I WATCH 2 THINGS
1. FUNDAMENTALS
2. INVESTOR PSYCHOLOGY/ASSET PRICES.
Main Fundamentals I pay attention to per Drunkenmiller:
1. Look inside the S&P500. Drunkenmiller says this is the best predictor.
-Cyclicals Decr. (Autos, Construction, Consumer Discretion, Retail)
-Staples Increase(Utilities, Consumer staples, Pharmaceuticals)
2. Yield Curve Inversion
3. Credit is readily available through banks, corporate bonds, high yield
bonds, private lending(Marks puts a heavy emphasis on this too).
4. Asset Prices(bubbles). These will be obvious. ex. Bitcoin, Tech, Housing
Psychology I pay attention to per Marks
1. Too much money chasing too few deals
2. This time it’s different
3. Confusing bull market for brains
4. Market is flawless
5. Investors are interpreting all data positively
Ex. Strong Data–>Economy strengthening–>Stocks rally
Weak Data—>Fed will likely to ease—->Stocks rally
6. Risk tolerance
I simply read Howard Marks memos to see where the state of the markets psychology is.
Per Marks, I can’t predict the timing, amplitude, speed, or bottom of the next recession. I can only make observations on where we are in the current cycle. I use the indicators above to help me block out the noise and distill it to a few things to put the majority of my focus on.
Taking the temperature per Marks
I don’t put as much emphasis on lesser important factors such as corporate earnings, economic developments, low credit worthiness, uncompetitive products, corporate events falling short. Markets are based more on investor psychology, asset prices > fundamentals. The 2008-2009 Global Financial Crisis is proof of this. Corporate profits and the general business environment(fundamentals) weren’t booming. Stocks were at normal level. But investors reckless behavior(psychology) raised the price of real estate(asset prices) to ridiculous levels.
Superinvestor Sentiments
I follow the viewpoints of the Four Horsemen(Marks, Dalio, Drunkenmiller, Tudor Jones). They have the best long term records of positioning their portfolios to survive/thrive during recessions which I equate to as successful market calls.
My action
If these metrics make me think that over the next 1-2 years that there is a 70% chance of a recession, 20% of it continuing to rise, 10% of it going flat I will begin to be cautious and focus on the risk of losing money. I am still looking for deals in the case that the 20% chance comes to fruition and the market continues to go up, but I have a higher filter for investments.
Example of defensiveness
1. Be extremely disciplined in buying. In the 2019 environment, Mohnish
Pabrai said that he is only looking for PE1 stocks to put 10% of his
portfolio and will hit target returns of >26%.
2. Buy equities that will be more valuable in a 1% growth environment than
a 3% growth environment. Ex. 2019-Cloud companies are in the second
inning and a lot of companies will switch to cloud to save money to cut
costs. Ex: auto-parts, auto-maintenance/mechanic, dollar general.
3. Hold more cash than normal
Cons of my approach
1. Being too far ahead of your time is indistinguishable from being wrong.
(HM). You run the risk of losing out on making money. 1-2 year time
horizon is an ambitious time frame to strive to predict. The 30% chance of
error is uncontrollable and unpreventable. Remedy: I am still invested but
not as much.
2. The four horseman have error rates. Tudor Jones and Drunkenmiller
can change their predictions quarterly. If you track some of their calls
you will find that they are plenty wrong. Also the four horseman
contradict each other which makes it difficult to choose which one to put
more emphasis. Remedy: Use them as a guide, not as dogmatic prophetic
claims. I tend to give Marks calls the most attention as he only calls it
when it is egregiously obvious. His memos are wonderful.
3. 70/20/10- are arbitrary numbers I came up with. There is no scientific or
calculating way I come up with these probabilities. I guess it is intuition
based on the indicators above I am using.
The Rational Cloner 