Market Direction & Portfolio Positioning

Sundays are usually pretty quiet, and generally consist of a little preparing of things to do for the coming week, a few coffees at the great Italian coffee shop over the road from my apartment in the East Village where I live in Manhattan while reading the news and some research reports, culminating in four hours or so of Law & Order re-runs on the couch after lunch.

Not so this Sunday. A ton of work awaits me this week - several stories, papers, a video-story (more on this another time) and two overdue chapters of a novel - all of which needed attention, my Dad flew into NY on business, and graciously, thousands of new readers decided to stop by for a casual weekend post I'd written on Saturday about mistakes Europeans make when they're in the U.S.A. In total, there were 73 comments by the end of the day on the post.

I have said here before that hearing from readers is one of the principle reasons I write this blog, and I believe passionately that it's the key concept at the heart of journalism and the arts for that matter too. As my grandfather once told me, "you can have the most talented opera singer on the stage, and the most splendid orchestra behind her, but what are they without an audience? Quite."

So I want to kick this week off by focusing on a comment made on this blog by a reader called Don, as a response to a post I wrote on Friday called "What Does This Mean?" The post concerned the nature of business news, and specifically what kind of business news was useful for investment decision making and what kind was useless, with some general outlines on how to identify the former from the latter to enable clearer - and better - investment choices. Don had this to say in response:

While there are thousands and thousands of opinions on the market in general (and they are best ignored), there are only two behaviors...buying and selling. We seek these so called expert opinions because they provide a level of comfort in an uncertain world, especially if the opinions match the way our portfolio is arranged. Personally, I would rather have my portfiolio set up to match the behavior of market participants. Right now the buyers are in charge, so I stay long. When that changes, so do I.

I find several things particularly interesting about this comment. First of all, it represents the belief and behavior of lots of market participants at the same time as being the very belief and behavior that others abhor, in particular the  so called "experts" who always parrot the same piece of obvious wisdom, "buy cheap, sell high". Secondly, it is a strategy that has in part made some enormous amounts of money, and lost others nearly, or maybe all of their portfolio. In fact, it's the same kind of thinking which has brought down numerous hedge funds, most recently Amaranth and Latitude.

The biggest issue with the strategy is that although it doesn't look like it, it is in fact very high risk, because you are trying to engage in a guessing game without any reference to the fundamental state of the market or assets you are investing in. But still, that doesn't mean you can't make lots of money doing it. It is a perfect illustration of John Maynard Keynes' anecdote of the market being like a beauty contest with the grand prize of £10,000 for the reader who could spot the "prettiest girl". Instead of spending time choosing who one thinks is genuinely the prettiest girl, argued Keynes, the readers would instead be wondering who others think is the "prettiest girl". The problem is, when the market turns against you, it can often be harder than the comment makes clear to see that happening (like oil companies right now). But with lots of people in the market thinking the same way as reader Don, such a mentality becomes impossible to ignore, because it in fact impacts the direction of the market.

I think ultimately a portfolio is best divided between a slice of momentum and a a slice of fundamental; that is, by all means take positions in the current market direction, but also don't be afraid to compliment that with sound bets which look right to you, no matter what the market thinks. Most of the advice and news you read on this blog will be the latter kind, incidentally, because I'm a great contrarian, and I believe in looking the other way for maximum profit. Still, no matter how brilliant your fundamental and technical analysis, like the opera singer who needs an audience, you always need market momentum behind you, or all the greatest analyses in the world won't help. When what you think are great portfolio stocks aren't performing, that means taking a commercial stance at some point too, and recognizing your analysis is sometimes just not in line with what everyone is thinking.

"Timing" is to the market what "location" is to the real estate sector.

Comments

[Don]

Thank you for commenting on my earlier post. Just to let you know, it is not a guessing game at all, in fact the rules we use are very specific. In my opinion, people who invest without evaluating investor behavior are the ones taking the risk or something which may be worse...missing tremendous opportunity. As an example, CNBC did not start taking about the move we have had until, to the best of my recollection, mid October, two months after we went long the market. Our market data worked as well in 1917 as it does today. Why? Because human behavior in the markets has not changed. By the way, thanks for an interesting blog.