Perhaps the most important ingredient to being/becoming a good investor...

...patience.

When I look back over the myriad names that I have owned and the reasons I owned them, and then look at when and why I sold them, and look at them now. I would have in virtually 90% of the cases have been much better off holding them than selling them.

The key ingredient that was missing from my investing DNA was patience.

Patience allows the compounding effect of time, the market (generally upward skewed) and your thesis to play out.

Time Perception

From Brain Pickings.

As disorienting as the concept might seem — after all, we’ve been nursed on the belief that time is one of those few utterly reliable and objective things in life — it is also strangely empowering to think that the very phenomenon depicted as the unforgiving dictator of life is something we might be able to shape and benefit from. Hammond writes:

"Time perception matters because it is the experience of time that roots us in our mental reality. Time is not only at the heart of the way we organize life, but the way we experience it."

Declaring Failure and Moving On

This is a very rough note. I think it could be fleshed out into a very meaningful article, but for right now it is just some top of mind reflections.

My underlying framework post-GFC was one where the business/investment cycles going forward was going to be more compressed (timewise) and more volatile. I was also heavily influenced by the new normal meme and how the economy was going to be stagnant as it worked through a balance sheet recession.

If I were to attribute a reason to that belief I would ascribe it to my ideological bias toward market economics and the belief that the market had not been allowed to clear properly due to significant artificial interventions. It was also heavily influenced by the recent traumatic past and the idea that modern markets/economies were more integrated, interrelated, more complex than ever before, and were consequently prone to momentum and cascade effects.

Financial marketwise this has not played out and I must declare failure and move on. I think the reason why financial markets have not reflected those beliefs is due in large part to hindsight bias and the massive trauma effected upon the psyche of market participants who endured the brutality and existential angst of a market implosion that could have gone even further. Investors have been fighting the last war. They have been overly pessimistic. They have been unwilling to give the Fed (or the govt) credit for stimulus. The market has climbed a massive wall of worry the whole way.

We are now at a point where the market is coming around to the idea that the Fed may have steered us over the canyon and to other side. The economy may be gaining sufficient strength to be self-supporting and a new cycle of more normal growth is going to ensue (even as the stimulus disappears).

That is the hope. We shall see how things pan out in practice.

Backfire

Taken from a SeekingAlpha article:

This phenomena is called 'backfire', and has been studied extensively by behavioral psychologists. The basic premise is that when confronted with facts that prove them wrong, opinionated individuals react very differently from the uninformed. Basically, instead of changing their minds and acknowledging the correct facts, they entrench themselves even deeper into their existing view.

Notes From November 19, 2009

Here are some notes I made toward the end of 2009.

Why is everything right again?*

The belief that we are past the worst. We are.
The belief that better days are ahead. Unclear.
The belief that the "crisis" was more a psychological phenomenon than something real. Who knows, but it has had real effects.
The belief that it is reasonable to take risk(s) again. Seems to be the case.
The belief that Fed tightening is still a long way off. Stokes the bullish fires.
Evidence that the economy is moving forward again. Confirmation.
Evidence that profits are better than expected. Positive impetus.
The strength in the market provides courage and confidence. Reflexivity.
Momentum trumps fundamentals. The same old game.

So what has been the trade?
Long equities, bonds, commodities, energy, and precious metals. Short the dollar.

Believe we need a super-squeeze in order clear the market.


Why did everything fall last year?
Financial crisis of confidence predicated on a financial system collapsing under a burden of bad debts feeding into a large recession.
The fear that everything was just a con game, a house of cards.

Psychological Foibles

You think the market has risen too far too fast and is due a pullback.

The conundrum.

How and when do you decide to get back in?

The Psychological Challenge
The market starts breaking a little. Hope rises. It is moving your direction. You don't want to jump in too soon. After all you have been short and patiently waiting for this for quite a while. You don't want to waste those missed opportunities (now sunk opportunity cost) by blowing your powder too soon and seeing it pan out in the fashion you envisioned all along. On the other hand, you have been in this position before on the run-up, failed to cover or buy the dip, and seen it tear off again, only to have to chase (or worse fight a losing cause).

There is no good answer to the question. Doing your due diligence. Setting price levels and being disciplined. Having a system, a process, and a philosophy. You're not going to win them all. But you do want to have a system or process in place where you put the odds on your side when you go to bat.

Acts of Commission and Acts of Omission

Taleb makes the point that the economic cost of acts of commission and acts of omission are equivalent (and I like this, a dollar not lost is a dollar earned), but that in our minds they are very different.

People do not realize that success consists mainly in avoiding losses, not in trying to derive profits.

He says that positive advice is usually the province of the charlatan (don't hold back Nassim...tell us what you really think). And he uses the example of bookshelves being full of books on how someone became successful, and how there are very few about those who went bankrupt.

Linked to this need for positive advice is the preference we have to do something rather than nothing, even in cases when doing something is harmful.

I would just make the point that the finance industry is built on this fallacy and takes advantage of this psychological glitch in our make-up.

Going Against The Grain

It is hard to put the kabosh on something when it is working well for you.

As the market rises, you begin rationalizing that all those winners are worth a lot more than where they are and the market is only now waking up to that fact.

By nature I am a contrarian, but I have learned greater patience in letting my winners run (need to work on cutting my losers loose). This has not necessarily been to my benefit as, although the markets have been positively trending since the low, I would have been better off at times looking to trade in and out of positions more actively.

Still, even though the trend is positive and I think we are moving away from the edge, I reduced my exposure to those names that have significantly outperformed and raised a little cash to provide cognitive support should the market trade back down and a little extra powder should any conviction opportunities present themselves.

I didn't feel like selling, but overruled my emotive state. I've seen a colleague do that before and thought he did a good job of it. It is kind of, "the markets have had a great run, I don't see anything that should lead me to sell per se, but I know things don't move in a straight line and it seems prudent to book a little profit ahead of the game."

A risk you've got to take

Ever since the govt decided to be fully committed to "solving" the crisis, the key has been to re-boot growth. Failure to do so, means you end up in a worse position than when you started.

The paradox, or the dilemma, is that in order to re-boot the economy you must cover the growth shortfall by creating demand (in the hope that this artifical stimulus will get you across the growth divide). Unfortunately, given the weak starting position of the govt's balance sheet, options are limited and running out, and any failure to re-ignite growth poses serious risk to the economy and the financial system (again).

In other words, having already committed to the current course of action, the government has no choice, but to go for it (it is already "all in"). Conversely, if it fails and the markets lose faith, then we have a bigger problem on our hands.

With each lapse or fault in the market/economy, the government will continue to bail with all its might. It has no choice. But in so doing, it raises the chance of bringing about a collapse in the system (markets call their bluff...an emperor with no clothes). Confidence is a psychological phenomenon. It is transitory. The general stability of the markets/economy to which we are accustomed, mask a more fragile reality.

Sadly, the risk you've got to take increases the chance of failure.

I Want to Repent of My Sins

I want to repent of my sins, but I am not sure it will change who I am.

The main sin I want to repent of, is the sin of tardiness. Or, more specifically, the sin of being too slow in changing my opinion. I have this nasty tendency of being way too slow in adopting a new outlook. It means that I am late to the party, and therefore miss a decent portion of the fun. It also often means, that I am so slow in changing my opinion/outlook, that I am actually ahead of the consensus. As such this tendency plays havoc with my convictions, but it also plays into my contrarian nature.

The biggest issue I deal with when considering a change in opinion/outlook is the fear of regret due to anchoring. Regret that I'll change my outlook just as the consensus comes around to my position.

All of which is to say, that I am currently doing my next year review and am seeing a lot of things pointing to a more constructive environment than where I am presently at.

The Problem With Being a Perma-Bear

The problem with being a perma-bear is that there is no joie de vivre.

When one is always looking for disaster to hit, every little twitch, every little movement from the market or the economy signals impending doom. It is hard to believe that the market might actually go up when one's underlying belief is that disaster is just around the corner.

All the foibles of behavioral bias manifest within one's outlook and actions. As such, it is hard to see the trees for the forest.

It seems to me that we are committing the same mistakes in the present that we have committed in the past. All the signs are there that we will reflate again, only to have to deal with the same problems again in the future. It is the timing of the "again in the future" that is so hard to forecast.

Cyclical Tailwinds Dominating Secular Headwinds

The current cyclical tailwinds of stimulative monetary and fiscal policy, and the natural turn in the cycle have transformed the markets disposition and created a more hopeful outlook.

Beware the Ides of March.

Lying in wait are significant secular headwinds (higher taxes and regulation, ongoing deleveraging, structural unemployment, higher savings/lower consumption, greater govt. involvement in the economy, rising inflation, higher energy & food prices) which when combined with the reversal of the current monetary and fiscal stimulus pose a serious problem for the markets recovery and the economy's long term health.

"Rallying because we're rallying"

Just heard a classic quote from a guy on CNBC.

"We're rallying because we're rallying. People are jumping in because they can't afford to miss this move."

Talk about exuberant irrationality.

I'm sorry to break it to those folks "jumping in," but they have missed the move and there is only more pain for them if they think they can time their entrance and exit to the last leg of this move.

Controlling The Hydrant

Will the Fed act quickly enough to reduce bank reserves when the velocity of money normalizes? If they are like anyone else in the market, they won't. The problem is not a lack of knowledge or vision related to the risk (they are fully conversant of the risk). The problem will be a failure of timing due to human nature and political pressures. Just as most market participants failed to time their exit from the market with a crisis looming (and their entrance back into the market by the looks of things), the Fed is likely to fail in its attempt to time the withdrawal of reserves from the system.

The Fed is playing a high risk poker game. One that they have demonstrated little aptitude for based on historical precedent. The problem is compounded all the more by the ongoing decline in the duration of government liabilities and the split personality of balancing inflation with employment. The result is, they have a smaller window of opportunity to get things right before the the market dings them, and the costs of failure mount.

Filling The Cascade Gap

I am a little surprised to see the market running so hard, so quickly after enduring the shock and awe that hit us in October and November of 2008, and the numbing malaise that laid us flat in Feb/March 2009. I can understand a big bounce off the bottom, given the magnitude of the decline, but then I would have expected the market to consolidate its gain and move forward in a more measured manner (especially given the cloudiness of the future). Strangely, this does not appear to be happening. Which leads me to think, maybe we haven't learnt anything from our recent brush with pure, unadulterated risk.

In trying to interpret these movements, the thought occurs to me that maybe as the Feb/March cascade was anomalous (and I think it was), perhaps the cascade move below 1200 in Oct/Nov was also anomalous (I'm not so sure about that). If that were so, then in essence, the market made not one, but two really big mistakes in risk assessment. And if that were the case, then we could possibly see a super spike back to 1200 to backfill the market's mistake. Such a thought is a red rag to the bulls, and a repudiation to anyone concerned with market efficiency and conservatism.

Don't Get In The Way Of A Charging Bull!

The market has got a head of steam up.

You could throw any piece of news at this market right now, and it'll devour it through rose-tinted lenses. It ain't thinking right. Will cooler heads prevail? I doubt it.

We're scaling that wall of worry, sucking in all those who are bearish and skeptical (and there are alot of them). Recovery is the only thing in the sights and minds of investors...until it isn't ("Got to get with the program or be left behind").

At what point will economic reality smack the market in the face? Hard to tell. It looks like pretty clear sailing through to the end of the year - generally positive economic data, stimulus monies and monetary stimulus hitting the economy.

More on that economic reality in another post.

Set-Up To Climb A Wall of Worry

I think an argument can be made that the market could be positioning itself to climb the proverbial "wall of worry."

We've come through the crisis and there is a palpable sense of relief that the worst is over, which is translating into a growing optimism.

That having been said, you don't climb the wall of worry by "getting happy." You climb the wall of worry by having the market move upward on negative news. We saw two examples of that today - the ADP Employment Report and mortgage applications.

Perhaps the strongest thing going for the "wall of worry" thesis is the idea that many market participants are still recovering from the psychological and wealth battering they took from the 60% market drawdown.

The disbelief and skepticism that all could be better again so soon, will increasingly draw these folks back into the market if it continues to climb. Stay tuned.

The Fear Of Being On The Wrong Side

There is an ever-present fear of being on the wrong side of the market. This, of course, assumes one has taken a position.

The fear comes from having been wrong many times in the past (and knowing that getting on the right side of the market trend is the most critical thing you can do to increase your chances of success), and hopefully leads to a healthy respect for the market and a risk management framework that minimizes the size of ones potential mistakes.

I'm caught in the middle right now, and have a wager either side. I have a healthy cash position should the market experience a retracement (which I am looking for), but maintain a reasonable equity exposure should the market chose to continue moving higher. With a significant lead over my benchmark, I am afforded the luxury of this strategy and position.

Having had good exposure to the beta trade off the bottom, bottoms-up issues are increasingly influencing my investment perspective and portfolio management positioning. As holdings run and hit my target levels, I am happy to let them go. And as prospective targets fall and look more attractive, I am happy to add them to the portfolio.

Confessions of a Conservative*

Ok. I admit. I have a conservative bias.

Oh, it hurts to admit as such, but it is true.

My conservative bias is, of course, the tendency to hang onto my view for too long, and only slowly adjust it over time. In the trade, it is a sibling to anchoring, overconfidence, and regret, and a cousin to ignorance and arrogance. Those banes of any good investor. None of which makes me happy of course!

Anchoring refers to our tendency to grab onto the irrelevant when faced with uncertainty. Overconfidence relates to the illusion of knowledge (a situation where we think we know more than everyone else) which translates into an illusion of control. Regret is what happens after you have bought or sold an investment (kind of like buyer's or seller's remorse).

*Was inspired to plagiarize these thoughts from James Montier's piece "The folly of forecasting: Ignore all economists, stategists, & analysts"

Did We Simply Imagine This?

The thought has occurred to me, and I imagine there are a number of others also wrestling with it.

Is all that we have just experienced over the past 20 months simply an existential crisis of confidence that led to a liquidity crisis, which begat a financial market implosion, which led to panicked firings and a related economic cliff dive?

In other words did we simply imagine this and all will return to normal?

Even if we did just imagine it, it is hard to believe that we will simply return to normal. The reason is because we now have to deal with the consequences of the reaction to the crisis, ie. decline in wealth, lost jobs, heightened insecurity, massive govt interventions in markets and economy.