Get Real or Go Home- Part 2

I am publishing an article here that was written for OPN subscribers on Oct 17, 2008. (I published one different version on this blog as well) We all know what has happened since then. The key objective of sharing this is not talk about OP’s prediction accuracy, but to share that it doesn’t take rocket science to analyze what’s going on the Macro environment. If you could separate the noise from the information load you go through in a day, the investment picture gets only better and better.

Below article is written only for OPN subscribers. It is compilation of several sources, magazines, articles and company presentations that I had privilege to receive. I have gathered this data, comments and suggestions to present my views. I maybe wrong, so pls take it with loads of salt and do your due diligence before making an investment decision.

Volatility is historically high, volumes are huge, stock selling pressure still not gone away and smart money is still on the sideline. Even though markets rallied yesterday, the internals were poor. Many of my friends, and in fact subscribers have lost significant trading capital in the last 4wks. Even though at OPN we stayed on sidelines, many of them thought it was bottom at every low/support point and were hit hard by this daily ups and down. This is a bear market and those who have not seen any bear market before (like my Chinese and Indian friends who are first time investors) they can’t imagine how brutal the bear is. It sucks your trading capital like a leech sucking blood drop by drop. Sorry for such a nasty analogy but the word of wisdom I have learned is that “In bear markets, winner is the one loses the least”. Do not be tempted to get in and out of the frenetic market we are witnessing. As old Charles Dow one said, “Exercise enough patience for six men”.

You will hear all kinds of chatter that this is the bottom, that was bottom and so on. All gurus or Pundits, including me, might give you this and that point. Some might give you historical data. I shall share one thought with you- “Ignore the past and you’ll lose one eye; Live in the past and you’ll both”. Don’t just jump onto every opportunity. Preserve your capital. If you have it, you can always make money.

This market has taken many by surprise, a lot of market gurus who have performed so well compared to best of the benchmarks are losing money and shutting down the shops. A lot of people who thought 40 VIX was high, or 50 was historical eye, are hiding behind the doors by looking at VIX at 80. The rules are being changed, policies are being reverted and yet no one talks of moral hazards as “Survival is the key”. Survival of this storm means drastic measures must be taken now, so you will have the opportunity to capitalize on this down turn in the future.

Consumer spending, which makes up 73% of the US$ 13.8 trillion US GDP (2007), is falling– this is very worrisome. If the consumer cuts a pity 4% of spending, we are talking about nearly 3% gone from GDP. US GDP is nearly 25% of the world’s GDP, that means nearly 1% of the world’s GDP will be affected just by US consumer cutting back by 4%. Don’t be fooled by official data, i’ll tell you simpler way. Just check you own budget, have you tightened the spending belt? By what % and you have a good gauge. And guess what, with Obama becoming President, tax increase might take place that will leave further hole in the consumer’s pocket.

http://en.wikipedia.org/wiki/List_of_countries_by_GDP_(nominal)

Falling real wage will erode personal consumption expenditure. For average household the debt service ratio as we as financial obligation ratio has been rising and are at record levels for past 20 years. I personally don’t think this is going to be v-shaped or u-shaped recovery. It might be something in between L and U. and someone has to spend and spend, and spend loads of money (Yeah you smell right, I am talking upcoming inflation in that cycle).

Though I don’t like watching Mad money as it disappoints me to see what kind of questions people ask and just based a few comments, how crowd turns Mad to buy the recommendation he give. Anyway, Jim is a smart man and here is latest from him  (http://nymag.com/news/businessfinance/bottomline/51007/index1.html)

“If all that seems depressing, take heart. The same sector that got us into this mess – housing – will lead us out of it. The federal government, sub rosa, has determined that we will have a European-style financial system, consisting mainly of four megabanks I mentioned – Citigroup, JPMorgan, Bank of America, and Wells Fargo. These are the institutions that will be deemed too big to fail and will be protected no matter what. In return for the creation of the jolly oligopoly, these four banks will have to make mortgage money available to all at a reasonable price, something that will help real estate bottom and begin heading upward before this time next year. Of course, it helps that Fannie Mae and Freddie Mac are nationalized and can absorb hundreds of billions in losses to make it so. It will also help that I expect short-term interest rates to decline to 1 percent as the Federal Reserve wakes up to the notion that the battle was, is, and will be deflation, not inflation, so rates have to be as low as possible to stir economic activity and drive unemployment down. Once that happens, and housing rebounds, the rest of the economy will follow.”

Net, my message is forget about getting ahead, we’re talking survive and therefore get real.
Here are some suggestions-

1. Manage what you can control. You can’t control the economy, but you can control your own economy.
2. Cut spending. Preserve Capital. Don’t trade too much.
3. Don’t trust your models and spreadsheets. All assumptions prior to today are probably wrong going forward.
4. Focus on quality
5. Reduce risk, manage it as much possible. If managing is not easy, seek advise or don’t take the risk.
6. Cash is king. You should have at least one year’s worth of cash on hand.
7. Adapt quickly
8. Don’t just let your capital be managed by any financial planner. Grill them with your questions, see their past returns, ask why are we in this mess, ask what asset allocation they suggest and why what was the historical performance and will it be different going forward, ask for their own personal performance records verified.

We are not in normal times. Get real.

This is not to paint the grim picture of future, but to share reality for if we know reality we can make real plans.

Profitable trading, OP

Well as it turned out, the picture was in fact grim, almost half of the world’s wealth was destroyed in a very short span of time. Hopefully this piece did help OPN subscribers.

That is past now and past performance does not guarantee equal future performance.

We are again at crossroads. Markets looks tired. I do recognize that there may be more to this rally, but I think the probability favors a pause. But as I mentioned yesterday, Markets can remain irrational longer than I can remain solvant so I don’t fight the markets. I am cautious with slight short delta, positive theta and positive vega. Helping me gain, should market correct any time and IV explodes higher.

My only message, stay cautious. I shall be sharing more data in the forthcoming days.

Take care, profitable Trading, OP