It has been over a month from my original post Investing in These Troubled Times (Part 1) so I thought of updating all of you on some strategies.

I have continued to stay out of buying in this stock market.  I have shorted the market from time to time using SDS which levers 2X1 moving opposite the S&P500 index.  It is not for the faint of heart as it moves as much as 20% in a day if the market moves 10%.  I usually step in when the DOW hits around 9400.  I put a stop in at 5% in case I am wrong.

For the slightly longer term investment 3 to 6 months maybe slightly longer, I have been buying municipal bonds with a average term of 14 years. The yields are around 5% tax free.  The thesis is that the credit crisis caused a flight to Treasuries The three issues/risks that I see for this investment are:

1. Liquidity
2. Default
3. Inflation

In terms of liquidity, I decided it is too risky to buy individual munis so I bought AAA rated Fidelity long term no load muni funds.  Much easier to get out if things go the wrong way.

Default risk is present and I will be keeping an eye out for any signs that the recession is impacting muni prices further than the 10% move already in.

Inflation is not of great concern right now.  We are entering a recession where rapidly decreasing demand is pushing all prices down accross the board.  Not to mention the significant deleveraging which will more than offset the dollars being pumped into the system by the fed.

Why is this a 3 to 6 month trade?  Well I believe that the credit crisis will thaw by then and the flight to Treasuries will reverse. I suspect that money will flow back to Munis and the price will appreciate about 8% for this type of investment.

 

I will keep you posted.  Until next time.

Angrywatchdog

This is obviously a very tough market in which to get your feet wet. I am currently sitting on cash and waiting patiently for the opportunities to evolve over the next 6 months to 1 year. These opportunities will present themselves but as a conservative investor, I want to wait until the risk has diminished in the market before I jump in. The following may sound ridiculous but it works. Create a list of 10 to 20 very simple investment rules and follow them religiously. Books on day trading will give you a great start on these rules. They sound simple but prove very difficult to follow as you become emotionally involved in the market. Having the list and referring to it before making a trade will keep you disciplined. The market runs on greed and fear and your advantage over the market is to remove these two emotions when you trade. Some of my rules are:

1. Don't fight the market. (If the market is going down don't try to stand in its way).
2. Don’t try to catch a falling knife: (This is what is happening right now in the market so do not be a buyer yet).
3. If you get in a trade that does something different than what you expected, get out. (If this happens, you did not fully understand what was driving the stock price and you need to take a time out and re-evaluate or move to a different stock.
4. When you enter a trade, put in your sell order and your stop loss. (By putting in your sell order, you will be reminded of your expectations for the trade when you entered it. This will help you evaluate when to get out of the trade.
5. Buy and Hold is for suckers. (A rule that is definitely not preached by money managers but has saved me more money than any other rule.)

As far as company picks, most stocks will get killed in this crisis and recession and a recession is here. If you must invest, I like Google and Intel. They are market leaders in their segments and may pick up market share in a recession due to their cash positions. I would stay away from the retailers for now. In terms of when to buy Google and Intel, wait. The stock market usually leads main street by 6 months. That means you want to buy these two 6 months before the end of a recession. How do you know when this is? There is no one answer to this question and any answer I give will run counter to what every money manager will advise you to do. I do believe you can time the markets and I will be following this market closely to try and pick the best time to buy. The forces that are causing the market to go down will drop away one by one until there is one or two powerful forces that keep pushing down on the market. As soon as these last two forces show signs of dissipating, that will be the trigger to enter your trades. Right now I believe we will not see the lows in the market during 2008. As such, I would not be a buyer of any stock right now.

Watch the market every day and try to understand why it is behaving the way it is behaving that day. After a few months of this, you will be able to identify the forces that are influencing market moves (employment, VIX, interest rates etc…).

For Recruiters:  A sample of my recent work is available below. It is a financial model of Brick and Mortar, a real estate investment company with 3 independent funds. Based on risk analysis in conjunction with this model, we averted a potentially disastrous investment in single family homes at the beginning of 2007.

• Brick & Mortar – Financial Model:  Financial Forecasts v3.xls (493.50 kb)

 Please feel free to download a Microsoft Word copy of my resume (Peter Sharpe resume.doc (33.50 kb)).

The groups described below have inflicted a greater financial damage on our nation than Al Queda could ever have hoped to. 

The sheer unchecked greed of Wall Street and the failure of government to recognize and halt excessive credit availability have taken America to the financial edge.  Last week (beginning Sept. 15^th, 2008) we as a nation experienced the unraveling of our financial system at the hands of those who remain unable to control their greed.  We all know how we got here, as those more qualified and smarter than I have written (http://www.msnbc.msn.com/id/26837854/page/2/ for a good quick summary).  The people responsible: 

• High Risk Homebuyers:

Homebuyers who thought that they would get a free ride into home ownership and refused to educate themselves about their true financial situation are at the source of the meltdown. I am not sure that I understand how a person who is making one of the most significant financial decision of their lives does not plan for a relatively likely scenario of real estate price declines.  I place the most blame with this group because without them, the rest in this list would have had nothing to do. 

• Government: 

Policies approved by both parties that allow Freddie and Fannie to leverage themselves to unimaginable levels.  Interest rates that were kept at ridiculously low levels invited imbalances in the market. A lack of leadership in government to confront excesses credit availability due to excessive leverage, complex derivative products, Hedge Funds etc.  Our representatives act in their own interest and not in the interest of our nation (I am talking about all representatives from all parties). 

• SEC: 

Lack of oversight of investment banks who have also been allowed to leverage up to 40X+ assets. What are these people thinking?  This is nothing short of negligence.  One tiny hiccup in the market and the whole house of cards will come down.  You don’t need sophisticated models to figure this out, you just need a napkin and a pen. 

• Mortgage Lenders: 

Nothing short of greed here!  Putting people in mortgages that they obviously cannot afford.  There are many mortgage lenders that need to be held legally accountable. 

• Real Estate Appraisers: 

Most Real Estate Appraisers do their job and allow the market to dictate the price.  I cannot find fault in that.  However, there appears to be significant number of appraisers who purposefully over estimated their appraisals and for those, there needs to be legal accountability. 

• Rating Agencies:

I am not exactly sure what this group does but I can assure you it is not their job.  These people took for example 100 sub prime mortgages, sliced them into groups and said that up to 80% were of the highest quality and investment grade.  You would have to be a moron to think that 100 sub prime mortgages are not correlated.  “Oh” they said “but the historical default rates on these prove that 80% is reasonable.”  If that is your answer then you should be fired.  If you look at default rates while real estate is rising, then invest away but to evaluate the true risk, try looking at a period of declining real estate and better yet when a real estate bubble has bust then the 80% should be more like 20%.  These rating agencies were plain wrong and they need to be held financially accountable.

•   Wall Street:

A collection of our brightest minds!  These people are definitely smart, no question about that.  So how could they let something like this happen?  Simple!  They are so focused on making money for themselves that they did not take the time to ask the question, What if.  It is the first question of risk analysis and these people didn’t ask it.  A first year at Wharton would have answered the question correctly but would anything have changed if Wall Street had asked the question.  Probably not.  When you pay someone 5 times their base pay in bonus based on current year’s performance, there is incredible incentive to “swing for the fences.”  If you hit the home run, you make a fortune.  If you miss, you leave and join another firm to try again.  

• Banks and Financial Institutions: 

Unfortunately for this group and for us, they were the last ones holding the bag in this giant pyramid scheme.  They were led to the CDO investments and jumped in without fully understanding the underlying instruments and their correlations.  A rule of thumb for investing, if you do not understand the instrument and how different market scenarios will affect your investment, don’t invest.  Because of their lack of understanding, we face a potential run on the bank.  Last week depositors feared a meltdown in the money market mutual fund area.  The run began but was swiftly stopped when government stepped in and backed the industry with a guarantee.  Banks got extremely nervous about a potential run on their deposits given their $100,000 cap of FDIC insurance per depositor vs no cap placed on money market mutual fund deposits.  The government quickly retraced and said only money market funds deposits prior to last week were guaranteed.   

Am I angry?  HELL YES!.  A lot of these people made a lot of money over the last 8 years and now we, the taxpayers are being asked to pay a hefty price to bail them out.  Will we pay? Yes because they have put us in a hole that can get a heck of a lot deeper if we don’t. But don’t think this is over.  There is a lot more pain to come due to the fixes we are putting in place today.

My next post will discuss the potential impact of the Government bailout.  Future entries beyond that will attempt to provide investment strategies to protect yourself.

I welcome comments and questions so don’t be shy.  Please post comments to my blog so that I can read and respond to them.