Keeping a Cool Head in this Turbulent Market

by: Roger Ehrenberg

Every day brings some other piece of bad news. This lender is in trouble, this economic statistic looks bad, sentiment is poor, etc. These are times when it is best to adopt the Warren Buffet posture - avoid CNBC, Wall Street chatter and all forms of PR-driven hysteria. If we could move to Omaha, we'd all be better off at times like these.

Because at the end of the day, all the current news cycle does is play on our human weaknesses and tempt us to make perverse decisions. Like selling out of fear. Like bailing out of perfectly good equities and fixed-income securities because of generalizing problems across individual securities and asset classes. And this is why most investors are poor at being active managers while a precious few take advantage of this phenomenon to feast on the rest of us.

It is what it is, I guess. But I am here to suggest that you not give into fear and uncertainty, but to keep a level head and to evaluate your portfolio and your prospects using data and facts, not suspicion and conjecture. I know this is hard, believe me. It is "gut check" time when you see the DJIA drop 300, Asia crater shortly thereafter and you can't pick up a newspaper anywhere around the globe without hearing of the subprime meltdown, hedge fund redemptions and a scared and jittery Fed. But like I wrote previously, it is the contra-instinct that is likely your best guide right now. George Costanza had it right. Do the opposite.

My best guess is that things will be pretty ugly for the next 12-18 months. I don't anticipate that the market will crater, but I do think the ripple effects of troubles with mortgage securities and the real estate sector will have far-reaching effects, and cause an economic adjustment that will be painful and time consuming.

If bad credits default and good credits can't get mortgage loans, and there is a glut of real property flooding the market that will be liquidated for cents on the dollar in distress, and all those consumer durables filling those homes won't be filling them any more, and Home Depot (NYSE:HD) and the like won't be selling as many building supplies, and consumer confidence weakens, etc., this is not a pretty picture. But I believe that there will be two constituencies that will flourish in the near- and medium-term in the wake of today's markets - those with the intestinal fortitude to hold on to good assets that the market is discounting now but will reward later, and value-oriented long/short hedge fund managers.

I think we'll be entering a stock-pickers market, one where those with a deep-value orientation and stock-picking skill will shine. The cream rises to the top in uncertain times, where margins of safety are large and actual performance and returns on invested capital carry the day. My hypothesis is that the top long/short managers that have been running 100/40 long/short books will become much flatter, much less net-long, and revert to 80/60-type positions where conviction and analysis rule.

I may be wrong, but it feels like a time similar to the early 2000s when top long/short managers just ripped it while the tech bubble was deflating. Time will tell, but this is my "blink" visceral reaction to the goings on. To the extent you can, act like one of these hedge fund managers. Keep a cool head. Really get a grip on your portfolio. And don't do anything rash. Because there are a group of smart, opportunistic, dispassionate people out there ready to take the other side of the trade and eat your lunch.

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