Double Journey

The market was down significantly today, almost 2%.  Despite this my portfolio was up about 1%.  Now you might think that is because I am short the market but that would not be the whole story.  I made money yesterday when the market was up by almost 2%.  Now I did not make as much money as the market but I also did not give anything back today.  One of the secrets that Warren Buffet always uses is to not lose money.  In a market like this one, it can be hard to do because of how it is whip-sawing back and forth.

I am achieving this through a very specific strategy.  I am pairs-trading.  This strategy is relatively simple.  You go long of one thing and short of another.  For example.  Say you are bullish on Broadcom.  You would like to buy it but it has had a pretty good run the last three months running up more than 50% in that time period.  To do a pairs trade you can buy Broadcom and go short of a broader index like the Nasdaq or the Semi-conductor index (SMH)  Why would you do this?  You are taking the market risk out of your stock purchase.  Stocks move up and down for any number of reasons.  Only half of a stock’s price has anything to do with the actual company itself.  The other half is related to the broader market and the sector.  You are betting that the thing that you buy will outperform its peers but hedging yourself in case the market does crazy things.

I am short of the Dow, the real estate sector, and U.S. Treasuries while being long China, Materials, and a bunch of individual stocks.  This on a whole has performed quite well.  I’ve lost some money on my short positions since the market has continued to rally, but my long positions have more than carried me up.  Could I have made more money if I wasn’t short?  Sure.  But the hedges have kept me sane by limiting my gains and more importantly limiting my losses.

I continue to use this strategy to great effect.  I think we are about to have another leg lower from here, there is weakness in the market right now and that is pretty evident.  I would like to get more short of the  market but won’t get too crazy right now as I can easily be wrong.

Don’t look now, but the market closed below the November bottom.  As I said in my last post, if it closed below this, all bets are off.  Next week is a make or break week.  Either stocks need to bounce here or we could easily have another 100 points to the downside.  Just a few weeks ago, I honestly could not  imagine a scenario where we could lose that 100 points. But in this type of market, it is impossible to really predict what the heck is going on next.

The news out there right now is just bad and looking to get worse.  A few things that caught my eye

• Markets reach down to twelve year lows.
• California unemployment reaches double digits.
• Buffet has his worse year ever.
• States budgets will continue to take a beating for years.
• Government needs to take even more action to help ailing AIG.

They say, when there is no good news, that is the time to buy stocks.  I am not so sure I believe that right now.  I still think we are only in the 6th inning with plenty of more pain to go.  At the very least, I think we are probably flat for the next several months here so there is no rush to buy anything.  I may take a small long position and see if a bounce happens, but it will be a very small position.  It will be a position I will get in and out of quickly either direction the market moves.

About two weeks ago, my company just went through a second round of layoffs.  This is happening about six months after we already had one round of layoffs.

Most people in my situation would probably be very concerned right now.  I am not.  I have been through layoffs before, and these are not quite the same.  This round was truly a right sizing of the company.  The company is still profitable and there are very few situations which would cause that to change.  Now, we have not been making as much money as we had forecast a year ago, but the fact is that we are still making money.  This is contrast to my experiences at a former company where we were bleeding cash and were doing everything possible from going under.   That was a pretty miserable experience as there was very little chance of turning that company around.

This is not the same situation.  There is very much some good opportunities for the company and for its employees.   How can I say this?  Some of the best opportunities are created when things look their worse.  One can just look at Warren Buffet’s strategy, buy assets when they are distressed.  Right now is a great time to invest in the market if you can buy the right things at the right price.  While it can be scary to double down when things look so awful, those are when the best opportunities arise.

The same is true during layoffs.  For those individuals who step up and do more, the opportunity is great.  During most layoffs, it is not as if the work just disappears.  The work has to get done somehow.  In fact, most of the time, there is more work to do as the company must better execute on a plan if it hopes to return to the “good” times.  During this round of layoffs, I have had to take on much more responsibility.  I had originally come in as the senior Program Manager on the team.  Shortly after the first round of layoffs, I inherited the responsibility of managing the development staff on a temporary basis  It was a responsibility I took reluctantly even though many saw it as a step up (I did not see it as a step up but that is another discussion). After this round of layoffs, I inherited even more responsibility and am now in charge of another development group as well as the entire testing organization.  Along with the additional responsibility came a promotion to a Director level position.   While I would have achieved this promotion in due time, it was much easier to obtain given my additional level of responsibility and the current organization structure.

My career growth has been quite fast and most of that has been through hard work and a good attitude.  But I’ve been lucky at times because I have been in the middle of turbulent and often difficult situations.   If things do not change, new opportunities are not created.  This is why change is good.   This is why I am not panicking even though my portfolio has taken a huge hit in the last year.  I planned carefully and was prudent when I should have been.  Because of this, I can now take advantage of opportunities when they present themselves.

What is Apple thinking?  I am going to take a slight detour from my new blogging pattern to talk about Apple’s announcement after hours.  It was announced that Steve Jobs is going to take a leave of absence to take care of health issues.  These issues surfaced months ago, and Apple dismissed it.  As recently as a week ago Apple said there was nothing seriously wrong with Jobs and today they come out and say, “Oops we were wrong”.  What could have materially changed in one week?

If there is one thing I know, is that you really need to set expectations correctly, especially with things as important as this.   A week ago, Apple should have either said they had nothing to say or that they did not know the full extent of the problems.  Many people who have seen Steve Jobs recently have said that he is looking pretty bad.  Reports are that several people who have talked with him say he is actually somewhat delusional about the current state of his own health.  That is not good to hear if you are an Apple investor.

Whatever the case may be, this is pretty bad news for Apple.  While I do not think any one person is the key reason for the success of a company as big as Apple, Steve Jobs comes pretty close.  I could argue that he is more important to Apple than Buffet is to Berkshire, and that is saying something.  I don’t think I know the name of even one other employee at Apple, and that is pretty rare for me.  Especially at a technology company as important as Apple.  Do you think this is a big blow to Apple, or am I just overreacting?

Take a look at the above chart (Click on it to see the full picture size).  It is a picture of the S&P 500.  On Friday, the S&P closed at 800 but it touched 740 intra-day.  The S&P has been at this level twice.  Once in 2002 and before that in 1997.  Is this the real state of our world?  Have we really made no progress in the last 10 years?  Is this at all realistic?

It is hard to say.  I’ll be the first to say, I never thought we would get this low.  I thought 850 was reasonable level for us to come back to.  But we fell right through that and kept on going down.   I knew this correction was coming.  I knew it was coming for a very long time.  In fact, I have been in a cash position for a LONG time because of this.  When I transferred my 401K almost three years ago on my way to Microsoft, I left most of it in cash because I though the market was so overvalued.  It is why I’m in such good position today to buy up assets.

But it is hard to imagine us right back where we started 10 years ago.  The prevailing wisdom espoused by so many experts, including Warren Buffet, is that buy and hold works.  It certainly did work when Buffet made his billions, but it has not worked if you have been in the market for the last ten years.  Granted, if you go twenty years back, or you go ten years in the future, you might be OK.  What do you think?  Do you really think we should be at the same levels we were at 10 years ago?   An age which just saw the explosion of the internet?  An age where most people did not own a cell phone?  Then again, it was the age when 20% down and 30 year fixed mortgages were the standard.  So maybe we do deserve to be here.

Today, it was announced that there was a change to the government bailout plan.  The new plan calls for the government to, instead of buying bad assets, to inject NEW capital into the banks by obtaining equity stakes in exchange for the money.

Now, while this plan is actually slightly better than the old one, it still is pretty bad and in fact maybe worse in the long run for the country.  Here is my big problem with the plan.  We live in a capitalistic society.  This is a good thing.  The cornerstone of any captialistic society is the banking system.  Banks are the ones with capital. They put the capital in Capitalism.  The antithesis of capitalism is government run enterprise, socialism.

Now while this plan doesn’t actually give control of the banking sector to the government, it is a step in that direction.  And all it takes is one little step, and another one, and before you know it we have government controlling that entire sector.  The plan is similar to the one Warren Buffet got earlier, just worse.  The hope is that this injection of money will spur banks to start the lending the is so important to the proper running of the economy.  But even if this plan succeeds in the short term, it has scary implications in the long term.

Government is notoriously inefficient.  It is scary to think that we would put the model of inefficiency over the very institutions that need to be the most efficient.  Banks need to base their decisions on profit motives.  However selfish and non-humanitarian that sounds, it is vital to the proper running of an economy.  Banks need to provide capital to those who will best deploy it.  Don’t believe me?  Look what caused this financial crisis.   The housing crisis was caused when GOVERNMENT decided that it was a good idea to start lending to people with poor credit histories and who could not afford their payments.

Now what will happen if we let government start having a say in who should get capital and who shouldn’t?  What happens the next time it is decided to help those who don’t deserve it.  Maybe it determines that the failing American car industry needs to be saved, and the banks should lend it money.  How can we prevent the people who run the banks not to curry to their employers and owners, the American government?  We can’t.  Nor can we prevent this from going past a “temporary” solution.  Too many times, “temporary” fixes become permanent.

I get their will be pain.  I get we might have a recession.  But really, should we be transferring taxpayer money to corporations that took huge risk and lost?  Does that seem fair?

Lost in all the news of the crisis is that Warren Buffet is starting to put some of his cash to work.  He has made two deals, one with Goldman Sachs and one with GE, for very very good terms.  Both investments are relatively similar and both are very very good.  He is guaranteed a 10% dividend for at least the next three years and has warrants to buy more stock at a relatively good price.

Here is the thing.  He is able to get these terms because he is Warren Buffet. Nobody else on earth could get this deal.  You could even argue that both GE and Goldman have an endorsement deal with Buffet in this case because, although they are forking over a lot of money, the get a lot in return with Buffet essentially telling the market what a great investment both of these companies are (I agree and really like Goldman Sachs long term).  Buffet has made a lot of money over the years, and because of that he gets to make a lot more money for years to come.

This is why you don’t do short term trades.  I woke up early this morning to check my long positions to find out that what was going on.  But what I thought would happen went the exact opposite way.  The market started down, which confused me, and continued to go down.  I kept watching it go down, and then closed half my position as I reached a 7% loss threshold.  I’m going to hold on to the other half for probably a move 3% either way and then close it out.

Like I said, wild ride.  If you don’t have the stomach for it, better to just stay out.  I will close out my long market position but I will probably open up positions somewhere.  I’m interested now in Novartis (NVS) becasue I want a drug play and I want an international play, and it does both for me.  I also want to buy a bank somewhere as I think the strong banks will do very well going forward.  Maybe US Bank (USB) which has weathered the storm very well.  And of course I want to buy Berkshire.  Seriously, Buffet is a genius, but I’m going to write about that tonight.

One of the things that bothers me a lot when I hear people speak of the need to do something immediately is the fear of recession.  Recessions are not bad things.  In fact they are pretty necessary in a well running capitalistic economy.  Granted, you don’t want to have a Great Depression sized recession, but it is absolutely needed if we wish to have the benefits of a boom cycle.

Think of it this way.  The economy has some average growth path.  But like any average, it is a combination of highs and lows.  The economy does just that, it has highs and lows.  There are going to be times when the economy is going strong.  This is a cycle that feeds on itself, growth begets growth.  But growth can also beget excess.  Economic growth, like a rising tide, raises all boats.  Some of these “boats” really don’t deserve to be raised.  They ride the tide of economic growth but really need to sink to the bottom.  These are the people who get rich by adding very little of real economic value.  These are the idiots who made a fortune buying houses with no money down, sitting on them for a month, and then flipping it for instant profits.  There is no real economic value in that and these are the type of people who shouldn’t be successful.

That is where recessions come in.  They are the great equalizer.  Recessions seperate winners from the losers.  Those who really do add value, continue to survive.  People who were prudent and realize that there is always a bust following any boom, are the ones who make it on to the next boom.  These are the people who realize that a long term outlook is the only outlook.  These are people like Warren Buffet who don’t ride the volatile cycle of boom and bust, but keep a level and even head amidst all the calamity.

In any well functioning society, there need to be winners and losers.  Sometimes in the short term, the winners and losers end up in the wrong bucket, and that is unfortunate.  This is when an average Joe loses his job despite doing nothing wrong.  But in the long run, it always works out.   If he is truly a winner, he will come out ahead before the race is over.

As a personal note, my family was destroyed during the recession in the 1990’s.  My father’s business went under and he subsequently deserted my family.  It wasn’t an easy thing to get over.  At the time it seemed like the end of the world.  But in retrospect, it was absolutely necessary and the best thing for everyone.  My father, although a good cook, probably wasn’t the best business man.  It wouldn’t be in anybody’s best interest, even my own family, to have propped him up and let his business continue.  My family survived it all and came out stronger for it.  I like to think that is because I really do belong on the “winners” side.

Hank Paulson went to the Hill today to attempt to sell his $700 billion bailout plan.  Surprisingly, those in congress questioned them hard about why this plan is necessary and why it is important to do something immediately.

As the hearing progressed, Paulson and Bernanke were on the defensive.  Several times they admitted there were several problems with the plan.  They admitted that the plan might not even work but that they had to do something and that they have to do it now.   The fundamental problem they want to solve is the confidence problem that investors and the credit markets are having.

You  know what the most ironic thing is?  These actions, and similar ones before it, have likely caused most of this mess.  Investors EXPECT the government to do something.  They always come to the rescue.  This is the type of moral hazard problem I fear most.  Investors get used to the government stepping in, and thus refuse to do anything until a plan is revealed.  This of course makes it worse the next time becaue the expectation is set, and until the government steps in, most investors will refuse to do anything.

I’m sure they will say, “Just this one time”, or “This is a special circumstance”.  I hear the same thing at work every day when we agree to do a hack or we rush something out that shouldn’t go out.  Every case is a “special” case.  Of course, that means none of them are, and neither is this one.  The scariest thing? Pauslon is raising such an alarm and then he is asking for carte blanche in the situation.  He just wants us to hand over the $700 billion with no strings attached.  Want to buy the worse assets from the worse banks?  Sure, why not?  We wrote him a blank check.  It just reeks of man with an ego too large for his own good; someone who thinks that they can solve any problem.

The plan should make sense.  With this much money involved, it should be obvious what benefits it would provide.  How come only Bernanke and Pualson seem to be the ones selling this plan?