Should Have Seen It Coming

Includes: VGZ
by: Steeley


BREXIT was a White Swan.

The market already priced a "stay" vote.

Little downside to a contrarian play.

I had been thinking about the last few days in the market - an old engineering habit of doing a mental "lesson's learned" after an event concludes - evaluating my trading activities and how I could have done better. It was clear I reacted, and too late, to take full advantage of the events. Could I have anticipated it? And if so, why didn't I?

BREXIT VOTE - a White Swan

My first thought (excuse) was, no.. BREXIT was a "Black Swan".

But no, that upcoming vote WAS common knowledge. This was a "White Swan" - the vote WILL happen, nothing stealthy about it.
The fact that the consensus incorrectly assumed a particular outcome doesn't change that.

MARKET - Priced to "Remain"

The "smart money" was (and had been) all week, positioning the market for (or assuming) a "stay" vote on Thursday. That expectation was also common knowledge.

The problem for most investors it appears, was having decided based on their own (or others) reading of the various cups of tea leaves that a particular vote outcome was the most likely certainty, and stopped the scenario analysis there, moving on to the stock reactions within the assumed scenario. An analysis process that assumes various conditions as a foundation for an analysis we engineers call "SWAG" (scientific wild-arse guess).

And armed thusly, most of us proceeded to make our portfolio decisions (essentially: would this stock benefit from the BREXIT vote more, or less, than some other choice?). Positions were tweaked, strategies calibrated, or, like me, satisfied with the allocations, and not recognizing the swan, it's "full speed ahead".

I should have pulled my head out of the minutia and considered the big picture more thoroughly. I'm sharing this because observing what happened Friday and Monday tells me I wasn't the only one who made that mistake.

The big picture question was: What will the markets do in either vote scenario (likely or not as one or the other may be)?

Upside/Downside Analysis

Assuming the Brits were not going to be "so stupid as to vote to leave" the EU, and therefore, the market was already positioned for that result, not a whole lot would change - it would be a "non-event". Neither the bears nor the bulls would move much based on that vote outcome.

BUT, what if the Brits were to do the unthinkable and vote to leave? Well, the bears would jump up and drag the bulls half-way to hell.

So, a "stay" vote had little upside or downside, but a "leave" vote, no matter how unlikely on Thursday ... that was nothing BUT downside for equities.

So, there was little risk and much potential reward in taking a contrarian position for the vote. Should they stay, you re-enter equities with little cost for the rest stop. But should they go, you can pick up all the equities you sold earlier, but at a huge discount. And better still, if your safe harbor (not just cash but say gold, or another sector that may remain stable, or benefit from the panic and flight) happens to grow in value during the melee, you can buy even more equities than you had before.

But it wasn't until I saw the futures lock down just after midnight early Friday morning (after the VIX blew through the trip at 26 and started hovering in the 50-70 range), that I realized I missed the swan and I couldn't dodge the hammer-blow coming to the equity side of my portfolio in the morning.

I mentally leveraged the small comfort that I was already about 35% gold at the time (a general defensive hedge I mentioned in one of my discussion posts on Wednesday before the vote - without any thought of BREXIT at the time - that elicited a reply that I must frame: "Your black swan swoon strategy is wrong...I mean early". Talk about baiting the devil...).

So yes, it could have easily been worse for me than it was going to be, but it could have (so easily) been much better, too.

Rejecting the temptation to throw limits into the open, early into the Friday session I saw a pause in the drop and took a market stop loss on the equities, then bought a bunch of Vista Gold (NYSEMKT:VGZ) that was going the other way with confidence, and by exiting that position at the peak, 5 minutes before Monday's close, mitigated some of the red.

Had I started that Thursday morning instead of Friday however, I'd have been a hero, instead of just a wounded survivor.

Summarizing: If you see an event coming, no matter how mundane or certain you think it plays out, run the what-if scenarios on the possible market reactions to it anyway. In fact, the more certain the consensus on the event outcome, the more potential downside risk it almost certainly has, and the more upside exists in the contrarian play. Then, if a contrarian play has little downside risk if the event actually follows the consensus, the decision on how to play it is simple.

To quote my personal hero Buffett (Jimmy, not Warren): "So simple, like the jitterbug, it plumb evaded me".

Because of arrogance or ignorance or just fatigue and myopia, huge numbers of people will always ignore the inbound swan. You can't do much to hedge the risks of the Black Swan short of hedging everything all the time, but by scanning the horizon and fully assessing the approaching big-picture events large and small, you learn to spot, and love, the Grey and White Swans. They generally leave lots of scavenging opportunities in their wake, if you're not among the casualties.

Closing: My cousin, an old Navy Submariner, once told me there's only two kinds of ships in the Navy - "submarines", and "targets".
History rewards Admiral Farragut for his audacity and success at Mobile Bay, but fails to record how many other surface captains followed his example, exclaimed "Damn the Torpedoes, Full speed Ahead", and were never seen again.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.