Hopelessly Bearish – Relentlessly Unconventional

by Jeffrey Sica on January 30, 2012

What Is The Irrelevance Of Conventional Wisdom In Achieving Investment Results?
The Epic BattleThe most difficult battle an investor must face in their investment career is the battle within them – either accepting and following conventional wisdom or developing a new way of looking at their investment strategies and financial futures. The most important element in this decision is assessing whether their investment strategies have accomplished the results they set out to achieve when they first started investing.

Conventional Wisdom versus Unconventional WisdomThe core characteristic of conventional wisdom is embracing old, often outdated strategies to achieve investment results. In most cases, it’s the “herd mentality” ingrained in our subconscious as being true. It’s what Orwell referred to as “group think” in his novel 1984 which is defined as “a way of thinking that happens when the desire for harmony in a decision-making group overrides a realistic appraisal of alternatives”.
 It is the polar opposite of unconventional wisdom, since unconventional wisdom involves embracing ideas or strategies which are not embraced by the masses. In investment strategy, unconventional wisdom refers to developing new, often unknown strategies which are relevant to market conditions as they are now – not as we wish them to be or how they once were.
 What Are The Cornerstones Of Conventional Wisdom And What Have Been The Results?The biggest “lie” on Wall Street and a primary cornerstone of conventional wisdom – “Buy and Hold”This fundamental idea behind the oversimplified strategy of “buy and hold “ is buying stocks with the intent to hold them for long periods of time – even forever in some cases – consequently dealing with whatever volatility accompanies holding them because if you hold them long enough they will inevitably appreciate.
The founding fathers of the “buy and hold” strategy are market gurus like Jeremy Siegal from the Wharton School of Business at The University of Pennsylvania and “The Oracle of Omaha”, billionaire Warren Buffet among countless others. They developed their strategies based on statistical data which was accurate … then.
These ingrained strategies are no longer effective, as evidenced by the fact that the S&P 500 first closed above 1300 on March 15, 1999 and has taken 13 years to close above 1300 as it did this past week. In the past 13 years, the S&P 500 has declined 50% or more twice and has declined anywhere from 10-30% countless times – so much for “buy and Hold”. As a matter of fact, not even the S&P themselves believe in “buy and hold”.
Since 1999 around 207 stocks were removed from the S&P 500 which included now defunct companies like Lehman Brothers, Bear Sterns, Enron and WorldCom each removed after they suffered massive declines. If S&P believed in “buy and hold”, instead of the 40 percent turnover in its overall company composition, the results would have been significantly worse. If the indexes don’t believe, then why should you?
The Lies of the Beautiful People – Who Is Responsible For Keeping “Buy And Hold” Alive and Well?The big banks and financial institutions like Citigroup (NYSE-C), JP Morgan (NYSE-JPM), Goldman Sachs (NYSE-GS), Morgan Stanley (NYSE-MS) and several others who have the most visible presence in the investment world. They spend exorbitant money on advertising and public relations to guarantee that they portray an image of stability, trust and customer service, thus creating an illusion in which they could convey a doctrine and philosophy that benefits them. The vast majority of these big financial institutions have made extravagant profits in trading, which involves short term investment strategies. They clearly don’t believe in “buy and hold”, yet they stand to benefit if they convince you to believe in “buy and hold” and remain forever bullish.
Why Are Big Banks and Financial Institutions Always Bullish and Why Is Their Core Doctrine “Buy And Hold”?

1. They only profit if clients stay invested. They profit from clients being bullish.
2. They detest holding cash in investment accounts. Unusual being that they are banks. The reason they detest cash in investment accounts and employ representatives in bank branches to convince depositors to invest in investment products is  because they make significantly higher profit margins on investment products then they do on cash.
3. They use their broad based exposure through analysts and corporate officers to convey their real or fabricated bullishness as a way to convince investors to stay invested. Several  spokespeople for big banks and financial institutions are scripted in what they can and can’t say, whether or not they believe it to be true.

 Failing To ConformIn my former life as a Managing Director of a large financial institution, I was given the opportunity to speak on behalf of the company only after I provided the company with a script on what I was going to say. I received a note which detailed what they wanted me to say which was directly opposite to what I wanted to say and believed. Needless to say, I declined the invitation to speak and remained silent and suffered until the great escape. I couldn’t bear putting the needs of an institution before the needs of the clients who worked their whole life to accumulate the money they had invested with us. I have since been liberated and say what I truly believe.
 Conventional Wisdom – Follow the Leader, Even If It Means Going Over A Financial Cliff

1. If an analyst or strategy was successful yesterday, it doesn’t necessarily mean they will be successful in the future, especially if they took significant risks to achieve those returns. An example is hedge fund manager Jon Paulson, who has been one of the top performing hedge fund managers for the past 17 years. In 2011, Paulson’s  advantage plus fund lost 52% after being up 17% the year before. In defense of Paulson, he is a hedge fund manager and anyone who invests with him should realize that there is significantly more risks investing in hedge funds and should stay away from strategies like his if they are unable to accept the severe volatility. The problem is, that  investors fail miserably when they follow the leader, if they ignore the risk and volatility of these investments.
2. The top performing strategies and managers tend to achieve astronomical returns by taking significant risks which could destroy a portfolio in a market collapse.
3. Banks and financial institutions are notorious for touting the strong performance of the investments that “beat the S&P” while concealing  those strategies which perform poorly. Statistically they have been overwhelmingly wrong in aggregate, especially at market tops like that of March 1999 and immediately preceding the market collapse of 2007. It’s no surprise that the vast majority of these so called market gurus are extremely bullish now.
4. Despite banks and financial institutions delivering subpar returns, one thing is evident – they don’t care.

Conventional Wisdom Of Bargain Hunting and Chasing Rallies – The Fear of “Missing OutIt started with widely used yet idiotic catch phrases like “the rising tide lifts all boats”, “the trend is your friend” and “don’t fight the fed”. I’m not sure how these catch phrases became conventional wisdom, yet they have proven to be disastrous in achieving investment results. Chasing rallies could best be characterized by the restlessness investors experience when they see markets rallying and don’t participate, paying no attention to the fact that the vast majority of major declines in the market have been preceded by dramatic rallies. They become like “dogs chasing parked cars”.
Investors who bargain hunt because they think a stock is “cheap” just because its price is lower than it was at a previous time, are destined to see that “cheap stock” get cheaper. The discipline behind value investing involves far more research, than price depreciation and an understanding that many times cheap stocks deserve to be cheap. Investors are slow to react to a market rally ending abruptly – by the way, all rallies end abruptly.
 Journey From A Bear To A Hopeless BearOur investment strategies have been mostly defensive since last year, until the summer, when I became a hopeless bear. It had become apparent to me that the market had become over dependant on government stimulus programs, central bank interventions and bureaucrats in general and as with any addiction, the markets dependence would be difficult, if not impossible, to break.
The central bank failed to stimulate the economy and or the economy didn’t improve. The European debt crisis began to accelerate making it evident that although the market could endure a Greek default through intervention by the European central bank, it could not endure a default in Italy – which is inevitable .The significance of a worldwide banking crisis is evident as distressed nations begin to write down debt. No conventional wisdom will succeed in what is about to happen.
Losing The Battle To Win The War – No SurrenderSome people think being hopelessly bearish means we’ve surrendered or maybe even become complacent, hiding under our desks waiting for the end – we haven’t. We have become relentlessly unconventional.
I’m not diving into the market head first throwing money at a basket of stocks, crossing my fingers and hoping for the best, so I haven’t participated in much of the recent rally as I am willing to give up short gains to protect portfolios. Unconventional wisdom is to protect portfolios first, while conventional wisdom stresses beating the S&P. I will never attempt to beat the S&P in an environment like this, if it means taking on the volatility of the S&P, because volatility never ends well.
Fear Of Commitment – No Emotional AttachmentI have no emotional attachment to any stock I invest in. I selectively buy and will sell quickly if  a stock fails to perform or declines to a specified predetermined price. I invest in anticipation of events with a likelihood of happening and I’m willing to accept a specified amount of volatility. If a position becomes too volatile, I sell it because as I’ve said before, volatility never ends well.
Into ObscurityI have no hesitation in buying obscure, often unloved, ignored stocks if I find value in them. I also will invest in things like natural gas pipelines, precious metals, currencies and real estate, as well as privately held companies. I will often short stocks or currencies as we are currently short the EURO and long the Australian dollar and the Canadian dollar and even commodities; all of which I wouldn’t hesitate to sell in an instant, if something fundamentally changed that could be detrimental to the performance of the stock.

Redefine What It Means To Be A Hopeless BearThe conventional wisdom that being a bear, even a hopeless bear, means investors can’t profit, is entirely false. It’s important to redefine what is most important when it comes to investing in an extremely volatile and dangerous market. While at one time conventional wisdom favored beating the indexes to achieve significant returns despite the risk, it is entirely unconventional to consider portfolio protection as our primary goal – but it is. As far as profiting in this market, I consider the bulls as being the complacent ones, stuck on conventional wisdom and useless strategies while we rigorously pursue unconventional  strategies to protect and profit our clients. Although we may face some criticism for not participating in this recent rally of the S&P for the sake of protecting our clients  and we may even underperform the wildly volatile S&P, one thing is certain, we will remain relentless and forever unconventional.