Jeffrey Saut: 'Do You Sincerely Want to Be Rich?'

Includes: DIA, EEM, QQQ, SPY
by: Jeffrey Saut

Excerpt from Raymond James strategist Jeffrey Saut's latest essay (published Monday, December 20th):

“Do you have the mental fortitude to accept huge gains?”

“This comment usually gets a hearty laugh, which merely goes to show how little most people have determined it actually to be a problem. But consider how many times has the following sequence of events occurred? For a full year, you trade futures contracts, making $1000 here, losing $1500 there, making $3000 here and losing $2000 there. Once again, you enter a trade because your (trading) method told you to do so. Within a week, you’re up $4000. Your friend/partner/acquaintance/broker/advisor calls you and, looking out only for your welfare, tells you to take your profit. You have guts, though, and you wait. The following week, your position is up $8000, the best gain you have ever experienced. ‘Get out!’ says your friend. You sweat, still hoping for further gains. The next Monday, your contract opens limit (down) against you. Your friend calls and says, ‘I told you so. You got greedy. But hey, you’re still way up on the trade. Get out tomorrow.’ The next day, on the opening, you exit the trade, taking a $5000 profit. It’s your biggest profit of the year, and you click your heels, smiling gratefully, proud of yourself. Then, day after day for the next six months, you watch the market continue to go in the direction of your original trade. You try to find another entry point and continue to miss. At the end of six months, your method finally, quietly, calmly says, ‘Get out.’ You check the figures and realize that your initial entry, if held, would have netted $450,000.”

“So what was your problem? Simply that you had allowed yourself, unconsciously, to define your ‘normal’ range of profit and loss. When the big trade finally came along, you lacked the self esteem to take all it promised . . . who were you to shoot for such huge gains? Why should you deserve more than your best trade of the year? Then you abandoned both (trading) method and discipline. To win the game, make sure that you understand why you’re in it. The big moves in markets only come once or twice a year. Those are the ones which will pay you for all the work, fear, sweat, and aggravation of the previous years. Don’t miss them for reasons other than those required by your objectively defined method. The IRS categorizes capital gains as ‘unearned income,’ that’s baloney. It’s hard to make money in the market. Every time you make, you richly deserve. Don’t ever forget that.”

... Robert Prechter – the Elliott Wave Theorist (1992)

“Do you sincerely want to be rich?!”

What a great question! It’s a question I ponder this time of year as I reflect on the year gone by. This year that question leaped out while studying the history of buying stampedes. Recall, the current stampede is now 77 sessions in length, which eclipses the longest such skein recorded in my notes of some 45 years. While reviewing the 1987 upside stampede, into the August 1987 peak, I rediscovered the aforementioned quote from Robert Prechter. It’s an excellent quip. Virtually everybody can identify with it.

On the surface the question seems laughable; who can’t accept huge gains? But in order to set yourself up for such gains you have to possess the courage to take an oversize position and maybe even leverage it. That kind of risk takes stomach and fortitude. Many times I have waited for the right moment, the big move, and decided against it. Maybe it was because I chickened out. While I often rationalized the hesitation away, the real reason I did not act was the emotional strain.

Yet, I know myself and have learned that emotional actions are failures most of the time. What one has to do is be able to step outside of themselves in an objective fashion. When you do that, it’s kind of like seeing things in slow motion. You are calm, objective, and can see ahead, perceiving the proper sequence of events. You just know you’re right and you act...

...I bring these thoughts up today because it’s very human to look back after this September 1st to December 18th “buying stampede” and say, “If I hadda . . . !” If I hadda bought that stock, that option, that index, in size, etc. . . . ! It’s painful. But, post mortems help you learn in this business. I’ve learned that history repeats itself in the financial markets, despite changing players and changing events. You have to identify the patterns, and then you have to possess the courage to act, to believe in your own discipline. “Do you sincerely want to be rich?” Know that’s a question with agonizing implications; and it may tell you more about yourself than you really want to know.

“Do you sincerely want to be rich?” To accomplish that goal, to make those “outsized” gains, you need to know one thing – in bull markets don’t lose your entire position! Certainly you can rebalance positions (read: sell partial positions) as the security in question rallies. However, never (repeat: NEVER) lose your entire position of a “bullish bet.” To be sure, you will hear a lot about how overbought the stock market, an individual stock, a bond, an index is; still, stocks can stay overbought longer than most participants think.

And, that is why I have repeatedly stated – if you want to be cautious in the short-term that’s okay, but don’t get bearish...

...Ladies and gentleman, as Warren Buffett opines, “All you need is one or two good ideas a year.” Clearly, this year has been replete with good ideas, as demonstrated by the performance of our Analysts’ Best Picks List for 2010). Still, a lot of 2010’s outperformance has been driven by getting two things right. First, you had to avoid getting “hammered” in the 17% May through June swoon. And second, you had to stay constructive on stocks from those June lows until now.

I think the trick in 2011 is going to be much of the same since I believe the wide-swinging trading range stock market environment we have experienced for the past 10 years will continue-- unless our elected leaders can come together with simple, workable solutions to the nation’s problems. Manifestly, I don’t think the nation can stand two years of gridlock given the issues we are facing.

As for themes, I continue to embrace no double-dip recession, slow economic growth, dividend yield, stuff (energy, agriculture, water, electricity, metals, etc.), emerging / frontier markets and their consumers (although the emerging markets are well overbought currently), technology, financials, active investment management over passive (indexing), and hedging portfolios to reduce the downside risk.

The call for this week: When I left the country last Tuesday the S&P 500 (SPX/1243.91) was trading at 1242 and my “call” was, “I think we are making a very short-term trading top here, but I don’t think any selling will gain much downside traction. All I think happens is the equity markets stall, and rest, while they rebuild their internal energy for another rally into the new year.” Well, I’m back in the country and the SPX is roughly 2 points higher than when I left and I still think we are setting the stage for another rally into the new year.

That said, there are signs that the current rally is long of tooth, suggesting the potential for a January “air pocket.” Furthermore, there is precedent for that. In 1981 the SPX suffered a 5% downside “air pocket.” Again in 1990 there was a 7% “hit.” In fact, January 2010 saw a 4% hiccup. Accordingly, while I still believe the upside should be favored into year-end, I am starting to consider some downside hedge “bets” to reduce the risk in portfolios.