2010 New Year’s Resolutions

I’m doing this more as a note to self (I know, I’m a little late).  I am writing my New Years Resolutions in order to become a better forecaster of the Economy and more importantly the financial markets.

Timing is everything and I would grade myself as a D in this category.  While I would grade my assessment of the economy at about a B, what matters is the timing.  Even though I believe that I correctly predicted that we would have a rally in the Spring (See my really old investment newsletter/s) I was WAY too early in switching to the other side (the bearish side) and did not consider how big an effect technicals, liquidity, and lower rates would be.  Everyone makes mistakes but what’s important is learning from them.  My resolutions are as follows…

The economy matters only 25% of the time: Other factors such as liquidity, sentiment, corporate balance sheets, margins, etc matter also.  This was probably my biggest flaw.  Following the economy shows us that it is still in terrible shape.  Whatever improvements we’ve made have been minimal for a recession of this magnitude, ISM surveys and Home Prices have improved, but this improvement is only noise in a large trend down in my view.  I thought the equity markets would see right through this, but they didn’t.  You know why?  Because markets simply discount future cash flows.  They don’t care what the quality of the growth is.  While historically big recessions = big recoveries, this recovery is very weak and is an outlier from a historical perspective, a sign that this is a different type of recession, one that we haven’t experienced in a while (only in the 30s did they).
Consider the wide ranges that a Conservatively priced market (Forward PE = 8-10-12) vs. an Aggressively priced market (PE = 20-24) entail.  Using earnings of $70.00 for the S&P, we would get ranges from (560,700,840) to (1400,1680).  The ranges are huge and call for consideration of other factors such as sentiment and liquidity.  Consider the technicals…

Technicals do matter: Analyzing technicals I found out can give you good perspective as to the “health” of a rally.  While not all the signs and rules work, they serve to show a story of an ongoing rally or bear market.  They serve to show where potential fights between bulls and bears occur, whether one or the other group wins the battle and what it means in the context of the war.  When this bear market was beginning, using technical analysis along with a well developed thesis could have given you a clear picture on when to execute your strategy. Homebuilders and Financials were falling long before the actual S&P started falling. Having a thesis of subprime mortgages creating massive problems for the banks and thus the economy in general would have been executed very well if one looked at the technicals and saw that the financials and homebuilders were falling…that would have meant that the thesis was correct and you could have gone from there.

Don’t Fight the Fed (Could this change?): Perhaps one of the biggest lessons for me is actually a catch phrase on Wall Street.  Certainly fighting the fed over the last 8 months could have proved catastrophic for a headstrong hedge fund manager focused on shorting the market.  While the economy hasn’t improved all that much (see point 1), the market continued to rally due to extraordinary stimulus by the gov’t.  The gov’t/Fed put in place policy that made the markets rally regardless of whether we were in recession or not.  Fight the Fed at your peril… but on that topic though… I think the Fed is starting to run out of bullets to fight this crisis.  The large forces of deflation for now have been in hiding, but I believe that this is a game of stamina and our gov’t is starting to run out of time and resources.  While this is a point that I promise to take this lesson into account, the situation is staring to become fluid IMHO.

Patience is indeed a virtue: My last promise is to be patient.  While one may be right in their strategy over the longer term, short term rallies or dips must be taken into account and capital needs to be applied in a prudent fashion.  Capital is a managers lifeblood and must be protected.  Dollar cost averaging is a must and certain conditions need to be met in order to deploy.  If one doesn’t have the patience, he/she can be right in their strategy but not the deploy the capital at the proper time… this would truly be a waste of work and time, not to mention that the strategy is actually correct.  This is one of the most important points.

Financial markets are indeed very tricky and only a small group of managers have successfully navigated them.  However, if one can see the real picture and learn how to deploy the capital, they can be very successful.  All it takes is hard work and passion.  May 2010 bring you fortune and success.  Good luck!

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