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'Tis the season of our discontent

I understand the bear case, I really do. Monetary, fiscal, and economic policies have backed us into a terrible corner. This affliction is worldwide, though some countries are clearly on the rising side of the teeter-totter. In this country, our decades-long reliance on the inflow of investment capital to offset the trade deficit may finally be reaching an inflection point.

If I take this knowledge to the hard reality of the market, what am I supposed to do with it? I think it is legitimate to point out the sky has not fallen yet despite the fact there are plenty of reasons for it to do so. If I sit on my cash horde ("horde" is a figurative term, unfortunately), then I incur terrible opportunity cost for the chance - the chance - some unknown event will trigger more acorns to fall from the sky to satisfy my internal chicken little.

Let's take the trade deficit for example. The 1980's were perhaps the zenith of the worries about the trade deficit. Rhetoric at the time would have led an observer to conclude the entire financial system of the United States was going to collapse because we were buying too many goods from Asia. If I listened to this perfectly reasonable argument and pulled my money out of the market for fear of a collapse, I would have missed about 400% in gains in the Dow. Oops.

Running a hedge fund must be something of a nightmare at the moment. Compounding this nightmare is the need to outperform, which magnifies your need to not only get the trend right but get it right ahead of everyone else.

Anyone who is truly informed understands the terrible risk of a crash. I dare say readers of the 'Ville are more familiar with these risks than most. However, pulling out of the market and waiting is no option. One could go net short, but there are enough people willing to put a bid under the market that a bear strategy hasn't really worked either. A net long approach exposes you to the fundamental disconnects mentioned earlier. You could ramp up your hedges as a percentage of your default position, but that costs money and robs from your performance. You could chase both ways, but that increases operational costs - again bleeding off performance.

Is it any wonder we see people handing trading decisions over to a computer model? In this context, doesn't the incredible rise in the number and value of derivatives currently traded make sense?

I've had a running conversation with one of my subscribers about the character of this market. He's arguing the current range-bound malaise is a temporary condition. Once the election is over (removal of uncertainty), whomever is bidding up oil decides they are done, and Mr. Greenspan signals the rate hikes are over he believes they'll rally. While I think all three of those are potential rally launchers, I suspect it just means we move into a slightly different trading range.

I wish I had a pat answer for you, but the dilemma that is facing all of you is an equal opportunity affliction. I struggle with it every day. Through a great deal of introspection, however, our team at Biotech Monthly has come to some conclusions that may help you at least get your own internal dialogue started:

1. We're naturally bullish. 2004 was the first year where we have been predominantly bearish and it is the first year we've underperformed. There is a lesson here about sticking with one's knitting as long as we don't take it too far.

2. Be aware of the bear case, but don't defer to it. In the last dozen years, they have been right five times in individual years and staggeringly wrong over the entire time span.

3. Pick good stocks and be clearer about the time horizon. If we pick stocks with considerable opportunity and they execute correctly, performance will follow. Price direction is important, but mostly secondary to The Plan.

4. Paste "The Plan" everywhere in the office so we don't forget it when the screens turn crimson.

5. Hedge risk, don't defer to it. Instead of withdrawing capital, protect it. While this might limit flexibility in certain situations (our chosen field of focus has spotty company-specific option coverage), it should work better overall as it allows us to retain more of the proactive approach that has been successful for us in the past.

As I said, I have no pat solutions to the dilemma that faces all of us. Perhaps through sharing conclusions from our recent introspective efforts - which is an ongoing process, I must say - I can help spur a discussion in your offices and homes.

No positions in stocks mentioned.

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