing finally in the month of August, perhaps through frustration: (all performance figures are estimates, and are net of commissions and reduced commissions for higher trading activity)
April: -0.16%
May: -5.09%
June: -0.21%
July: -6.24%
August: -17.65%
What did I do wrong? Figuratively speaking, it was the desire and excitement of trying to tame the bucking bronco (i.e. trading wild markets). I had once made my money by milking the cows, by staying within my niche, and by stepping away from conditions that I wasn't psychologically geared to trade in.
That's a loss of 27% over five months, and that's how the market had exacted its tuition fee. To quote a great text, Reminiscences of a Stock Operator, the author noted: "...Fate does not always let you fix the tuition fee. She delivers the educational wallop and presents her own bill, knowing you have to pay it, no matter what the amount may be..."
August was an eye-opener. Losses will do that to me, and with great effort and examination, I went back to my core competency. The numbers showed my strategy was once again working:
September: 21.09%
October: 3.06%
November: -5.87%
December: 33.6% (approx.)
I closed the year up about 92%. Most of the money I made in December came from shorting stocks on the verge of fundamental and technical collapse, like Xerox, which had its debt downgraded to junk status in the wake of the deterioration in the company's cash flow position.
Buried in the December figures was a traumatic experience that brought to mind the experience of Victor Neiderhoffer, the once-great hedge fund manager that blew up in the face of the Asian currency crisis. His style at some occasions is to go counter the trend in extraordinary periods, and in such cases, his style often provided returns that he claimed were statistically significant (i.e. not just random). I believe his blow-up occurred when he leveraged heavily into the currency crisis, and the markets did not snap-back like it had done so many times for him in the past.
Only in my instance, I had leveraged heavily into an EMC position that flashed many oversold signals. I swung hard once the rubber band seemed like it could stretch no more. The problem was, I didn't imagine that it could actually snap the next day, tumbling over 11%. Well, I was over 180% long, so I had a one-day decline of about 20%. That was a 1987 event in my portfolio, one could almost say. To me, it was a two or three-sigma event, and it taught me to add further controls to prevent such occurrences in the future. Despite the pain, the lesson was valuable, and fortunately, I learned it while my capital base was relatively small. The impact of the shock, however, still hit full force. This is another occasion where the above quote from "Reminiscences.." is particularly applicable.
After such a hit, one is usually recommended to walk away from the situation because of the tendency to do what's called vengeance trading. Objectivity is often lost in such a situation, and trade sizes can become abnormal in the attempt to recoup losses much quicker. The problem in such circumstances is that one's objectivity is often compromised, and it is emotion that is the primary driver behind the trades, which very often leads into more losses.
"Walk away," I was urged by a colleague.
The situation seemed to put me in a state of numbness; no emotion, and I checked myself briefly to make sure that I could still operate rationally and logically. One of my traits that I find valuable is that intense pressure situations increase my tendency to act rationally. I become very logical and more calculating, and my clarity of thought is usually magnified.
That's when I opened my barrage of short sales on pre-determined short targets that I hadn't yet acted on. If the market leaders were going to get taken out and shot, then, I reasoned, these other pigs had no chance either. By the end of the day, I had recovered a third of my losses; the next day, I had recovered another half, and by the end of the week, I had on net just lost around two percent. Victory from the jaws of defeat.
What fascinated me was the realization that I was seemingly able to score at will. During the ordeal, I quickly became more comfortable with heavy position sizes, knowing all the while that I had the ability to immediately reverse my position the moment it did not feel right to me. I wouldn't have done that though in situations I couldn't monitor closely. That's when a more diversified (and smaller position size) approach becomes handy. But I had the benefit of being connected to the market's pulse, so I was comfortable enhancing position size.
Before the Big Doofus Trade, December had already been quite a phenomenal month, having capitalized on the Xerox short, but more so from the very long position I established in Conseco. Its picture already tells a thousand words, and unfortunately, the shorts were wrong at just the right time.
As of this moment, I am entirely in cash, but that cash position has often been implemented throughout the day as I probe multiple issues for long or short positions.
I currently hold a defensive attitude toward the market. I think the strategists that believe the S&P is going to rise 20-30% this year are a few books short of a library, so to speak. My expectation is about a 6%-7% average rate of return for the S&P through the end of the decade, but that's just an average, so the return bands will stretch and contract above and below that level over the years to reach that figure. So, if the market earns more than that, my thinking suggests that the market will be borrowing its returns from the future, and vice versa.
I thought I heard from the WSJ that we've had the worst returns since 1981 for the Dow, the worst since 1977 for the S&P, and the worst for the Nasdaq since its inception in 1971. That's helpful in re-establishing equilibrium for the markets, but I find troubling the overwhelming number of advisers that are so bullish in the market, with figures suggesting that this is the best time to invest in the past 20 years. Count me among the skeptical, but I do admit there are interesting values in the market, if one is selective. Even Buffett's gotten out of his comatose state and is now buying again.
In any case, best of luck to us all. May our returns be better than last year's.
Rainier
Note: all opinions expressed are my own and pertain to my personal trading account and are independent of Wells Fargo. By no means should my comments be interpreted as recommendations to buy or sell securities. |
