Double Journey

I’m taking the week off to take advantage of the Thanksgiving holiday.  So I’m going to write some post ahead of time and post them throughout the week.

I do not take vacation too often.  It is especially odd that I’m essentially taking a week off of work, although I’m really only taking three days of vacation.  It just seems there is never a good time to take vacation and now is particularly tough for me.  There has been some upheaval at work.  While many people get stressed out in these types of situation, I always take it as an opportunity.  I have made the most progress in my career in such chaotic situations.  It is in these times that great leadership is needed and those who demonstrate it stand to do well.

To exacerbate the situation, I’m very interested in trading this week.  I really do think there are some great buying opportunities right here so long as you are in it for the long term.  There are several things on my shopping list that are very good buys here.  I still think the market could go down from here.  But I don’t think it is down another 40%.  We might have 10% more to go, and then there will probably be a leveling off.  No need for me to pick the bottom, also no need to chase the market up.  I just wish the market would settle down for a few days.   If I can, in between catching some sunrays and watching out for any killer whales, I am going to try to do some trading and of course some blogging.

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.

Wow, this market is getting ugly isn’t it?  Just when you thought it couldn’t get any worse, it did.  Seven straight days down.  Not just down, but huge moves down.  After the bailout, the market is down over 20% from a week ago.  Doesn’t look like the bailout plan created much confidence in the market does it?  Are we done yet?  Probably not.  I can easily see the market going under 8000 and probably even 7500.  From the market peak, the market is down almost 40%.  That is a pretty scary number if you think about it.  To give some perspective, here are the declines of some of the major bear markets

• Tech bubble burst- 34% (Over a 2 year period)
• 1987 Black Monday - 23%
• 1970 Stock Market Crash - 45%
• 1929 Crash, The Great Depression - 89%

So, while we aren’t in the worse crash of all time (not even close) we are in one of the worse crashes in recent history.  If the market goes down another 5%, which it could easily do in a day, we could easily be in the worse corrections we have ever seen. Is this justified?  It is really hard to say.  I find it hard to believe we can drop past 50% but I also have to admit that we are in unprecedented times.  I am getting my shopping list ready, and looking for a way in.  I won’t be blogging tomorrow, it is the girfriends birthday and we are going away for the weekend, but I will be thinking hard about what I want to own.

I think you need to stat looking to buy.  I had no interest in buying for several more months, but I seriously did not expect the market to go this far down this fast.  I still am mostly in cash, at least 70%.  That’s partly because my equity portfolio is so far down this year :)  But seriously, you want to buy the companies that are going to make it through this mess.  These are companies with

• Strong balance sheets with very little debt
• Strong cash flow
• Can grow by avoiding using debt and funding it with cash on hand
• Globally diversified
• In economic insensitive markets

As crazy as it sounds, I’m also interested in banks.  The sector is getting destroyed, and clear winners are going to emerge.  You add this to the fact that the government is making it EXTREMELY profitable to be a bank these days, and you have a recipe for some very big winners in the future.

So what are you doing in this market? Staying on the sidelines, losing your shirt, or feeling like a kid in a candy store?

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.

Tomorrow is going to be a blood bath.  This weekend saw Lehman preparing to file for Bankruptcy before the opening bell. To add fuel to the fire, Bank of America has agreed to buy Merrill Lynch.  The good news for Merrill stock holders is that it appears that Bank of America will pay a significant premium over the price at the close of business on Friday.  This may balance out the fear that the market will have after the collapse of Lehman.

I’m expecting significant pain for myself in my portfolio.  When I look at what I have, it should on the surface be OK.  I have some consumer staples and some energy, which should be fine.  I have no financials in my portfolio, having sold of Goldman Sachs when it was 20% higher than it is right now.  My big fear is in my technology and my international positions.  My largest position is in some international mutual funds.  These have been getting killed lately, and I expect there to be more pain in the short term.

That being said, I am hoping for a serious plunge.  I have a long term view of the situation, and I’ve been waiting for the market to be taken out back and shot.  I’m not sure this will mark the bottom, I really do think we have a few more months to go, but we will hopefully get close tomorrow.  But then again, given how the market seems to do the exact opposite of whatever it is supposed to do, maybe we will see an up day.  If that happens, continue to stay on the sidelines.  I have for the most part, and I’m looking pretty smart for it.

I’m trying to get back into the swing of reading. Of course, I naturally gravitate toward financial investment books.  As I’ve posted before in my blog about the best investment books to read, the best books are those you will actually pick up and finish.  I’ve been hard for time lately, so I decided to pick up another book in “The Little Book” series.

This time, I picked up The Little Book That Builds Wealth by Pat Dorsey.   You will notice that this is the same Pat Dorsey who wrote another one of my recommendations, The Five Rules for Successful Stock Investing.  I like his style of writing, even though some might find it dry.  I find it to be easily understandable for even the average person with little investing background.

The book focuses on the concepts of economic moats.   It is a concept used heavily by the likes of Warren Buffet as well as the company Pat Dorsey works for, Morningstar.  The idea is simple.  Those companies that have sustainable and strong competitive advantages, will in the end be worth more money than those that don’t have such advantages.  Despite the rather simple concept, the book does spend some time trying to convince the reader why the concept is important.  It actually is something that needs to be explained, because it is a rule often ignored by so many (myself included).

For me personally, the most useful thing was not how to think about companies that I am looking to invest in.  It was most useful to me as a way to think about my own company.  It got be thinking about the industry I am in as well as my company’s position in it.  The book made me think about ways I can help my company create a lasting economic moat or if it was a waste of time to even try given my industry’s dynamic.  I actually recommend it highly to anyone who has major influence in a company and is looking to jump start ideas on how to create strong competitive advantages.

So overall I recommend the book.  Probably because it fits in so nicely with my own investment style.  Just take a look at my Shopping List (which I know needs to be slightly updated) .  Almost every single one of those picks are a wide moat company.  All of them were picked before I ever read this book.    Great minds just think alike.

This is why you wait to invest right now.  The market is just sloppy right now and you have to be a pretty brave soul to tread into this quagmire.  My advice to you is this, if you have some stocks you have been looking to get rid of, do it now.  Sell on this bounce, because the market is going down from here.  Take something off the table.

Some stocks are starting to look pretty interesting here.  I still like Altria here.  It is down with the market and there is no good reason for it.  You can buy this stock on the dips.  I haven’t been a big fan of Google stock and was strongly advising people to sell at the $720 level (it topped out at $747).  However, it is back in the $500’s and went as low as $519.  If it comes down to around $510 I’ll have to take a very hard look at it.  I also would love to buy into Berkshire.  This is exactly the environment that Buffet will kick some ass in.  Great long term play if you have the cash right now.

A few weeks ago, Aaron had asked me why I buy individual stocks rather than invest in index funds. He makes a good point. Index funds beat 80% of the market. When you factor in their very low cost, it would seem silly to invest your money any other way.

And I generally agree with the principle that for most people, the right thing to do is to invest your money in index funds. However, I’m not most people. I love thinking about what trade to make. I love doing the research before I buy a stock.

Some liken stock picking to gambling. I really don’t think anything could be further from the truth. True, short term stock picking can be very hard. There are random fluctuations that happen for no other reason than the sentiment “feels” something is going to happen. That can be quite scary.

However, a stocks long term price is 100% correlated with its earnings, and with enough homework, you can figure out which stocks have the best earnings potential. You won’t be right 100% of the time, nobody ever is, but you can certainly pick more winners than losers.

I take the Warren Buffet advice on investing. Put all your eggs in a basket, and watch the basket closely. My portfolio at this time is relatively small, and I watch it closely. That being said, I’m getting hammered along with the rest of the market. So who knows, maybe I’m totally wrong about picking individual stocks, but I’m having fun doing it.

Update: It occurs to me that my point wasn’t totally clear here.  I actually think that index funds are good things.  Most of us are dummies when it comes to the market.  Most people don’t need to be experts.  If you aren’t, then you should invest in index fund.

A while ago I took a position in some Natural Gas drillers.  Specifically Grey Wolf and Nabors.  I never really planned on owning them long term.  I just took positions because I thought I wanted a few different energy plays and so I branched out into an area I wasn’t totally comfortable with (mistake #1).

I actually did OK on these at first, and saw some good gains.  As I was in this for a trade, I should have gotten out, but I didn’t.  Soon after, the price of Natural gas spiked down and never recovered.  Since I didn’t have a lot of money invested in either position, I didn’t really worry about it.   I figured that it was OK and that it would eventually come back.  So I held.  Held like a chump.

I should have just gotten out of the position when it reversed.  I made a classic mistake that so many of us make; I let a trade become an investment.  I held on to the position WAY too long in the hopes that it would eventually come back.  Hope, it’s the one case where it really isn’t a very good thing to had.  I kept telling myself that energy was a great story and it would continue to be so (it is, but this wasn’t the way I should have or wanted to play it).  I kept coming up with excuses to keep the stock.  But that was unnecessary.  It was a trade.  Trades don’t have reasons, only investments do.

I finally got out of the positions this week.  I did it to take the capital loss and offset some capital gains I have but it should have never come to this.

are a few great stocks. I’ve started my wish list where I will put all the stocks that I’m actually interested in buying. I might buy one out of ten stocks, but it will give you an idea of what I’m thinking. I’ll update it regularly so check on it often. One of my goals this holiday was to figure out what stocks I was going to buy for this journey. Thus far, I haven’t identified any, and have only listed some good long term plays. I’ll continue to plow through some ideas that I have and hopefully come up with a good play for tomorrow or later this week.

Hope everyone is having a good holiday. If you want to get me a gift I really need some short term trade ideas.