Saturday, May 22, 2010

PIGS - Market Tremors

In my family of origin, reading something you thought interesting to a sibling, parent or child was a sign of love and affection, as well as a way to stay connected and to expand your world. Receiving one of those readings was taken similarly.

So, on a recent trip, I asked my wife to read to me, as I ground it out for the fifth hour on the freeway on our way there.

“Read what?”, she asked.

“The business pages, please.”, I replied.

But then I glanced down at the paper and saw the front page headline – “Markets Pounded – PIGS to blame”. Knowing my wife’s market nervousness, I told her to skip the reading. Instead of it being an enjoyable pastime for us both, I know she’d be pounding me with questions about our holdings, feeling sick if we lost anywhere near the average and dismal if it was more.

Which brings me to the point of this exercise: she reacted just like many people do. At a sign of market decline, they seriously question the market in general, and their holdings in particular.

Unfortunately, it is usually only at times of market extremes like these that people begin ask these questions, and it is usually in this order:

1. Market Exposure – Am I comfortable with the levels of equities I hold?

2. Holdings – What are my specific holdings – what is their orientation, what is their risk profile? How much am I counting on “the future” (potential growth of earnings etc.), rather than “the past” (historical earnings, etc.)?

3. Emotions – What is my emotional readiness to handle declines or lags in my portfolio, without changing strategies?

4. Rationale – What was my thought process for assembling this particular portfolio, and how well will this rationale hold up if market conditions are reversed?

5. Process – What process and tools did I use to construct this portfolio? Have I given myself an edge in some way?

In a bear market, the predictable answers to #1 and #2 are “I have too much equities – I need to lighten up”, and “I have too risky holdings, I need to sell”. In a bull market the answers are of course reversed. Typically, whether in a bull or bear market, few bother to get around to questions #3, #4, and #5.

If you want to outperform the market, aside from being willing to assemble a portfolio that looks unlike the market – and all the perceived and real risk that can entail - you need to spend considerable time on questions #3, #4 and #5.

In fact, I believe you need to reverse the order of asking these questions. That’s because they form the long-term framework for sticking with your ideas. And retail investors are notorious for dumping both their strategies and equities, just as market conditions begin to favor those very equities and strategies.

So, over the course of the next few postings, we’ll look more deeply at all these questions, in what I regard as the proper order (1. Process; 2. Rationale; 3. Emotions; 4. Holdings; 5. Market Exposure).

(Reprise series from 2008)

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