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Resist Urge to Overshoot


Emotions are the enemy.

"Markets can remain irrational longer than you can remain solvent."
- John Maynard Keynes

Remember the prediction of $200 a barrel of oil? Peak oil overrode any rational thinking regarding demand destruction as speculative positions via the Enron (and London) loophole played their supportive role. Then the bubble burst thanks to the credit crisis with demand destruction and the exiting from speculative positions by financial investors bringing prices down to earth. Now we have the mirror image of that period with fear so thick you could cut it with a knife.

The world economy is headed for a sustained period of low to negative growth and oil, now under $80 a barrel, is being justified as rational because demand destruction is here to stay.

The larger investment point I am attempting to make is that the greed/fear cycle has a tendency to take things to an extreme, especially in this time of extremes. At one end, the sky is the limit. At the other, the world is coming to an end. Frankly, neither is correct: it only seems that way when you are knee deep in the process.

Investment Strategy Implications

My oil example above illustrates the tendency of markets to overshoot when their fundamentals are taken to an extreme. The financial media finds the rationale du jour for everyday during the overshooting periods, providing more rationales than could possibly make sense. So, let me offer this thought - Warren Buffett has a phrase for times like this: "Be fearful when markets are greedy and greedy when markets are fearful".

Forced liquidations (via investor redemptions) and the absence of lines of credit (the inability of mutual and hedge funds to meet such redemptions courtesy the credit crisis) are pushing many areas of the equity markets to outrageously undervalued levels. For those who can look past this valley of fear, there are many babies thrown out with the bathwater. For such investors, however, the Keynes quote strongly advises that the prudent management of your capital must not be ignored.

If the advice of both Keynes and Buffett are adhered to, investors will look back at this period of panic redemptions and deleveraging driven forced liquidations as a very attractive buying opportunity.

Oh, by the way, from a technical analysis perspective, nearly every major market index I track has produced a major non-confirmation low yesterday.


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No positions in stocks mentioned.
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