How Do You Define Your Reality?

I come at the markets and investing from several distinct perspectives: As a Trader, as a Strategist/Economist, and as an Asset Manager.

As someone who started in this business as a Trader, I know that as a trader your reality is defined by what is on the screen in front of you. The trend is your friend and momentum is your lover. You cannot afford to ignore all the liquidity sloshing around you, or the very obvious underlying bid to the markets. Buying the dips is a money maker (until its not), and you cannot afford to miss that opportunity. I am all too aware that he who lives by momentum dies by momentum.

While the talking heads opined how much the markets liked Bernanke’s comments yesterday, the Trader in me just snickered. Like many of you, I saw the big buyer of SPX futures at 9:59am — he lit up the markets long before any human had the ability to read Bernanke’s comments and determine they were dovish on inflation. It was just a well timed program, and if you ever spent any time on a trading desk, you said to yourself, "Jump on board, the big boys are taking us higher!"

However, the Economist in me sees the widening disconnect between what the majority of the public believes, and the less sunny reality beneath. I know that the Q4 GDP 3.4% data was junk economics at its worst. We know GDP will get revised downwards to 2.25% or 2.0% or worse. We now have 3 consecutive Qs of decelerating economic growth. My inner Economist knows that the business cycle has not been repealed. It notes the vaunted post-Christmas Gift Card Sales Surge failed to
materialize, with disappointingly flat January retail sales. The re-acceleration meme so prevalent last quarter was utter mythmaking spin. These are the facts.

We know that Real Estate has been the prime driver of the Economy this cycle, and the bottom calls for that sector have been dead wrong. I read the "incontrovertible evidence" of the bottom is that the Homebuilders, down nearly 50% from their peaks, have bounced modestly. I remind you that the Nasdaq, was down 41% in 2000, only to be followed by a 34% bounce. I prefer Bill King’s observation: the "major reason to believe housing has not yet bottomed: Yesterday, Easy Al, speaking about housing, averred, ‘I think the worst is behind us.’ Didn’t he say that a quarter or two ago?"

Yes, he did. And that was before the sub-prime debacle began to unfold. Everyone but the Cheerleader-in-Chief should know that it has quite a ways to go before it finishes its painful unwind.

My inner statistician looks at earnings at an historically high percentage of GDP, and knows that a reversion to the mean is inevitable. With this quarter’s likely drop below 10% Y-Y earnings on the S&P, we know that a mean reversion rapidly approaching.

The Strategist in me notes the complacency, the near record levels of
NYSE Margin, the somewhat frothy Bullish Sentiment and the slightly
stock skewed asset allocation, the VIX at ~10. However, none of these factors are at levels that scream contrary indicator. At worst, they are a yellow warning light. Smart strategists have to have the patience to wait for the needle to "get pinned," as exuberance can run further than most expect. Indeed, this most recent two day rally could even jump start the process to take us towards those excessive levels.

As an asset manager, I know how painful it is to miss the upside (we got Bearish in late January 2000, and watched markets scream higher for 10 painful more weeks). But I also know how much damage gets done in the down cycle, and watched people who failed to heed the warnings get utterly demolished, their assets shattered, their retirements ruined. Our aset allocation is now ~65% long, 20% short, 15% cash, with the stocks doing well, the shorts doing not too poorly, and the cash earning 5%. We have mostly big caps and agricultural chemicals and a smattering of other names, and very little tech. But this is uncomfortably long, and I am itching for the signals to move me towards a more defensive posture.

And still, we wait.


Jeff Saut likes to say where you stand is determined by where you
sit. If you sit at a trading turret, you care not a whit for the
longer term concerns. You get a P&L daily, your open positions are
marked-to-market every close. The trader part of your brain is loving the lift, regardless of the source. 

But the rest of your gray matter might be none too happy with everything else you process. It really matters "how you define your reality . . ."

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