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I Resemble That Remark



Jay's last paragraph in this Buzz raises a very good point. He says "Just one man's opinion, versus a plethora of shorting this and adding this short and all the double-talk which is pretty much a heads I win, tails you lose style of money management. "

To no one's surprise I am sure, I can identify with that description rather closely. I have - wrongly - allowed the macros to dictate a fair portion of my investing / trading, where following the tide would have been umpteen times more profitable. In chatting with the Iron Horse and other hedgies, they regularly ask me why am I so hell bent on fighting Hoofy when if things turn, there will be plenty of time to jump on Boo's wagon.

IMHO the highlight above is perhaps the most crucial distinction between the doom-and-gloomers, and the bullish crowd.

Perhaps conditioned by my exposure to two real estate meltdowns, a market which by its very nature does not move as quickly as the equity markets and generally does not allow marginal holders a graceful exit, or, often, any kind of exit at all, I am somewhat predisposed to think that that's how all meltdowns take place: with the doors slamming as the participants panic for the exits.

The securities markets are intrinsically more liquid, but even there we saw 15-30% wrecks unfold in a matter of 7 to 14 trading days, in 1987, 1997, and twice in 1998. In 1997 and 1998, the collapses were openly backstopped by the Federal Reserve, while theories abound as to who rescued the market at about 11:00 am on October 20, 1987. Without those interventions, things might have turned out not quite so happily.

What today's doomsayers argue, at least some of them (us?), is that in the next swoon there will be no backstop. First, the leverage in the financial markets has grown to such a degree (and even the most bullish observers generally concede this point), that no intervention is likely to arrest the avalanche once it is set in motion. Second, try as they may, such a meltdown would require central banks to inject such a massive amount of money into the system that the value of such money would degrade exponentially precisely because so much of it would need to be injected (read "printed"): Therefore, even if feasible, such intervention would most likely end up being useless. And to boot, the central banks' tools (money / credit) are already compromised as it is by the massive imbalances already weighing on the governments' balance sheets, which have already tarnished the value of many fiat currencies.

I will recognize that - statistically speaking -- the unraveling described above would constitute a "tail" event. As Snoop Tone aptly put it at MIM2, "we know the sun will explode at some point, but betting on it is not a good investment."

The questions then are: 1. What are the probabilities of such an event occurring; 2. If it occurs, when will it occur?; and 3. What's my probability weighted risk/reward.

I am no statistician, so if you are looking for numbers, sorry. But I submit to you that even the most skilled of mathematicians would have trouble coming up with any meaningful figures. The world financial system is stretched so wide that I bet you half the institutions claiming to be hedged against risk do not have a clue as to whether the counter-party is good for the hedge, if they know who the counter-party is at all. IMHO, the very nature of this web increases the risk significantly because the trigger could be coming from variables that were never in the picture when the initial risk assessment was made.

Assuming the unraveling actually occurs, I do not have a clue as to when. I am convinced though that with every new derivative being created, the sensitivity of the system to even minor problems goes up, and as smaller and smaller problems can become the trigger for an implosion it becomes more likely that any one of these problems will raise its head sooner than later.

Lastly, is it worth living in a financial bunker waiting for the big one to hit? Aren't we supposed to, "enjoy the journey?" I suspect that only your individual risk profile can answer that. There are people who routinely look for the thrill of extreme risk, that's their ultimate journey; for them, the risk is worth it. Call me Chicken Little, or just chicken, but for my money (and much of it is), if the upside of being long the market for the next 10 years is a mean-regressing 5% (plus a premium for our market beating skills), and the downside is a complete wipe-out, I am far more comfortable passing on the upside, guarding against the downside, and taking some chances on actually benefiting from the latter rather than the former.

Which brings me back to Jay's statement: Am I a double-talking, head I win, tail you lose manager? I don't think so. If head is a bull market, Hoofy and Jay will win and I will likely lose some. But if the tail event does come up, I am afraid Boo will take no prisoners.

In the meantime, hopefully we can all enjoy the journey.

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