I’m right on the razor’s edge here. Caught between the my technical framework that clearly states an important low took place in early June and a mechanical system which I have sworn the utmost loyalty to the point of servitude.
The mechanical trend following/reversal system I have in place to determine my asset allocation points is about to switch back to bearish should tomorrow be extraordinarily weak. It will also switch to bearish if the remainder of this week simply drifts lower. I was afraid of this outcome when I moved from a 50% invested to 75% invested position last week.
What this means for me – if it does manage to flip back to short-term bearish – is a move back to 50% invested and 50% cash. The more daunting matter at hand, however, is the fact that my long-term indicator could flip next week, taking me to 100% cash.
It’s a gut wrenching place to be for a hardened bull that is sitting on well researched positions that I know will be higher given time. But my asset allocation model comes first. It comes ahead of any technical analysis, trajectory points, price mirrors or correlation studies that I post here.
It comes ahead of my feelings for a company. It comes ahead of earnings models. It comes ahead of companies with innovative products, a potential groundbreaking technological breakthrough, the cure for a small penis or the midnight munchies. The asset allocation model is my discipline and I stick to it.
This hardened attitude comes from lessons learned in the past. I reference 2004-2005 often on this website, as it was those difficult years for my former hedge fund that made me into the trader/investor/money manager I am today. I can’t put the blame for the back to back down years that caused the closure of my fund on any one thing in particular. It was a combination of things, ranging from hubris to a lack of respect for risk.
One of the factors I consistently think of when that period comes to mind is a correlation study that I became obsessed with. And why I shouldn’t I have been obsessed? That correlation study allowed me to nail the 2003 bottom and propelled my fund to #1 status later that year. I had that correlation study posted on my wall with different variations and outcomes. It literally took up an entire wall of my office marked in various colors to indicate potential scenarios. The correlation study became my go to backdrop when any scenario went against expectations. I didn’t have a bail out switch. There was no mechanical system in place to save me from me or in this case from IT.
2004 and 2005 were a struggle to say the least. Needless to say, the correlation study failed and I was lost. It was a terrible investment stretch punctuated by calls from angry investors.
I remember one investor in particular from New York who was relentless. She blamed the performance of my fund and the substantial losses she suffered for her husbands grave health. She would criticize every detail of my investment analysis. She was in contact with me more than any other investor. I am not the type to shy away from calls because of performance so I would just take it. She scared me.
Other investors handled it differently. I had lots of individuals who had been advisory clients since the 90′s. Their reaction was more disappointment than anything else. The disappointment from investors I had laughed, celebrated and basically grown up with as a fund manager was more difficult than the angry investors who had hopped on for the ride late like the lady from New York. They liked me too much to shred me, but I could sense that they wanted to.
December 31st, 2005 I sent out a note to investors saying that I was closing up shop and that their capital would be returned to them shortly.
After such an experience, it would only make sense that if I was to return to the game I would have measures in place to make sure that I never experience such pain again.
Here are the two measures I took that have made the greatest difference:
- No leverage
- A mechanical system in place that takes asset allocation decisions out of my hands
No leverage takes excessive, perhaps ruinous volatility out of the equation.
A mechanical system that allocates into and out of positions doesn’t allow me to get caught in a 2000 or 2008 type crash, putting me into cash well before I can get hurt.
The rest of it is all me. As you have seen, I can pick my stocks. That is all I am focused on now.
I find companies that meet my criteria. I let the winners run and I cut the losers short.
There is nothing sexy about winning consistently in the markets. It is a mechanical process. It is a job. The day you realize this fact is the first day of the rest of your life in the markets.