Taking Care Of Business

I went to the dentist yesterday, fortunately I had an easier time than Thomas Levy.

Taking care of yourself means going to the doctor and dentist every once in a while and getting some regular exercise. Do these things and you improve your odds for success.

The right approach to your portfolio also improves your odds for success.

Based on emails, comments and talking with people I get the impression that a lot of folks make investing more complicated than it needs to be. Everyone knows they should be diversified but how many people are diversified?

Plenty of people have been burned making a big bet on something speculative yet they keep making big bets. A lot of people worry about a 5% decline even though history is on their side. Beating the market becomes an obsession when saving properly is far more important than year to year results. People who save properly just need to stay relatively close the market, even if they never beat it.

The realization that it can be simple is an important building block. A moderate mix of best of breed companies, foreign countries and a couple of narrow themes, combined with proper saving, will do the trick for a lot of people.

There will be market cycles, proper asset allocation in relation to when you need to start drawing income is always important and if you are so inclined and want to take steps to smooth out your ride, ok, but keeping it simple works and big bets will bite back more often than not.

Everyone knows these sorts of things but very few people act on them.
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"Chiggity Check Yourself"

Sage advice from Pepper Brooks, color dodgeball commentator for ESPN8, The Ocho (second reference this week).

I wrote up an article for RealMoney that drew a lot of what I would characterize as emotional responses. We have had a couple of clients have emotional responses to the current market volatility and some emotional comments on the blog.

A big picture way of thinking of this is that we have had a bad month. There might be more bad months to deal with or not but that is what we have had. I went to page 155 of the 2007 Stock Trader's Almanac, the one with month by month changes in the S&P 500 going back to 1950, and I counted 53 bad months with a bad month defined as a 5% drop or more. So almost one a year. The one a year is less common than the 2-3 per year every few years and there were a couple of instances where there were more than three in a year.

So 53 times in 56 1/2 years (it only goes half way through 2006) means, to me, that this is very very normal. Emotional responses to very very normal will likely result in a bad decision.

This is what behavioral finance is all about, emotional responses to financial events where emotion is the last thing you need. There have been white papers and the like on this subject.

How many of the 53 bad months have you endured in your investing career so far? How many more do you think you will endure in the future. Now replace bear market with bad month in that last sentence.

I prattle on about having something in place to try to take defensive action if a bear market looks like it is coming. The entire point is to remove emotion from the equation. Look at a long term chart. If you first invested 20 years ago to the day (so right before the crash) with a long term time horizon and literally never sold anything (assumes index funds) you have endured wars, bubbles, terror, various financial crises and you have made a fortune--way ahead of inflation.

So if you can actually smooth out your ride all the better, but it isn't even necessary for success.

I can think of no reason why the next 20 years should be any different so worrying about a bad month becomes incredibly unproductive and depending on the person even physically harmful.
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Familiar Chart Pattern

Long time readers might recognize this chart I use in my technical study as this is what stocks did on Tuesday.

I had a post on RealMoney yesterday in which I said that the panic is over but that the event is not. The market then got whacked. I tend to think that the panic is in fact over and what is happening now is the discounting of how serious this will or will not be.

I mentioned over the weekend that no more selling made no sense to me. That such a big threat could resolve itself in a couple of weeks just seemed wrong, still does.

Based on a couple of the comments yesterday the panic may NOT be over. This is subjective of course but I think the panic of early August was the discovery of the problem. Now that it has been discovered it needs to resolve over time.

Generally speaking I have thought the worst case scenario from this would be a normal bear market and while I have been less vocal about a normal recession this wouldn't be shocking either.

Regarding the Bespoke table from yesterday a reader asked "How do you time your over weighting or under weighting of a sector? Why do you think it is reasonable to time sectors, but not time the market?"

It depends how you use the word time. As a means of short term trading I don't think it is ideal for managing other people's money (this is my perception only and I am not saying what other people should do) and I am not that good at it. In terms of following the economic and stock market cycle, recognizing when sector weights seem to be out of balance--these are very long term things. I have had roughly the same underweight in financials for several years. When the yield curve normalizes I will be closer to equal weight. Is that timing? In a way yes and in a way no.

My focus in the regard involves infrequent need for big change, trying to add value if possible and smooth out the ride a little. This is right for me, it is ok if it is not right for you.

Another reader asks "Why am I in this market when a risk free internet bank pays 5.5%????"

When do you need to use the money? In that time frame what do you expect will be the better hold; a diversified portfolio or a money market. Whatever you answer is what you should own. If you want stocks you need to realize that at this point the market is well within down a little.

Yet another question asks "do you get more bearish as we cross below the 200 dma for a second time?"

I don't think of it that way, but maybe I should. Right now the portfolio is behaving as I hoped. Generally accounts are going down a little less than the market so as we grind around in this same area I don't see a need to add more double short (this can change at any time). The real thing here, and I think most clients get it, is trying to use the tools to try to protect against down a lot. It is helping out for now but time will tell what I do next; I will share whatever that is.

And because Adam asked, Boomah! Speaking of Adam, read this if you have not already done so.
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Bespoke Speaks

The crew over at Bespoke cranked up the Gee-Golly-Whiz Machine to spit out this table of SPX sector weights going year by year back to 1990.

I posted a less detailed type of thing from them before and some readers saw the utility and some did not but this is huge for how I construct sector weights in the portfolios I manage.

It should be easier to see if you click on it. It is also easier to see by clicking on it in Bespoke's original post.
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There Goes The 200 Day

For now anyway.
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Non Sequitur

I was on the stairmaster at the gym for a few minutes yesterday and on one of the TV monitors was coverage of Scrabble from ESPN2. You might expect Scrabble to be on the Ocho but there it was on the Deuce.

Over the weekend, although I did not watch, I saw a listing on the onscreen guide for ATV racing (also on the Deuce). As more and more channels get put onto our set top boxes there will be more and more "sports" televised in the future than now. There are more sports televised today than ten years ago.

This will seem crazy but I think there is a retirement planning tie in to this along the lines of a part time job. Where I live plenty of people drive ATVs (this is an example). A few years ago, before I had the blog, I owned shares of Polaris (PII) as a demographic play. The idea was boomers get older, buy second homes and get a couple of big toys to go along with the home like an ATV.

I had a lucky trade and have not really thought about the stock since and while I don't know if the stock has benefited from this since I sold out the company should be, at least I am seeing it play out first hand here on the mountain.

It would behoove all of the manufacturers to sponsor events in all sorts of age groups with prize money to be won. Now think about applying this to products from other types of activities. I am envisioning a wide but shallow pool of money for these things. Other ideas could include fishing, hunting, bowling, dominoes (another sport covered on the ESPN family of networks) and so on. I realize professionals already do some of these things but I am thinking wider and shallower and there must be many others ideas.

I am talking about activities that people love to do that they could compete in and make some money. If a relatively young retiree (say around 60) could compete for a few years and clear $10,000-$15,000 per year as part of a $75,000-$100,000 income need they could relieve some portfolio stress for the time they could compete.

I realize this is sort of far fetched and anyone could naysay this for several reasons but I think successful retirement in the next few decades will require innovative ideas. If it becomes possible to make money as described above plus a part time job plus, if you can find a niche, eBaying your (or as in my case your inlaws') crap you can relieve a lot of stress on your portfolio plus stay productive.

If you are not VERY wealthy or don't want to work at your job until you are 80 some sort of idea that you can come up with could be the difference between an easy or difficult retirement which is the big macro behind this post; be accountable for your own result and think outside the box.

Good luck and congratulations to Cecil Cooper, the new manager of the Houston Astros.
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Can He Be Right?

Jeremy Grantham is quoted in this Marketwatch article saying the S&P 500 could lose 40% between late 2008 and the end of 2010.

We may all be as mad as this guy if he is correct.

It certainly seems reasonable that we could at least have to endure a normal bear market at some point between now and then but cutting in half, or coming close to it, twice in a decade is pretty far outside the fat tail.

However any scenario is possible and it makes sense to have at least a rough idea of what you would do if Grantham turns out to be correct.

A move of 40% over a period of 18 months or more (the time period implied in his statement) is sort of a slow decline. The kind of decline that many people will tell us not to worry about as we go. To frame this in the way I write about it (and think about it too) is that on the way to the down a lot he calls for is the the down a little that happens every now and then.

Any time the market goes down a little it could be on its way to down a lot. This does not happen very often but slow declines that result in down a lot hit down a little first. In this context sticking to whatever get-defensive strategy you believe in becomes of paramount importance.

An important point to remember is that if the market does actually go down 40% and you do a great job in protecting against most of it, you will still endure a decline of some magnitude--again, if you navigate this scenario fantastically well. Most of us, if we are lucky, will be down a lot but hopefully less than 40%. A 25-30% decline in a down 40% world would be a colossal success in my opinion.

That may not sound great to you but the average 10% annual gain includes all of the worst bear markets in history. Adding ten percentage points of outperformance in a one or two year period would be huge to your long term result.

I would suspect that in a slower decline, that is one without panic, diversification would work, that correlation would not go up between investments where it is usually low. In this environment I would want to own foreign currency and bonds, different sorts of countries (commodity based, surplus or in their own world), cash and big cap defensive stocks all come to mind as places to overweight. I would also hope that I had positioned the double short fund well going into this to neutralize some of that decline.

I have no idea if Grantham will be right and there is really not much need to correctly predict something like that either. Any time the market goes down a little (not the market condition to fear) it could devolve into down a lot (this is the thing to worry about). You can't know when it will happen so don't sweat being right, just stay disciplined and and hope to miss a chunk of it.

The picture is of Adam Arkin playing his recurring character of Adam in my all time favorite TV show; Northern Exposure.
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Sunday Morning Coffee

The poll question from the video drew some interesting responses and questions that I'll try to answer here.

RW has been shooting the lights out with some good short sales, congrats. As far as his question about call writing funds that own foreign stocks; I am aware of two a Blackrock fund with ticker BOE that I own personally and for clients and an ING fund with ticker IGD. I would also suggest checking with Eaton Vance; it seems to me that they have one but I am not sure.

There were a couple comments surrounding the YTD number for the S&P 500. It closed 2006 at 1418.30. It closed Friday at 1479.37. That is a gain of 4.305%. Next add 88 basis points for two dividends (ETFConnect has the yield for SPY at 1.77% and it works out to 5.185%. As for VFINX, the Vanguard fund, I have no idea how closely it tracks the index.

One reader asked what it would take for me to become more sanguine on the markets given the lift. Well lets not forget I might get this wrong but thanks to the snapback noted by some readers in emerging, commodities and a couple of foreign names my having added to my double short fund the day of the discount window cut is not holding me back. It might start to when the snapback effect peters out. As far as being sanguine it just doesn't add up to me that the events that unfolded won't create another down leg of some sort.

I added some double short last summer with bad timing, the market went up a ton and I lagged that up move slightly. I said going into that trade I would be thrilled to lag a huge move up and the same holds true now. If from the low we go up 25% before doing anything else and I lag by 3-4%, that would be a fine outcome. Market up 20 plus percent and you are close either way, you are doing just fine.

As for the discount brokerage question. We use Schwab but I have my HSA at Options Express because Schwab doesn't have an HSA yet. The commissions are in the $15s which is not competitive but everything else about my experience with them has been superior to Schwab by a mile.

The other comments about performance were very useful and it seems as though my thought was unreasonable so apologies for being insensitive. Hopefully I can offer a couple of constrictive nuggets toward these comments.

A lot of the results that were lagging one way or another had some recurring points. People love the closed end funds. I say the same thing about them over and over; moderation. The slapping these funds have taken is far from unprecedented and they will get slapped again during the next financial panic. They do snap back in varying magnitudes but they create volatility when you least want it. Selling during the snapback is probably not a great idea but if you learned you have too much invested I would say to lighten up when things normalize. My weighting is modest and is for areas that are not otherwise easily investible with other products.

One reader ran into problems with stop orders. I have written essentially the same thing about stop orders many times in the past. Stocks go down at different times for different reasons. In that context using the same type of stop order for all times makes no sense to me. And as the reader notes, when do you get back in? Someone is going sell at the bottom tick for every stock. It might be you on your stop order. That will happen every so often and that is OK but if you got stopped out on enough of your holdings at down 8% a couple of weeks ago that it dramatically changed your allocation and you didn't get back in two days later when it took back the 8% figure, well what then?

Mind you, I am not saying I would have jumped in two days later but this all points out that a lot of sales in a fast decline (you gotta be sick of me writing this by now) is a bad idea.

BillB, I said the comment from anonymous was harsh in the context of how defeated the person seemed to be in the comment not that he was picking on you, sorry for the poor choice of words.

Is 72% in fixed income recession proof? Is it mutual funds or actual bonds? Rates are very, very low. Depending on your average maturity you will get crushed if rates normalize and you don;t make changes ahead of time. As a rule of thumb for intermediate maturities; a 1% lift in rates will correspond to an 8% decline in price. Could a ten year treasury, which yields 4.63% today yield 6.13% a year from now if we cycle through a recession and start the next expansion? If so you are down 12%, assuming you go further out than t-bills. That much in bonds has quite a few vulnerabilities, you need learn what they are and hopefully your broker knows the answer.

I will conclude with a reminder of sorts. Constructing a diversified portfolio that does not require a lot of trading (based on the comments I do not think the audience has a lot of day traders) does not have to be complicated. Some exposure to all the big S&P 500 sectors along with some foreign exposure and the realization that not everything will go up at once is a great starting point. Keep the products simple and don't make big bets on anything. These are things you already know how to do.

The picture is from Alaska. That is a glacier (or maybe a fjord) right in the middle of the shot.
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The Big Picture For The Week Of August 26, 2007

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Microcosm

During the recent selloff emerging markets and materials felt a lot more pain than the broad market. This makes some sense on two levels. One is that both areas have outperformed the broad market for ages and the other is that in averting risk people sell things that are thought to be risky.

As time goes on and declines of varying magnitude come and go you may be inclined to trade around these declines. If you do there will be some declines that you trade well, some that you trade poorly and some that you miss altogether.

The accompanying chart shows shows that coming off the bottom from last week that emerging markets, as measured by iShares MSCI Emerging Market (EEM), and materials, as measured by WisdomTree International Basic Materials (DBN), have come back significantly faster than the S&P 500.

Neither of these funds are all the way back, not even close, but the extra decline felt before is now being made up with extra snapback. If the market indeed takes back essentially all of what it gave up earlier this month it makes sense to think that these other areas will take back most of their respective declines as well.

To be clear this post is not about predicting what comes next. The point is to create some context around fast declines and what happens if you miss them or maybe to point out that some folks will be better off not trading them. A recurring point on this site has been that fast declines are usually followed by fast snapbacks which is what we have had so far. That is not to say that a slow decline may not be next because some sort of decline could be the next thing but panicking into fast declines is the wrong trade because there is some snapback.

Anyone who struggled emotionally earlier in the month with their portfolio might want to think about some changes now before or in case the market panics again. I have no trade to make in that context but some folks might.
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Sectorology

There was an interesting flurry of comments yesterday regarding sector weightings. I left a chart up from Bespoke and made the comment that I believe in staying in touch with sector weights and to lighten up when a sector gets out of its historical whack.

There were two comments by one reader saying that it makes more sense to "to compare price to book of various industries with their historical norms and bet on some reversion to the mean."

In a subsequent comment he says "it doesn't make any economic sense to talk about what is the correct percentage of market cap weight for 'tech' in the S&P 500" and then repeats his preference to price to book.

Another reader sort of called him out essentially saying there is more than one way to skin a cat.

I view this whole thing much differently than the commenter. I view the price to book belief as more of a bottom up approach. I will not say it makes no sense but I do believe bottom up is the more difficult method.

In the early 1980s energy comprised almost 30% (it may have been 26% actually) of the S&P 500 and then imploded in on itself to a larger degree than tech did at the start of this decade. These two examples are extreme and they don't happen in this magnitude very often. The financial sector is currently the largest in the S&P 500 and has been over 20% of the market for quite a while. This has been part of my thinking in not wanting to go heavy (in addition to concerns about the slope of the yield curve).

Managing this sort of thing is very subtle and a bottom up person probably doesn't care but I think it can really help out every now and then.

As far as the comment on tech, I view this differently too. There is precedent for semiconductors to provide leadership early in the cycle and for software to do a little better later in the cycle. It might be worth knowing that before you load up on semiconductors at the end of the cycle. Buying this sub-sector at the wrong time creates a headwind. You might still do very well but you are overcoming a headwind to do so.

Using an example from the other day with financials. I talked about adding a little volatility in the sector once the yield curve gets right side up. Inverted curve, late in the cycle calls for, IMO, one type of exposure. A steep curve early in the cycle calls for another type of exposure.

This carries over to various sectors. Also at different points you want a different average cap size in the portfolio or tilting to growth or value is the better place to be. Again this is subtle stuff but I am convinced that I have added basis points making these sorts of decisions in client portfolios. This really is what top down is, it determines a lot of the return to be had and I think requires being less right than owning a bunch stocks that should go up because they are cheap.

Carl Yastrzemski might be the least talked about hall of famer from the modern era, outside of Boston anyway. You can read more about him here.
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Good To Know

This from the gang at Bespoke.

This sort of thing is very important to keep tabs on. I believe tech topped out a hair under 30% and telecom was near 12%.

Over time sectors will get way out of proportion. When that happens it makes sense to lighten up.
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Why Have A Billion...

First something market related. Joe Kernen just made a comment about the markets maybe stabilizing which amused because the futures were up more than nine points.

If we go on to have a great big up day have we stabilized? I'm thinking no. Even if the bottom is in (too early for me to think so) it seems difficult to fathom that given the type of event we have had (I believe we are still having) we could be done shaking out in just one month.

I write about the market snapping back quickly from panics but this would be very quickly.

A couple of hours ago Random Roger's Big Picture crossed the million hit milestone. I realize Barry gets a million hits every couple of weeks but it has taken almost three years here.

I had been looking forward to this for a while but then had an odd epiphany last week about this site.

There are numerous sites that syndicate my content and so the number of people that read what I write far exceeds the numbers on my sitemeter account.

A while back I was invited to join something called BlogBurst which distributes content. Reuters picked up my blog. If I am reading my BlogBurst page correctly there have been 1,015,802 (candidly the number makes no sense at all but that is what it says on my login page) views of my content on Reuters in the last week and another 12,713 views on a site called the Palm Beach Post.

I have no idea how many read me on Seeking Alpha but since their Alexa number is in the 5000 range I am thinking quite a few. So the 1 million figure on my blog means almost nothing; really the site might as well not even exist as opposed to just syndicating content.

This site generates a couple of hundred dollars a month in ad revenues and nothing from syndication. That syndication does not pay is ok but I am having trouble reconciling that the folks doing the syndication do get paid. One of the syndication sites has a plan in the works to remedy this and I have signed papers but am not sure when it kicks in.

I obviously enjoy blogging and since I do have a job I can survive just fine without it paying but as blogosphere content has evolved I am not sure compensation has kept up.

Most bloggers I know don't derive any real money from their sites but a couple of the biggies clearly do which is great but at some point some very good content will disappear as a function of bloggers not being able to figure out to change the compensation model or justify the time spent. I, however, am planning to be here for a while.

Thank you for indulging me in this rant.
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Bond Building Blocks

A reader left a quote from Forbes about important it is to watch the bond market for early signs of trouble for stocks. The reader then goes on to ask how one watches the bond market.

I don't think the answer to this question can be simple. The first point to make is that the bond market is not always a stock market mover. There are all sorts of other markets that seem to take turns influencing stocks and at other times none of them really matter. This changes frequently and so the first thing I guess is to pay attention enough to know what, if anything, stocks care about right now.

As far as bonds specifically I tend to take a big picture, long term view. The starting point is that yields are generally low now and have been low for several years. Low yields means prices are high. If prices are high that is the wrong time to risk. Quoting yields on the treasury curve is easy to do. On Yahoo Finance the 13 week is ^IRX, the five year is ^FVX, the ten year is ^TNX and the 30 year is ^TYX.

Those four along with the Fed Funds rate tells you a lot. If you were alive in the 1990s and 1980s you know that today's rates are low by historical standards. So if rates are low don't take a lot of risk. Another thing I write a lot about is an inverted yield curve. An inverted yield curve means something is not right. It does not matter whether you can figure out what's wrong or not, an inverted curve means there is a problem and that is not a good time to take risk in the bond market.

One way to reduce risk when yields are low is to shorten maturity. Another way to reduce risk in the bond market is to have less exposure to emerging market or high yield debt. I am not saying zero exposure, just reduce it in case things do get ugly.

This now introduces the idea of credit spreads. This can be very complicated but the riskier the type of bond you look at the larger the yield advantage should be (simplified example) compared to a treasury of like maturity. The yield advantage is the compensation for taking more risk. When that compensation is poor (IE spreads are narrow) reduce exposure. When spreads are wider the risk taken makes more sense.

I follow the emerging market spread through the Jyske Bank Emerging Market Daily report. I don't really follow junk bond spreads, that is not vital in the current state of the portfolio.

Another place to get bond market info is Bloomberg's bond page.

With what I read and what I see on CNBC World I am on top of the yields of a lot of foreign countries. I fell like this creates a better context for me to understand what is going on in the US bond market.

The point of this post was to try to lay down some building blocks so that then more in depth study can be done by anyone who cares. I have always thought the bond market was very complex. I have learned a lot (relative to where I was starting from) in the last five or six years and would suggest anyone wanting to manage their own portfolio do the same.
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Um, What Am I Missing?

No joke, I got a solicitation in the mail today from Countrywide for some sort of mortgage product.

WTF?

And although I didn't think I needed a mortgage, I really want this product.

That second line was a humor attempt.
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This Could Matter

This is where the t-bill rate was quoting a few minutes ago.

Wow.
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Reader Questions

A reader asks;

What advice do you have for retirees. I am out of mkt. now. Do I wait for lower entry, or tip toe in? What might happen next 2 months or so?

Well I don't have any great advice. Going to zero equity exposure is a huge bet. While I specifically think making big bets is a bad idea for most people due to the likelihood of being wrong either coming or going it is even tougher to make such a big bet with no plan of re-entry (this is how I read the question).

If the market races higher starting with last Friday's lift never to go down again then any of the benefit derived from selling out will be lost. If the market tanks and he then times his re-entry perfectly it will have been a brilliant (or lucky) trade. There is no way to know what will happen, I think reality will be somewhere in between the two scenarios I gave. Assuming he timed getting out very well he now has to be very right getting back in or it will have been for naught.

Being that right two times in a row is a tall order and not a position I would want to be in. I have no advice for this person but if you are going to make big bets I would urge you plan ahead of making your bet.

Another question;

What is your goal for an annual rate of return? 6%? 8%? While I know we are always looking for the highest returns, what point of return puts a smile on you face, at what point is it okay but not great, and at what point is it just disappointing?

The question is not framed in manner I think of this. The stock market averages 10% or so per year. If you look at a Stock Trader's Almanac you will see that the market very rarely goes up exactly 10%. if you look will see years the market is up a lot, years it is down a lot and everything in between. Average all of them together and you get 10% or whatever the exact number is.

If the market finishes the year where it is right now, up less than 2%, I think getting 8% would be tough to do. Maybe you could do it but a lot would have to go right. If in 2008 the market is up 26% (not a prediction just an example) getting only 8% would be an utter failure, getting 12% would be an utter failure.

I tend to believe you can only get what the market gives. Getting 6% in a 2% world is possible but getting 20% is not unless you take huge risks. Like the market, a diversified portfolio will have years of up a lot, down a little and smaller moves and all that will blend to give you an average that will be in the neighborhood (a little ahead or a little behind) of the market (assuming you want a diversified portfolio).

In that context if you add a few percentage points of extra return every few years you will be lucky and enhance your long term result greatly.

Another aspect of this not touched upon is getting a little less than the market return with much less volatility. This is a topic explored on this site several times in the past. If the market averages 10% and you get 8% with only half of the market's volatility you are having another type of success. This is an appropriate strategy for people with a lot of money, relative to their financial plan, or people who are not comfortable with normal stock market volatility.

I'll explore this again another time but it gives the second question an entirely different dimension.
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Gary Kaltbaum

A reader left a link to an article by Gary Kaltbaum that included this table. It shows the dollar value, in billions, of the adjustable mortgage resets of recent months and what is coming down the road month by month.

I didn't see where Gary got the info from (apologies if I missed it). In his article Gary spells out a logical case for how big of a problem this could be, as I read the article he is certain this is bad and has gone 100% cash in client accounts.

Looking at next March the $110 billion might work out to 366,000 households if mortgages average $300,000. Using that dollar figure and adding up all of the months greater than $50 billion I get close to 2.75 million households impacted.

If that number is close to correct how many of those households will have to severely alter their spending habits? If that number turns out to be large then what does that do to the economy? While I don't have the answers I suspect that, despite one reader's comments, it would not be 1929 all over again.
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Sunday Morning Coffee

I heard several reasoned voices on the network saying that they were buying stocks for the result they would deliver over the course of a couple of years as opposed to the next couple of weeks.

I can't disagree. While I do try to smooth out the ride if possible, stock investing should have a longer view (differentiating investing from trading).

One aspect of assembling and then managing a portfolio is incorporating themes that you think are important one way or another. One of mine that I have written about many times is Iceland. For purposes of this post it doesn't matter why I think it is an important theme and for you maybe it is China or uranium or clean energy or anything else.

The themes that you care about are vulnerable to something (or vulnerable to several things). Among other things Iceland is vulnerable to carry trade unwind/risk aversion. When the yen rallies I know Iceland will lag. It has happened in the past and more importantly will happen in the future.

Whether Iceland ends up being a good long term investment (or not) will not hinder on the occasional yen rally.

If Malaysia is your thing you are probably vulnerable to big declines in the price of palm oil. Palm oil is big thing for the Malaysian economy. While I have not studied palm oil closely it seems plausible that your Malaysian stock or fund will feel a palm oil price correction.

Even if I don't quite have the palm oil example quite right you get the idea.

This recent broad decline has taken just about everything down so just about every theme has had a setback. There will be other times where the market will be humming along just fine but your theme won't be working out, kind of like uranium earlier this summer.

Any long term idea will encounter hiccups, this is unavoidable. Some of them will be fundamental threats and some will have nothing to do with the particulars of your theme. If you really are investing long term (in this context) you have to expect air pockets to come, I mean really expect it.

Additionally not every theme out there will work out in the long term. If you embed several of these into your portfolio it is unlikely you will be right with all of them. Wrong doesn't have to mean something goes to zero, I am thinking that you take on a little more volatility without getting any extra return.

Not being able to be right about all of them makes the case for moderation. I own an Icelandic ETF (owned in account in Iceland). If I am wrong and horrible things happen the index underlying the fund will not go to zero. If it cuts in half I will have a 1.5% hit to my portfolio. So really very little consequence for being wrong.

Getting taken down because there was too much exposure in something is a very preventable investment error.

The picture is from Chase Field in Phoenix when the Red Sox were in town.
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The Big Picture For The Week Of August 19, 2007

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Financial Sector

I have written a lot about looking down the road to what might be coming, then following the event as it starts to play out and thinking about portfolio shifts in that context.

One thing we all need to think about is that at some point the financial sector carnage will end. When it does it will make sense to go heavier into financials. This is not intended to be the usual shopping list hooey that you hear about on the network every time the market drops 1% but more about the idea that after what is shaking out as a real sector beatdown but that the group recover at some point in the future.

The more serious you think the subprime/liquidity issue is the longer it is likely that it will take to unwind. I wouldn't think that if they rally in the next week that all the problems will be solved. While I have never thought this was apocalyptic I will concede it could be serious.

Serious as it may be it will end. A month, a year, I don't know but at some point. When it does adding to your financial exposure will be the right trade. Among other things the curve would need to normalize, time would need to pass and ideally a big company would need to fail. As nasty as that last one sounds a large failure is a good way to scare the market into a real bottom.
In that light it makes sense to think about where you might increase exposure. I have one stock in mind. I have learned the story, been watching the stock for a while but have a lot more time to study it before I buy. The name does not matter as it could change in the future, the point here is process.

The sector is in trouble, the trouble will end, and once it does makes sense that the more volatile names within will provide leadership. As a general idea increasing volatility at the start of a new cycle and then letting up on that volatility as the cycle matures has been a reliable pattern in the past.

To be clear, I think a trade is months away. I am simply looking ahead to what comes next.
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Yields

The violence in the short term treasury market (yields going down) and the dollar skyrocketing against everything but the yen should tell you that this is a panic.

My comment does nothing to imply when it will end but the context is panic and having survived many panics before, which we have, will hopefully make it easier for you to manage this one.
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Perspective

I just got back from a medical call, it was a head on collision, thankfully only minor injuries.

Here is a quote that Larry referred to me from a site called In Search Of The Perfect Investment.

The quote is from someone named Dan Good and I would add if you have a diversified portfolio.

Media euphoria when it went up through 13000 and media gloom when it sank below.
Unless you were foolish enough to be on margin, how has your life really changed?

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Confusion

I think this apartment building is in Canada. "I'm on the fourth floor, c'mon up."

For 2007 my prediction for the S&P 500 is for the market to close the year between 1350-1375, a decline of 3-5%.

As the year started my down a little prediction looked very wrong and now it doesn't look as wrong but we have a long way to go.

The video I made for that prediction is an interesting mix of things I look right and wrong about. I actually mentioned LEND by name as being a candidate for sub-prime trouble, go figure.

You are probably aware that the S&P 500 closing at 1406 last night puts it in the red by almost 1% for the year. Chances are your account is either still up a little or it is down a little (obvious statement) but there is something to consider. Occasionally the stock market has a down year, in fact 28% of the time the market has a down year. I don't know if this will be one of those or not but if it is, well ok, that is not new, it has happened before and is guaranteed to happen in the future.

It might be tough for me to convey how this action repeats over and over and so have no emotional response to any of it. It is also difficult for many investors to realize this is normal market action but it is normal. The context of this statement is that if you have a diversified portfolio and completely blow every aspect of protecting against a typical bear market decline (20-30%) the market will bail you out by going up at some point. Earlier this summer we made back the high on the S&P 500 after it cut in half a few years ago.

Some one will confuse that with my saying don't ever sell anything which is not the case, I'm just pointing out the normal context in case you really get it wrong.

Because declines happen regularly, the idea of having a "get defensive" strategy planned out ahead of time and just sticking to it makes it easier to deal with. If you are one to take any defensive steps you should also realize that it is unlikely you will nail the trading exactly right. That's ok its normal.
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Everybody Run!

This sums up the day with about 30 minutes to go. Everything started out just fine and then the homecoming Queen goes berserk.
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Bumps In The Road

So it was a rough ride in the bus yesterday.

The story with Sentinel and then late in the day it was Thornburg Mortgage (TMA) with some sort of problem with access to capital and a delay in the dividend. TMA dropped 46% during the regular session but rallied as much as 9% after hours.

It seems to me that the TMA CEO was on the network just last week saying that things were ok but maybe I am remembering incorrectly or maybe it was a different Thornburg Mortgage.

Giving TMA every single benefit of the doubt in this circumstance, I think this makes a great case for top down portfolio construction. For a while I have been expressing concern about excesses of all sorts in the financial sector and the inverted yield curve leading to some sort of problem. As of yet we don't know the full extent of the problem but I will stick with the idea that Kudlow is not worried enough and Roubini is too worried.

The way this has shaken out a problem of some sort has been visible for months. The act of just paying attention and knowing a little bit of history could have lead anyone to simply reduce domestic exposure to the financials. Some readers are fond of commenting what a jackass I am but still saw some sort of problem and wrote about it often.

Notice that this very simplistic process did not require the ability to quantify the problem, I still don't have any idea how serious this will be, or time this event. When the curve inverts just reduce some exposure and be a little more conservative in the sector; far from black box.

Occasionally a comment will be left saying how dumb it is to follow external events. Well I obviously I think it is quite important. Writing about this event before, during and after will hopefully give some context about one person's way to navigate this type of reoccurring market action.

If you cut back ahead of time, one way or another, great but if you didn't, remember this event because it will happen again at some point in the future. After fixing itself the curve will probably invert at the end of the next economic cycle, a lot of people will tell us it doesn't matter "this time" as was the case a few months ago because of some different detail and that will be wrong. Yes, the details will be a little different but betting the result will be different will not be smart.

Regardless of any of that, I write the same thing when the market is doing well as when people are getting worried. Maintain a diversified portfolio, have a trigger point to take some sort of defensive action, stick to your plan and know that declines of varying magnitudes are normal. While this decline is "different" it is the same.
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Pressman Takes On...

Fake news shouldn't deter prudent investors

...the Wall Street Journal. Good stuff from Aaron.
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Phew!

Thank goodness all the subprime/credit crunch issues are now behind us!

That seemed to be the message on the network (Adam's term) yesterday thanks to a day that was a touch less volatile. From the no-one-wants-to-get-blindsided department I doubt this is the last of the subprime news in the short run or the longer run. Even if the selling is done for now (not saying it is), it is a good bet there will be something else in the next few months.

I personally don't try to trade short term around these things, I spelled out over the weekend how I positioned myself and when, but I don't want to be totally unprepared if there is another shoe to drop.

If we are done selling down for now and then another 6% hit comes from this sometime in the next six months you hopefully won't be caught off guard. Big picture this whole thing is about messing with access to capital. When this happens it can take a long time to unfold. This became an immediate market threat only a few months ago. While I don't yet have a great feel for how serious this is, it could take more than a year to fully unwind.

Unfortunately most media accounts focus on the wrong thing. As I have mentioned a few times, the default rate is not going to be the thing. The default rate will remain low, this is good for consumers but the market risk is to the pools of capital that invest in the mortgages. There is less investment demand, another round of potential liquidations with fewer buyers is coming soon and a widening of spreads which all hurt the holders of this paper.

A mortgage pool going from 99 cents on the dollar down to 89 cents on the dollar doesn't effect the person who borrows the money to buy the house--hence the default rate has nothing to do with it. But own one of the bonds leveraged two, three or four to one and a 10 cents on the dollar (just an example I am making up), well you can do the math for yourself.

Whatever this will turn out to be, I doubt it is unprecedented in terms of fundamental impact and market impact. It take some amount of time, the market will endure some magnitude and then move on. Moving on will take longer than Kudlow thinks but less time than Roubini thinks.
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PoTAYto PoTAHto

An interesting tone has developed in the comments lately, one that has come up before, about different approaches to market participation.

The thing that gets lost in there sometimes is that there are many different methods of investing in the capital markets. If you spend time looking you will find research that says buying strength wins out. Spend a little more time and you will find research telling you to buy weakness. Same for selling strength and selling weakness.

Research shows ways to trade a lot and have success while other research says to never trade. Then there are studies about behavioral finance which make it seem like no one could possibly trade well. If you spend enough time you will find research from someone credible on every possible aspect of investment approaches.

At different points in time any of them can work and at other points any of them can fail miserably. I don't see how any one style can work all the time. Fortunately long term success doesn't hinder on never ending success.

Part of success comes from being able to sleep with whatever you are doing. If you are trading too much to be comfortable then trade less, if you are not trading enough, trade more. If you are comfortable then big changes don't need to be made but over time as you learn more you would probably make subtle changes.

On this site I write about what I am comfortable doing and why. I think the only tactical advice I give is that you should have some sort trigger point to take defensive action. I don't say what yours should be, I just tell what mine is. Some readers, in that same spirit are generous enough to share what they do in the interest of capital preservation.

The thing that I would hope you take from this blog is a little bit of my process, then go to other sites and take some of their process and combine that with what you believe and create your own process. My style, whatever that might be, is the same thing; little snippets from other people combined with my own observations.

One last point is my style, still evolving as it always will be, is right for me, not you. You need to create your own style, assuming you manage your own, that needs to be right for you.
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Sunday Morning Coffee

Busy morning ahead so just a short post.

According to this, the Lone Star purchase of Accredited Home Lenders is off. I don't know if it true because all I could find on Yahoo Finance was a couple of articles saying the deal was in trouble.

There is precedent for concern in the market when deals get canceled. Since all things sub prime are such a mess now though I am not sure that this deal falling through (if that is what has happened) could make it worse but we'll know soon enough.

The special on Fox News yesterday, this Ben Stein article and other places try to offer solace by saying how few sub prime mortgages there are and how few of them are in trouble. Unfortunately for the markets that isn't the aspect of this that matters. What does matter, IMO, is how the risk is concentrated amongst the holders of this debt.

While I don't think this is the end of world it may not be the end of the selling either.
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The Big Picture For The Week Of August 12, 2007

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Pukification?

There is a lot of news swirling around about various central banks injecting liquidity including the Reserve Bank of Australia which also raised its rate this week.

Ashraf Laidi from CMC Markets said on the show Foreign Exchange that this is worse than 1998. If that is correct we should brace for a lot more equity selling. I have to say I don't know if it is worse than 1998. If it compares to 1998, well we have already had one of these and so while there might be more selling, might there be a faster snapback?

In terms of managing emotion, for anyone feeling emotion, this is a fast decline. People worry during fast declines and don't worry during slow declines. The nature of fast declines is they snap back quickly. We saw some of this earlier this week and I think we would see more snapback whenever this round of the selloff exhausts.

I repeat this sort of thing often because it always seems to be true and also to try to convey the extent to which this sort of trading is normal market behavior that has happened many times before and will happen many times in the future. I also try to convey my lack of emotion during all types of market moves. I think that my remaining unemotional and showing this over and over might help some folks be less emotional too.

In managing your own portfolio calm and rational is probably the better way to go. Hopefully you have some sort of trigger point for some sort of defensive action and all you need to do is stick to it, this is also something I repeat over and over.

No matter what you think about this, it has happened before, been worse and come back.
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BNP Paribas

So now we add BNP Paribas' hedge funds to the list of calamities. The dollar and the yen are generally higher, stocks look to open lower and the ten year treasury yield is much lower.

In my blogging of late I have tried to convey a sense of caution and that financial problems take a long time to work themselves out. It is unlikely that the BNP Paribas news will be the last of the credit market big stories.

There were one or two comments that suggested buying the last dip was the right trade. For some people, strategically it might have been (here I am not picking on anyone in case the market finishes down which is not a given based on recent volatility) but, to repeat myself, things that mess will the financial sector are a big deal and trying to trade around them is not right for most folks.

One aspect of my job is to know when to overweight volatility and when to underweight volatility. Late in the cycle and with a financial something or other that is an easily definable and visible threat is a time to underweight volatility--in the context of managing other people's money.

I think that most individuals do not want the volatility and for now most of the juice seems to be in the financial sector. I have disclosed being very underweight domestic financials for a long time. Look at a financial sector ETF against the SPY for the last couple of weeks. The simple act of underweighting that sector reduces the volatility.

I don't know if it is too late to do that now or not (but I don't think so) but something similar will happen in the future with this same sector or another one and hopefully you can be better prepared for that even if you are on the wrong side of the financials now.
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Random Thoughts

You know those Ameritrade commercials where the guy says he hates finding out he paid more than the quote price? Well unless something has changed, if you actually paid more than the quote price (which is very difficult to know to the millisecond) you are entitled to a price adjustment.

I made a point during the selloff of saying that fast declines usually result in fast moves up, which is what has happened. This is pretty much how it always works.

Its what comes next that is tougher to figure out. What ever is really the magnitude of subprime, it is not now better than it was two weeks ago.

The problems I outlined this morning, or more correctly my perception of them, are still there and their probability of mattering should be no different to you but for now I remain concerned that things are not healthy. I only sold one stock and will replace it with something else next week if the market stays above its 200 DMA. Some are calling this an oversold bounce, we'll see.

Chuck Schumer is a buffoon.

"I'm gonna let the Bush Tax cuts expire." Is that the sound of Hillary's campaign flushing? I don't see how anyone can win on letting the tax cuts expire.

Barry broke the record last night. I remember when Hank Aaron broke the record in 1974 too. I seemed to care more when I was eight. Maybe I'll care more about A-Rod when he breaks the record?
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Is This Anything?

Add Luminent Mortgage and Impac Mortgage to the list of mortgage calamities. Also the market breadth has not been too hot.

Companies getting pasted and poor market internals is what happened back in the Internet meltdown too. This is just a little factoid not an analysis or a prediction.

In terms of analyzing this the market does not cut in half twice in one decade. I suppose it is possible but in terms of realistic probabilities; I would say no. However these little under-the-market's-hood items could, like before, lead to a sizable but probably overdue decline.

This year we have had two mid single digit dips and people freaked out. If you look at market history, get yourself a Trader's Almanac, you will see that 20-30% declines happen often enough that they should be thought of as normal. A decline of that size will happen at some point in some market cycle which will then help put a 6% decline in much better perspective than was portrayed last week.

Whenever the next bear market starts we should expect a decline of more than 20%, 20%. I have no idea if the current mortgage/liquidity issue will be the tipping point or not but the yield curve has been in varying states of inversion for a long time which is an unhealthy condition for financial stocks and financial stocks are vital to the market and lubing the chassis for the economy.

Problems in the financial sector often come home to roost. This might be happening now or it might not. There are arguments on both sides of the debate and they sound plausible but I can't get away from the fact that inverted curves lead to trouble. Combine that with money that was too cheap and too abundant for too long and you have a recipe for recession and bear market, NORMAL recession and bear market not apocalypse.

I don't know, nor do I feel the need to predict the timing of the next recession. This merely pops us as a risk with a decent probability. For now stocks are flirting with rolling over but have not really done so yet.

Do what you want with this but I have been concerned about this for a while and continue to be so now.
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Say Nothing

The Fed should say nothing.

I was on Capital Connection last night on CNBC Europe and was asked about the Fed. My hope is that the Fed says nothing about the liquidity/subprime story.

While this is very unlikely I think the more they say the more worried they are. The more worry they convey the worse the stock market will take it.

My view anyway; I'd love to be wrong.
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Rollercoaster

The market has certainly been on some kind of wild ride the last few days.

The selloff on Friday was clearly a panic down but Monday's rally was arguably a panic up. If so, I am not sure anything is really resolved.

A one day decline of 2.5% isn't really capitulatory especially when the rally the next day is just as big.

The internals were not great for such a big day either. On the NYSE there were 52% advancing and 47% declining according to Yahoo Finance.

I also think that the huge run up in the financials after getting pasted on Friday, along with these other things leaves me questioning the market's short term health. But of course nothing may come from this concern.

I noted last week I was weighing the sale of one particular stock or adding to my double short position. About half way through the day I sold the stock, Starbucks (SBUX) but did not add to the double short. SBUX is a discretionary stock, a sector I am and have been underweight for a while. Discretionary is usually not a great place to be heavy toward the end of the cycle and this has been the right call this year, as measured by the Discretionary Sector SPDR (XLY) but Starbucks has struggled so I sold it.

Given the market action Monday I don't mind having a touch more cash raised.

From the bottom up SBUX has had trouble off and on with various estimates and while I believe people will always wait in line for a fancy coffee the stock has been a let down for quite a while.

If the stock goes up from here it will look like a bad sale and if the stock goes down it will look like a good sale. As I write this now there is no way to know but a touch more defense by lightening up in the wrong sector feels right for now.
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Read This

The Aleph Blog: The FOMC as a Social Institution
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I'm Not Sayin', I'm Just Sayin'

I have no idea what the market will do on Monday or later in the week but this might be worth bringing up now in case I can't post in the morning.

If there were to be a actual crash like in 1987, what would you do within your portfolio? There is no right answer for everyone and for some people the right answer is to do nothing. Whatever is right for you you should know in advance what you would do or maybe have a couple of different plans in place.

If the market did crash, I know my double short would go up and I expect (but maybe not) gold would go up. Assuming no crash (which is the better bet) I have figured out how much double short to add for each account now that the market is below its 200 DMA and that is one option I might pursue but if the market fell 20% tomorrow I would be more inclined to sell what I have as opposed to buy more. Further I can see where some of the foreign stocks would not go down as much especially if the "crash" came later in our session. There might be a delayed reaction the following day in the ADRs and so I might sell an ADR into the crash too.

I might also sell my gold in that type of scenario. I don't have it exactly figured out to the minute each exact action I would take and when but generally speaking I have a plan in place if there is a crash.

This becomes even more important for people who are prone to emotion.

The idea of lifting hedges in the manner described may seem counter intuitive but there is no bigger panic than a one day 20% decline. After a crash fear will be off the chart and while I may not have the stones to buy stock for clients on the day of a crash, it doesn't change the history of crashes; they exhaust almost all of the sellers.

Someone will probably leave a question asking what if it keeps going and while it might, I am unlikely to think this is any different than other big panics. I would also add that even though I would expect a snapback after a crash, selling into that snap back might be the better trade but I'll weigh in on that if it happens, which again I am not expecting.
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Sunday Morning Coffee

A few items to ponder this morning.

Jim Cramer and Larry Kudlow (I believe Larry said this on his show on Friday) said that the Fed should lower rates in the face of what is currently going on in the subprime/liquidity/hedge fund crisis.

I don't know if they should or not but if it is the right thing to do and they do it don't they face the question of Cramer told them to cut and they did? BTW, Adam brought up the same point on his blog and I am sure other folks have too.

Reality is not the point here but I think it would create a perception problem, maybe a bad one. I really don't claim to have the answer but it is a question that bugs me.

Barron's had a mention of the Jeremy Grantham comments that I mentioned having read on MartketBeat. One comment from Grantham in Barron's was that "in five years, he expected that at least one major bank will go belly up." Well I am not sure what you think of that but if the subprime/liquidity mess is as bad as some people say then a major bank or brokerage will fail. This is what happens in bubbles or big manias or whatever this is.

Keep in mind this is not a prediction or any type of analysis but simply a good memory of how these things usually pan out.

Barron's also had a big article about junk bonds, questioning whether it made sense to wade in yet. One thing about unwinding big events like years of money that was too cheap is that it takes a long time to work correct. Sub prime was a problem in Q1, then it went away (from the headlines anyway) and now it's back. We might be talking about it less by labor day but the problem will not be gone. This relates to the junk bond article in that risk is being repriced. Pools of capital need to make some changes to what they own and this sort of rotation could take months which I think means that although spreads are wider than they were, they will get wider still.

I am not saying there needs to be a horrible end, I wouldn't rule it out, but it will take longer to work this out than what I think I am hearing other people say.

Over the last couple of years I have been writing about this whole thing as an excess of liquidity but I don't recall ever trying to guess what the outcome would be. This is not something that has to be done. Recognizing where an excess might be and tilting away from it is much easier for anyone to do than try to time this sort of market event, quantify it and then trade it. That to me borders on a type of rocket science that I know is beyond me.

I mentioned in this week's video about having been underweight financials for a couple of years and the notion of excess liquidity is why. If you are heavier in financials now OK, learn from this. There will be an excess somewhere else in the future. The simple decision to underweight where the excess exist becomes a much more important decision than the stocks chosen in that segment of excess.

The picture is from Molokai on the east end near mile marker 16.

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The Big Picture For The Week Of August 5, 2007

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Ooof

Hopefully you don't feel like the guy in blue from the Italian national team.
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Grantham

MarketBeat Blog - WSJ.com : Crying Wolf Pays Off

The MarketBeat blog has some nuggets of gloom from Jeremy Grantham in which he does concede having been too bearish but calling for very dire things nonetheless.

His arguments are plausible, as a lot of bear cases are, but in the end he will be right or wrong, I don't know which.

If he is right in terms of magnitude any well planned strategy for defense will help. Thus it should not be important whether he is right, wrong or right for the wrong reason.

My plan is simply be disciplined and not get emotional.
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REITs

A common belief that has popped up in the last few years is that everyone should allocate a lot of money to REITs. There are some that advise 10-20% to REITs as being appropriate.

The 10-20% idea has never made sense to me. I have been writing about maintaining a moderate allocation for a long time.

The context here would be pretty much every type of REIT except mortgage REITs which I have never liked and timber REITs which rightly or wrongly I view as different. Am I am talking about malls, storage, office parks, warehouses, apartments and the like.

This chart reveals that domestic REITs have had a miserable few months, foreign REITs have struggled a little while the S&P 500 nets out flat. Folks who listened to the 10-20% crowd are either lagging badly or have had to be very right elsewhere in their portfolios.

I think this is analogous to putting 20% into commodities, all the studies saying this is a good idea notwithstanding.

I am a huge fan of REITs and have been for a while but believe in a moderate allocation. Clearly interest rates going up is not a good thing but I would not have thought they would have dropped by this much but only having one REIT at about a 3% weight (maybe a touch less now) means I didn't have to be right about the magnitude of the decline. The one REIT I use across the board is down 20 something percent and while that is a bummer (recurring theme here) there has been no real damage done overall.

One reason I don't load up that REITs have almost no presence in the S&P 500 (I scanned the list down to SLM corp and didn't see any) so the way I view things adding a few percent can add some value but adding too much amounts to a big bet.

The other thing is that with rates coming off all time lows and still being historically low it hasn't been a great place to be heavy. For anyone with no exposure it might be a good time to add a little. Prices are down 25% and while I have no idea if they will go lower they are a lot cheaper than when Sam Zell sold Equity Office.
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Preparing For A Little Defense

The S&P 500 is flirting with its 200 DMA which is an important indicator for me. While I say that the market breaching its 200 DMA is the trigger point for me to take some defensive action it is actually the day after it closes below its 200 DMA, if that next day is a down day.

If we are down toward the close on the day after I will take some action. For this go around I am still mulling between the sale of one stock, adding to my double short fund or both. I spent the last couple of days lining up my ducks so that I'll be ready if I need to be but maybe that I spent a couple hours preparing means it won't happen (insert nervous smile).

So to be clear the changes I might make at first would be simply a tweak. If, as has been the case the last couple of times this turns out to be a non-event I won't miss a rally, I would just lag a little. Invariably someone will call me an idiot for being wrong about this but I hope I am wrong. I am trying to protect against something that I hope never comes but realistically only comes along once or twice a decade.

If this turns out to be wrong I think the reason why might tie in with something Helene Meisler wrote about on RealMoney early on Wednesday morning. To paraphrase; she said that the market going below its 200 DMA is far less likely to be important if the 200 DMA is still rising, which it is. She says that a breach is much more important if the 200 DMA is falling.

This is helpful. For now I am not changing my plan. I'll take action as described above if I need to. Then depending on what happens next I will either reduce long exposure more or increase it back if the market takes back the 200 DMA and can keep it for a few days.

If I end up being wrong and having to increase net long exposure in a week or two, we are talking about 2-4 trades in total for accounts with 40-45 positions. The important thing is being disciplined without creating undue turmoil in accounts and making sure clients are not too leveraged to one single outcome.
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Take A Deep Breath

The market is clearly in an emotional state. It is during emotional times like now that mistakes get made. Selling now is not necessarily a mistake, nor is buying. Where I think mistakes come in is when you wake up, see what is going on and just decide to make serious changes.

Jim Cramer said something on TV about selling financials. I do not know the entire context of what he had in mind but blowing out all of your stocks in that sector yesterday in reaction to American Home Mortgage without having probably heard of that stock or having decided in advance how to handle a crisis, or studied past crises is probably a bad idea.

I think the trigger points for panicked sales are lack of preparation and being unaware of the current events that threaten or move markets. I write a lot about removing emotion from managing your portfolio. Over time the market is guaranteed to go down every once in a while, guaranteed. And a little less frequently the market will go down 25% or so.

You know this will happen at some point (this is not a prediction of when). It makes sense to to understand a little bit about what has caused huge declines, understand a little bit about the difference between fast declines (like crashes) and slow declines (like in 2000). It also makes sense to understand the current events that could move the market now and understand how similar threats have moved the market in the past. This will help you make better decisions.

I alluded to this on Sunday night, I was trying to point out that avoiding being blindsided will help you not succumb to emotion. A reader put it best when he said being aware of what is going on goes a "LONG way towards eliminating the 'WTF happened?' thoughts" that come along every now and then.

As I mentioned the other day, if you have an exit strategy planned out from before the market hit the skids and you stick to it you will be calmer and realize that days like yesterday or weeks like this one past just come along every now and then.
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