Coby, I would take exception to your view that I assume that the market is rational, and therefore predictable. I don't look to the market to provide me with a return and though I am wont to discuss where the market should be as much as anyone else, I certainly do not rely on those predictions to make my returns. And, as former friend <G> Ken Sanders will tell you, it's a good thing I don't, too. In all three of my portfolios, it is the securities themselves that provide my return over the long haul, not a return to rationality in the market. If the market turns, that is so much icing on the cake. However, I maintain that the market has bipolar disease and is never rational. It is either overly euphoric or manic depressive. You can never tell when one pole of bipolar disease has run its course and is about to go the other way. What you can tell, at least often enough to make money at it, is when a stock or a bond or a commodity will pay investors to hold it. Let me illustrate this by going through each of my portfolios.
1. In the capital gains portfolio, when I buy a stock, I am really looking at dividends over a long haul holding period and terminal breakup value. So, when I see a Haliburton under $30 a share, and believe that by holding that stock, I will earn discounted dividends and terminal value equal to about 10% a year over a 20 year period, I don't need the market to be rational to make money. I can just hold on til the cows come home. Now, if somebody comes in and pays me enough to make it worth my while to get out of HAL, that is nice, too. But I don't rely on the market following my game plan. I just rely on Hal being as good a fundamental value as I think it is at these low prices.
2. In the income portfolio, though I do make small bets on the direction of securities prices with a portion of this portfolio, mostly, I lock in guaranteed rates of return where I have breakeven, minimum, on the downside and much higher on the upside. The market does not have to go my way. I try to buy issues where it will pay me off early at a higher rate than the lock-in, but I don't rely on that happening.
3. In 90/10, when I am using calls, it is the same as the cap app portfolio. The market does not have to move my way. The co. or bond simply has to be such a good value that I can exercise the call somewhere along the line and realize dividends or interest above the market rate. This may require a lot of expiring worthless to work out, hence the 90/10 technique, but it does not require the market to recognize the error of its ways.
With puts, I should be able to exercize the put somewhere along the way and realize more from the short sale rebate than from the discounted dividends. Again, this may not happen right away, but if I am right on the fundamentals, it will happen.
So, what I am saying is that I do not need a rational market. I just have to be right on fundamentals and the securities will pay my freight. It is nice and I make a lot more money if the market realizes I am right, quickly, but it is not absolutely necessary. But when I am hurt is when I am wrong on fundamentals, as I have been with Page and Gems, not when I am right and the market happens to move the other way, as with Midway Games. As long as MWY is doing what I expect it to do, I'm not proud or tired and I can wait. I'd rather be paid now instead of later, but I belive I will be paid on this stock. <G>
That is why I spend much more time valuing a company's true worth as an ongoing business, and performing similar exercizes for bonds and commodities, and much less time worrying about what the market will do. True, I will often wait, especially on the 90/10 portfolio, for the market to give me such an odds on advantage that I feel really good about playing. But the market returning to rationality is not something I expect. I move from euphoric bubble to depressing crash is something I expect but do not rely upon.
Hope this one makes sense.
MB
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