Brandon Potts

Jul 12, 2017

7 min read

Learning? Let’s Talk About Earning — Part 2

In Part 1 I wrote about some of the prevailing trends in our current market, including:

  • investment allocation (how much $$ you should deploy into markets)
  • my personal take on entering trades (I prefer uncrowded, limit orders)
  • obscene debt levels due to quantitative easing (numbers too large to comprehend)
  • the Trump Bump reflected in today’s valuations (a mean-reversion is due )
  • the Melt Up thesis (the end of bull markets experience the largest gains)

I concluded with a model portfolio that I believe will allow us to capture gains in the case of a bull market, but will also allow us to profit from a bear market.

For any of you who have YET to read Part I, I encourage you to do so now.

It should go without saying, but I will say it anyway! I offer my thoughts here and I encourage anyone reading this to simply use my thoughts as a starting point for pursuing a personalized investment strategy that you, and only you, are responsible for.

Everyone knows that investing for the long-haul is the smartest way to do it, but I find it foolish to ignore our present situation of insane debt loads, increasingly shady politics, shifting geopolitics, and most importantly, a global zeitgeist of FUD (fear, uncertainty, and doubt).

Meaning, I find it very difficult to rationalize the action of blindly pouring money into any low-cost index fund based on the assumption that markets always go up. Especially in a high-risk environment like the one we have today.

Our goal as investors is to increase our working capital. While you may be comfortable increasing your capital via small gains over extensive time frames, I prefer to sit on my hands until a mispriced situation presents itself where the gains are considerably higher than the capital at risk.

So sure, there are times where I may be earning 0% because I am holding cash, but at least these cash holdings will not be exposed to any losses should a correction occur. Also, when the correction rolls over, I can buy up positions I have been researching and at a beautiful discount to where they are today.

This is how to increase our working capital, folks. Let the markets come to you, not vice versa.

The main question is, why would you expose yourself to crushing losses for dismal annual returns of 4–5%?

I am not pursuing the “traditional” investing route of buying blue-chip stocks and sitting on them forever. Unless you have the mental and emotional fortitude to commit to a strategy that employs dividend-paying stocks, requires an outlook of 20+ years, and you fully appreciate the concept of compound interest, I recommend you reconsider going all-in with the “traditional” route as well.

To be clear, I am not saying avoid blue-chips, dividend payers, and the value-investing approach (think Benjamin Graham & Warren Buffet). I am just suggesting that you do not allocate ALL of your investable assets to this approach. This is a crowded strategy, and when any trade becomes crowded a reversion to the mean (uncrowded) is likely closer than expected. In fact, I have a small allocation to these very funds in case the bull market reigns supreme indefinitely.

Eventually, one day, I will commit to the traditional, long-term strategy. At this point, however, a shorter term “Trump Bump” will have reset and a longer term credit default cycle will have turned over and I will, hopefully, have added a sizable amount to my working capital by investing in positions that go from uncrowded to “it’s getting a bit stuffy in here.”

I carry an outlook varying between 1–3 years, 3–6, and 6–10 years, depending on the trade type. You could say I am more interested in the “short term” game, though that is subjective. It’s also worth noting that despite my time frames, I cannot predict the future nor can anyone else.

The best way to approach investing is to simply save, save, and save some more and wait for stocks to take a large decline very rapidly, a panic. Panics are also a subjective event. From a day trading perspective, a panic can mean a single-digit decline, whereas from a long-term investing perspective a double-digit decline is a panic. Panics beyond this are rare, and waiting for these is really a guessing game, but can be extremely profitable.

At the height of the panic, deploy your dry powder (cash) into cheap assets when everyone is freaking out and hold on for a few years. It is hard to do this, because emotionally we want to feel like we are making money by doing nothing. We want to feel like we are invested in something sexy, and we are missing out if others are making money while we aren’t. So the hardest part of this strategy is waiting for a panic, however you decide the define one.

Again, why risk ALL of your money just to make 4–5% a year, when you can save up SOME of that money and enter positions for cheaper down the road?

Then, the odds are in your favor for gains much higher than a meager 4–5% annually.

Sure, you “miss out” and grow frustrated when you see and hear friends gloating about how they nailed one stock and made 1403% overnight. Here’s that friend (looking at you early Bitcoin buddies)…

I didn’t say it was easy, but like most other things in life I think the things that require the most effort and discipline are the accomplishments we cherish the most. I am hoping that one day I can look back at my current approach to investing and say that I am grateful I dedicated so much time and effort to educating myself and always looking for opportunity.

The thing you absolutely must realize is that by investing in pursuit of 4–5% gains it exposes you to 100% losses. Would you not prefer exposure to 100% losses, but instead in pursuit of substantial gains?

After all, anytime we invest we are exposed to 100% losses. Don’t forget that.

We are swinging for the fences while minimizing our exposure, folks. It’s called asymmetry, and we look for an imbalance leaning towards the upside in our favor.

So what’s an alternative to pursuing 4–5% gains via S&P 500, the Dow, Vanguard index funds?

Again, to stuff away savings like a squirrel before winter, and wait for a “Store Closing” sale.

The thing about today’s hyper-connected world is that fear spreads rapidly. So along with any sort of downward pressure will come fear, and as a result of this fear, more selling and even more downward pressure. This snowball effect will eventually land stock prices in the “oversold” price range.

This is where we want to enter our positions. At the height of the selling and the fear, we will strap our boots on and go bargain hunting. THIS is the time to buy and hold with the “traditional” value investor approach.

If you are gambling your money you want a higher risk/reward. I see limited value in buying into a bunch of stock at the tail end of a bull market. However, this is exactly what people are doing. Sure the party may last longer than I expect, but it will end.

Every cycle does.

In fact, the only reason I would entertain the thought of entering traditional positions in a historically long bull market would be during the preface of a melt up.

The melt up is a possibility, and as such, I am still cautiously bullish on the market. But I am keeping a close eye on my current positions and understand that now is not the time to get greedy. I am closing out my big winners for a profit, and letting the cash pile up while placing limit orders that are well below market value for stocks that I would like in my portfolio at some point.

Hell, even the Omaha Oracle himself, Warren Buffett, has been accumulating cash waiting for things to cheapen. Think he knows a thing or two about market cycles?

In summary, for as much as I read and study the markets, I think our best bet as investors is to save funds, study trends, educate ourselves, and chart a course of action for the bargain hunt.

Here is a model portfolio that I feel comfortable recommending for those of you looking to diversify a bit. Tailor it to your personal requirements.

Bullish holdings

Biotech (various), Cybersecurity ($HACK), Chinese Tech ($KWEB) , and US Tech ($ROM). These stocks will likely catch wind in the sails in the event of a massive melt up bull market with unbridled enthusiasm. Odds are that if/when your Uber driver is telling you he is buying into market, these stocks will be outperforming (and profit-taking should be your next thought).

Bearish holdings

Precious metals, Cryptocurrency (more on this later) and Long-Dated Put Options on heavily-indebted companies (auto and retail are good places to begin searching here). These holdings will rise in value when the markets experience volatility. They also serve as insurance to Black Swan geopolitical events (i.e. war, protest, Brexit, etc.). Black Swan insurance is a lot like fire insurance, by the time you realize you need it it’s too late.

Fun Money holdings

How about cryptocurrencies? Talk about asymmetry and volatility. This is the ideal space to risk little capital for substantial gain.

“There are decades where nothing happens, and then there are weeks when decades happen.” — Lenin

DISCLAIMER : This content is for informational, educational and research purposes only. This post is not to be taken as personalized investment advice.