You Said It Was A Bear Market - Not Me

If Nathan Thurm was an equity strategist that is probably what he would say.

My prediction for the S&P 500 for year end 2007 was 1350-1375. I was off by a couple of weeks. The importance of this is, of course, nil. The market could bottom out a few months from now at 1100 or the bottom could have been yesterday. Either way, Jan 16 will not be meaningful or memorable - it's just a date.

I was struck by how many comments there were in response to my crack about not drinking soda. To my perhaps disjointed way of thinking, it brings up a point of balance in our lives. It is natural for people to derive stress from their stock investments. One of the themes to my writing is that you should train yourself remove emotion from the equation.

Someone who takes the time to read stock market blogs, like you, is closer to their portfolio than most folks. On one hand, this could mean you are more in tune with the cyclical nature of the stock market, so managing emotions is easier - but on the other hand, you see the ups and downs of your balance more frequently and you might be more prone to emotion.

If you have been reading my writing for a while you have hopefully noticed that my mood is not impacted by the stock market. As opposed to what they say on TV, a down day in the market is not terrible - it just is.

I don't sweat bear markets because they are a normal part of the cycle - we know they will come. As an investment manager, I don't sweat lagging the market. Part of the job, assuming you aren't the single dumbest participant, is that there will be years where you beat the market and years where you lag. I know there will be years I lag, so there is no point in stressing out about it. If you are having trouble, remember there is more to life than watching your account tick up and down. Hopefully you can train yourself to remove emotion from what you do but if you can't you should either spend less time on your portfolio (and more time exercising, balance right?) or make some strategic changes.

One idea for a low impact portfolio is to put some in the PowerShares BuyWrite ETF (PBP), put some in the Merger Fund [MERFX], buy a foreign dividend ETF, buy an absolute return or managed futures fund and do something with your fixed income along the lines of Nassim Nicolas Taleb's idea of owning a diversified basket of foreign short term debt (no percentages given, so we can keep it compliant).

If you need to go that route to keep your sanity or health, just know the drawback, which is you will lag big bull markets (which are guaranteed to come back at some point) and you will probably need to save more than you are saving now.

Comments

[Geoffrey Lordi:]

Roger,

I'd sure like to consider PBP a little more closely, but with 600 shares traded (and a spread of $0.18) as of 2.23pm on Thursday, 01.17.08, it's not exactly liquid, is it?!

Best,
Geoff

2008 Jan 17 02:25 PM

[Internet2k4:]

Like many I have a long-term optimistic core index portfolio, centered on US equities, but also a trading account, which is where I "seek Alpha" for better or worse. Watching Ben Bernanke on CSPAN this morning, pitching with more emphasis on "quickly" than "well thought out" a stimulus package for consumers, at the expense of more near term federal deficit spending, I'm bearish for at least most of the rest of this year. Personally, I like the economy of the new doubleshort ETFs as trading account hedges, both US (e.g. DXD, SKF) and internationally, because they require half the money and half the downside exposure, and you sell them on your best bet that it's over. If RN has a comment about their use, I'll be very interested.

2008 Jan 17 02:38 PM

[Roger Nusbaum:]

you are right, but a lot of interesting exchange traded products have low volume and wide spreads. there are some ETFs, no idea if PBP is one, where a reasonable limit in the middle will get filled.

Additionally in the context of set and forget I am not sure that slippage needs to be priority #1. clearly "too wide" is also in the eye of the beholder but I would like to see a friendlier quote :->>

2008 Jan 17 02:43 PM

[Geoffrey Lordi:]

Hello, Internet2k4,

I might not be Roger, but I can say that DXD and FXP have proved very useful hedges in our portfolios, as well. SRS, if you're interested in considering the trials and tribulations of the housing market, has also been a lucrative investment.

When building strategy outside of our core holdings, I'll definitely consider appropriate investments in shorts, always as a function on my feeling for the long side we're taking.

2008 Jan 17 02:45 PM

[Roger Nusbaum:]

FWIW i have disclosed many times over having waded in slowly into SDS while building cash--I started in on this ages ago. My weight in SDS started in low single digits but of course has come to hedge a little more as the portfolio has gone down some and SDS ahs gone up a little. That combined with 15%-20%, depending on the client, cash has allowed me to go down less.

Down zero is not realistic but I think down less can be.

I can't say what I would do from here if I was 100% invested.

2008 Jan 17 03:08 PM

[Malkiel:]

Actually, the Wall Street Journal just said it:

"The Russell 2000 index of small stocks fell and is 20% below its recent peak, the traditional threshold of a bear market. 3:05 p.m."

Long-term studies of the market have indicated that something like 60% of the market's days since time immemorial have been "up" days. This means that the market is normally a "bull" market, or, in another way of looking at it, "bear" markets only last half as long. So an actual "bear" market is not a "normal" part of the market cycle, it's a short and anomalous part of the market cycle, and constitutes a rare buying opportunity. Instead of buying hedges people should be buying discounted goods in preparation for good returns on the statistically not-too-distant rebound...

2008 Jan 17 04:01 PM

[Internet2k4:]

GL, RN: I bought DXD at DJIA 13000 thinking way back then that it had climbed a ladder and tied a rope around its neck, chose it but added more and SKF after August. I see that SDS has out (i.e. under) performed lately. Re low volume big bid/ask, I'm no day trader but on a given trading day spread is a real factor - limit, not market, orders. I confess to a superstition: that before noon, trading is dominated by impulsive hormone driven by pretty 20-somethings in suspenders and/or short skirts, who get their direction later in the day from the grey beards over lunch hour.

2008 Jan 17 04:07 PM

[Wisdom-Seeker:]

A close look at the chart for BXM (index behind PBP) doesn't fully support Roger's claim that it provides a significantly smoother ride. Peak-to-trough drawdowns in the various dips have been comparable to the S&P's drawdowns. (The BXM drawdowns look to be 75-100% of the size of the S&P's, though sometimes they are over more quickly.) And it's still very correlated to the S&P. As RN said, it's a valuable tool in the diversification arsenal but not a panacea!

2008 Jan 17 06:50 PM

[Roger Nusbaum:]

over the last three months BXM down 4% SPX down about 11% through 1/16. Coincidently they were both down 2.95 on 1/17. Nothing is perfect but it goes down less the vast majority of the time.

2008 Jan 17 08:55 PM

[Investor2410:]

Why would you suggest buying the Merger Fund? Down 3.7% YTD, down 2.8% in the 4th quarter, barely up 3% last year. Bloomberg ranks them down in their market neutral category. There are 40 other funds in this category that outperform them. Bloomberg's description of the fund also indicates a change in portfolio managers suggesting a transition problem.

2008 Jan 18 11:27 AM

[mixter:]

I used to think investors in the stock market were intelligent and astute. Now, I think of them as being dumb sheep willing to follow the leader off a cliff. If all of the stock market gurus are so damn smart, why aren't they extremely rich?

2008 Jan 18 11:35 AM

[Roger Nusbaum:]

take a look at a long term chart of the merger fund, it smooths out the ride over the full stock market cycle further it was just an example.

2008 Jan 18 02:50 PM