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The Straw and the Perfect Storm

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Risk management key in tough times.

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Good morning and welcome back to the swarming. Last night, after a particularly long Hump Day struggle, Mr. Practical and I gathered for steak and vino. It's a tradition of sorts, as we've been friends for 20 years and have come to rely on each other for alternative energy.

As we settled in and settled down, we broke into our usual banter of politics, theology, quantum physics and yes, the state of the financial system. He and I have been monitoring the cumulative imbalances since before the tech bubble and marveled at the unnatural forces that have seemingly supported the financial system since.

There is indeed a difference between a legitimate economic expansion and debt-induced largess. While it has flown largely unnoticed underneath the mainstream radar, it's readily apparent to foreign holders of dollar denominated assets. Minyans know all too well about Our Wishbone World. Slowly but surely, the rest of the world seems to be catching on.

We often say that trading, in its purest form, is capturing the disconnect between perception and reality. That's a fluid, multi-linear and ever-changing enigma, which is why the brightest minds on the planet continually attempt to solve the puzzle. It's the very definition of risk vs. reward.

At the heart of our chat was the recent speech by Ben Bernanke. We've long mused that the Fed would opt for the devil we know (inflation) over the devil we don't (deflation) despite the latter matter steadily forcing itself into the housing scene. Even still, they let the dollar trade steadily lower as they were in too deep to shift course.

We suspect that Big Ben likely got the call. You know, the call that enough is enough. You can't lean on globalization as an upside catalyst and then ignore it when it doesn't fit your plans. From the tech bubble to real estate to China to commodities and finally, the mother of all bubbles, debt, the margin for error is thinning and, as Mr. P is apt to say, risk is high.

Yesterday, while speaking to an esteemed audience at the MarketWatch summit, I offered some of the above thoughts through the lens that in order to understand where we are, we must appreciate how we got here. At the end of that somewhat somber discussion, someone asked if I ever worried about sounding too bearish.

My response was that the answer lies in whether you're taking a snapshot or watching a movie. It's an incredibly important context, both in terms of perception and risk management. Indeed, while I'm conscious of the macro crosscurrents, I trade the tape both ways. Sometimes, as I did into yesterday's close, I even step to the sidelines to catch my breath.

What I can say-and what I know Mr. Practical agrees with-is this: While the deleveraging process will be painful, it will ultimately lead to a sustainable rebirthing of the business cycle. If we were allowed to take our medicine (rather than being injected with artificial drugs) on the back of the tech bubble, we would have already been on the path to recovery.

I'm not smart enough to know whether this process self-corrects through cancer or a car crash but until it does-one way or the other-the underlying risk to the system will persist. That doesn't mean we won't see rallies and runs, it simply means that risk management trumps reward chasing and our three core tenets of capital preservation, debt reduction and financial intelligence remain in place.

As the check came and we finished up, we mused that finding our way through this financial fray is akin to sucking air through a straw while swimming in a perfect storm. That imagery stuck with me as I enjoyed the fresh summer air on my walk home.

The storm will eventually pass. I just hope there are enough straws to go around.

R.P.

No positions in stocks mentioned.

Todd Harrison is the founder and Chief Executive Officer of Minyanville. Prior to his current role, Mr. Harrison was President and head trader at a $400 million dollar New York-based hedge fund. Todd welcomes your comments and/or feedback at todd@minyanville.com.

The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

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