Trading, Investing and Speculating
By Tony Allison, December 21, 2009
Today’s culture seems to have a very short-term perspective on the just about everything. Wall Street focuses on this quarter’s results; Washington’s vision extends only to the next election cycle. The average Joe looks to the coming weekend, or perhaps his next paycheck. As the nation’s attention span appears to shorten further every year, so does its vision of the future. And as investors, it seems more and more people are adopting the behavioral characteristics of the trader.
Looking out at some of the key economic issues directly in front of us we see:
- The oversold US dollar starting to strengthen, as most of the planet has been in the “short the dollar” side of the boat this year.
- Commodities starting to correct as the dollar strengthens, after a big run-up this fall.
- Developing countries like China and Brazil looking ready for a correction.
- The possibility of de-leveraging reasserting itself in 2010.
These may be valid concerns, but they are more concerns for the trader, not the investor who should be looking ahead years, not days or months.
Traders, traders everywhere
It seems everyone rides the momentum trade these days and then runs for the exits when the markets tank, selling aggressively. But it’s really not everyone. It’s the traders, which include enormous hedge funds, investment banks and other institutional “hot” money. These traders are certainly large enough to move the markets, and they often move in a herd. These big boys are exclusively concerned about this quarter’s results and this year’s results. That is because their bonuses and other compensation are directly tied to this year’s results against specific “benchmarks”, such as the S&P 500 index.
The individual with money to invest would be wise not play this game, as it is very hard to be successful as an individual trader with limited knowledge, experience and resources. Even the professionals blow themselves up, as hedge funds arrive and disappear on a regular basis. The big difference is they are playing with OPM (other people’s money)!
Ride the long term trend
I believe investors should concentrate on longer term trends and fundamentals, not the “issue of the day” on CNBC. All of us tend to react too quickly or emotionally to economic news that, while perhaps relevant today, may not matter at all in six months. When we hear that the dollar has just “broken significant technical resistance” many people who are invested in commodities for instance, may react emotionally and sell in a panic. It may indeed be an issue that moves the markets short-term, but people react as if lines on a chart are more important than our government’s overwhelming debt problems or profligate money printing. All markets correct, but trying to catch the turns is very difficult and often quite expensive.
Core portfolio strategy
Investors who have a long-term approach should have a “core” position representing the majority of their portfolio that reflects their convictions on long term trends and fundamentals. This core position can change, based on circumstances of individual companies, but mostly shouldn’t be fooled with as long as the trends continue. To quote the legendary investor/trader Jessie Livermore,
“It was never my thinking that made big money for me. It was my sitting. Men who can be both right and sit tight are uncommon.”
Another, much smaller portion of the portfolio can be allocated to taking advantage of the herd. When the traders panic and sell off in fear, investors can use this period to buy equities that will benefit from the long-term trends. Conversely this portion of the portfolio can be sold into periods of trader confidence and momentum. Never expect or try to pick bottoms or tops; just be aware of the current sentiment.
This contrarian strategy, while obvious, is not nearly as easy as it sounds. It requires focus, discipline and nerve. Acting opposite from the vast majority is not a behavior we learn in school. It’s just the opposite in fact. People are encouraged from a young age to go along with the group. And overcoming the very human emotions of fear and greed to go the other direction is also easier said than done. The “core portfolio” position ignores both emotions and just sits tight.
Investing with conviction
None of this advice is new or surprising, and most is simple common sense. But so many people who call themselves “investors” actually behave like traders, much to their detriment. Perhaps the reason they take such a short-term view in times of euphoria or panic is that they either do not understand or have no firm conviction regarding the long-term trends and fundamentals underlying their portfolio decisions. So it is much easier to be swept along by the emotion of the day instead of calmly “tuning out” the din around them.
One should also consider the role of speculation in the investing process. Most people would define speculation as placing money in a high-risk asset. But I refer to the definition of speculation put forth by legendary speculator Doug Casey. His definition is “someone who allocates capital in order to profit from distortions in the market caused by government intervention.”
Casey believes that a portion of one’s portfolio, perhaps 10%, perhaps more, should be allocated to speculations that can yield 1000% gains. The speculations need to be carefully chosen and diversified. This is not always easy; as Casey has stated many times that it’s very hard to find many really appealing speculations.
“Especially in volatile times with inflation written on the wall, you can’t afford to just sit on cash or supposedly “safe” investments. You need a portion of your portfolio invested in speculations,” said Casey in a recent interview on his website. “Unfortunately, most people don’t understand systemic risk and believe the government can shield them from it. And they’re afraid of volatility, although volatility can be your best friend.”
Debt, Debt and more Debt
There are many market fundamentals that come into play and help set the economic trends we now are experiencing. In my opinion, none are more important than the overwhelming levels of debt in America and around the globe, and the response of the world’s central banks to the current credit crisis.
In 2010 the US government will have a budget deficit of approximately $2 trillion to finance (if you include all the “off budget” items such as the wars in Iraq and Afghanistan). In addition, there will be $2 trillion more in US sovereign debt coming due that will need to be re-financed. The staggering total for one year: $4 trillion. Where will that money come from and at what interest rate will it be financed?
The following are excerpts from an article posted on our website entitled “The Debt Bomb” by noted international investment manager Peru Saxena.
“Make no mistake; the developed world is drowning in debt and as outlined above, there are only two viable options – a global economic depression or very high inflation. It is our contention that the policymakers have chosen the latter option and over the following years, we will experience the trauma of severe inflation.
Look. The American government is staring at total obligations of US$115 trillion, America’s debt to GDP ratio is off the charts and the American public is also up to its eyeballs in debt. Under this scenario, you can bet your bottom dollar that the American establishment will try to reduce this debt overhang through a process known as monetary inflation. If you have any doubt whatsoever, take a look at Figure 1 which captures the incredible expansion in America’s monetary base. As you can see, over the past two years, the monetary base in America has expanded from US$827 billion to an astonishing US$1.93 trillion! Up until now, this surge in the monetary base has not permeated through the broad economy but once the money velocity picks up, the money supply will zoom and the end result will be surging price inflation.
It is notable that America is not alone in pursuing inflationary policies; most nations all over the world are printing money and debasing their currencies. In this era of globalization, no country wants a strong currency and everyone is engaged in competitive currency devaluations. Given this reality, we firmly believe that this money and debt creation will cause an inflationary holocaust over the coming years.
America has run out of choices and if the Federal Reserve does not inflate away this mountain of debt, the biggest sovereign default in history is guaranteed. Now, given the ability of the Federal Reserve to create confetti money, we are convinced that it will opt for the inflation tonic. Remember, inflation dilutes the purchasing power of each unit of money and it will make America’s debt more manageable. Of course, this inflationary agenda is not a secret and this is why many creditor nations with huge reserves are beginning to diversify out of the American currency.
It is our observation that throughout history, monetary inflation has caused asset prices to rise and this time should be no different. In the past, when inflationary expectations spiraled out of control, hard assets were the prime beneficiaries and this trend is likely to remain intact in this inflationary episode. If our assessment is correct, over the coming years, stocks, precious metals, commodities and real-estate will appreciate in value versus paper currencies.”
Whether Saxena or other analysts prove to be correct about coming inflation or not (and I believe he is), it is extremely important to educate oneself about the economic and political realities in the world today, and assess the potential that these enormous, unsustainable debt levels may cause serious disruptions to the global economy. With that knowledge, the key is to structure your “core” portfolio to best preserve your wealth and purchasing power as we move into a new, and likely volatile, decade. And then just sit tight, which may be the hardest part of all.
I wish you all a peaceful holiday season and a prosperous and healthy New Year,
© 2009 Tony Allsion