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How I have been trying to act on

May 21, 2010 | About:
Due to my recent flurry of activity, a few correspondents have asked me for an explanation of what I am trying to do. This is my take on the big picture and how I have been trying to act on it.

The Big Picture:

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John Hussman, Vitaliy Katsenelson*, Jim Rogers, and Tim Knight all believe that we are in a secular bear market that started in 2000. I think they’re right. I also find it compelling that four investors with such varied backgrounds — a Ph.D. economist/mutual fund manager/former options mathematician, a traditional value manager, a great macro investor, and a great technician/trader — are essentially on the same page when it comes to the big picture.

– Secular bear markets can last about as long as the secular bull markets that preceded them. The previous secular bull market (1982-2000) lasted 18 years. So it’s possible the current secular bear market will last for most of the rest of the decade. Maybe longer, who knows. But when it ends, the major indexes will probably be about where they were when it started.

– Secular bear markets generally end, and secular bull markets start, when valuations on stocks are extremely low (because so many investors have given up on stocks by then). For example, at the end of the secular bear market that followed the Great Depression, trailing P/E multiples on stocks averaged about 7x, if memory serves, and stocks had higher yields than bonds, on average.

– Secular bear markets include shorter cyclical bull and bear markets. The current secular bear market has included, so far, a cyclical bear market from 2000-2002, a cyclical bull from 2002-2007, a cyclical bear from 2007-2009, and a cyclical bull market from March, 2009 to (it appears) April 2010.

How I’ve been trying to act on this:



During the cyclical bull market rally phase:


– Bought OTM puts (e.g., trying to buy umbrellas when it was sunny out).

– Didn’t add a lot of net short exposure. Entered some market-neutral pairs trades (e.g., Revisiting an Altman Z”-score pairs trade).

– Sold some long positions into the rally and raised cash (e.g., portfolio pruning). These are my current long equity positions and the reasons why I currently own them:

Biggest position:

AYSI.OB: because I think it has multi-bagger potential from here. My average cost is about 96 cents per share on this, and I haven’t bought any above $2.29 (I also have attempted to quasi-hedge the risk of a drop in Chinese iron ore demand here by buying puts on AYSI’s largest customer, BHP).

Second biggest position:

USEG: because I think it has multi-bagger potential from here. My average cost is about $2.80 on this and I haven’t bought any above $2.85.

Small positions:

TIRTZ.OB: because it has a nice yield

HBM.TO: inertia

PNDMF.OB: inertia

TINY: inertia

BRK/B: One share to keep my Geico discount.
During the last few weeks (what I think has been the beginning of a cyclical bear market.1):

– Shorting stocks (e.g., New short position: AKS).

– Buying contra ETFs in IRAs, in lieu of shorting (e.g., EDZ and FXP).

– (one off) Buying a lottery ticket to bet against gold (“Everybody is bullish on gold”).

– Getting stopped out of shorts (I’m using trailing stops), sometimes for a loss (e.g., CENX) and sometimes for a gain (e.g., HGSI, round one).

– Getting stopped out of contra ETFs (trailing stops, again) sometimes for a loss (e.g., 0 Comments) and sometimes for a gain (e.g., EDZ).

What I would like to do later this year:

– Buy shares of a small stock or two with multibagger potential at attractive prices.

– Buy more of AYSI and USEG iff I continue to believe the respective investment theses are intact and they drop in price.

*Katsenelson calls it a “secular range-bound market”.

1What I think is happening and what the market does are, of course, two different things. I’m not going to argue with it. If we get a spike to the upside in the near-term, I may cover my shorts early and wait it out.

About the author:


Rating: 3.8/5 (13 votes)

Comments

DaveinHackensack
DaveinHackensack - 4 years ago
Looks like I the headline here got cut off. Maybe we could replace it with something that will fit, e.g., "My game plan".
DocMoney
DocMoney - 4 years ago
Dave, I like your big picture view but I personally would be afraid to short anything. With volatility high as it is lately, chances are really high you'll get stopped out of your positions, which means a high chance of loss of capital.

I agree with portfolio pruning - I have been selling or trimming the positions that now appear overpriced and either keeping the cash or replacing them with better priced securities. This has helped decrease volatility in recent weeks.

Speaking of volatility, I am considering using VXX as a bit of a hedge. Seems like it may work better as a hedge than various ultrashort positions... What do you think?
lrm21
Lrm21 - 4 years ago
Dave,

Great post. I am very curious, if you would share how you go about locating the stocks you mentioned as they are small and microcaps and fly under most investors radars.

DaveinHackensack
DaveinHackensack - 4 years ago
DocMoney,

Since Tim Knight expects a near-term rally to the upside before the next leg down (and he seems to be fairly accurate at this sort of thing), I'll probably hold off on adding new shorts or contra ETFs right now.

I wouldn't consider ultrashort ETFs a hedge. I didn't use them as a hedge, but as a way to add short exposure in IRAs where I can't short stocks.

I haven't used VXX, but I suppose a similar general principal would apply with it as with OTM puts, i.e., you'd want to buy it opportunistically when volatility is low.

Lrm21,

Thanks. Finding long ideas is still a work in progress for me. I haven't really looked for new ones in a while, but I have a few stocks on my watch list that I'll consider buying at the right price.
Dr. Paul Price
Dr. Paul Price premium member - 4 years ago
Dave,

The new Forbes has an article in their "Money & Investing" section showing the 5-year returns for mutual funds that, like you, aim to limit losses in any market environment.

They compared them to unhedged balanced funds, the S&P 500 and the U.S. Bond Market for the 5 years ended April 30, 2010. Here are their results...

Fund Category ............... 5-Yr. Annualized Total Returns .............. Fees per $100 Invested

Hedged Fund ................................... 2.6% .......................................... $1.70

Balanced Fund ................................ 4.1% .......................................... $0.25

S & P 500 ....................................... 2.8% .......................................... $0.09

U.S. Bond Market ............................ 5.4% .......................................... $0.22

It is noteworthy that even in a putrid 5-year period (for stocks) the extra fees on the hedges ate up more than 100% of the benefits that the hedges provided.

Dr. Paul Price

www.BeatingBuffett.com
DaveinHackensack
DaveinHackensack - 4 years ago
Paul,

I am pretty conscious of cost when hedging. As I noted in above and elsewhere, I've been doing so opportunistically, when volatility is low and the market is up. During the next significant correction, I may sell what puts I have and not buy more if I feel the cost is too high and the market doesn't have a lot further to drop. I suspect the funds in the study didn't have that same flexibility.

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