ManyPeaks.com

While on vacation in Jackson Hole last week, a client inquired why — after mostly dodging the waterfall selloff 2 weeks ago — their Absolute Return account hadn’t participated in the 3 day rally from Monday 3/19 thru Wednesday 3/21.
My email response:

First, on a daily chart — my primary timeframe for gauging the health of a stock or index — the market is in a downtrend now. This is a decent bounce, but until further notice, any bounce is by definition a countertrend move. The index charts would need several weeks’ worth of repair (”backing & filling”) to renew my confidence in the overall market.

Since we make primarily a long side investments, low-risk opportunities are fewer now than when in a multi-month rally mode that we experienced from Fall 2006 thru late Feb 2007. So my move is to tread lighter and do relatively little building of positions meant to be held for weeks/months (& seeking 10-40% gains). Trading moves that are counter to the main trend in one’s chosen timeframe requires very short holding periods, small % gain goals, and lots of attention. It requires true “day trading.”

Being away from the screen for much of the day during my vacation, I would not feel comfortable loading up on the long side just to try & catch a bounce such as we have experienced this week. There have been relatively few trades executed for Absolute Return clients as I nurse several small positions and await both my return to the office and the bigger timeframe setup that I’m anticipating (which is a failure of this bounce in the next few weeks and some very juicy trades on the downside). My opinion & actions taken for clients of course will change if this scenario does not develop.

Remember that the first two return goals of the Absolute Return account are (1) No down years and (2) Double digit net returns. The third goal is to beat the indexes. I plan to accomplish all three during a calendar year, but unlike a huge long-only mutual fund, I do not “have to chase” the market as it rallies (typically by buying higher beta stocks) to maintain my lead or try & catch up to the S&P 500. I can await the best pitches that I can find. I’ve found that patience is a virtue in my trading, and as you know, returns are not linear. As a manager who’s compensated mostly on performance, I am looking to forward to creating the next new high in your account’s value.

Finally, just like my strong outperformance in February, 3 days is such a short time period that over the course of a year it’s both fairly inconsequential and primarily a product of luck & randomness. If you’re interested, I would recommend the book “Fooled By Randomness“>Fooled By Randomness” where the author tells many tales where luck is confused for brains. Good portfolio managers are truly good “luck managers.” When it’s good, try to maximize gains.. but when it sours, limit the negative effects through sound risk management.

Sorry for the length, but I hope I’ve answered your questions.

I’d love to catch every move, but am happy to wait for a better pitch. On a shorter-term basis, I anticipate a little sideways chop during this week and then a jaunt back up toward the 12,6-700 level in the Dow (the DIA ETF depicted below trades at 1/10th of the index). The ability of that rally to stick (for several weeks/months) will go a long way determining the fate of this market during 2007.

15% invested