In an environment like the one we are in today I think it is important to revisit the difference between trading and investing. It is very easy to get caught up in the wild gyrations of stocks and confuse the daily (and weekly) swings as “investing”. In my opinion, this is actually just noise caused by the people who are “trading” within the markets in an attempt to take advantage of volatility and short-term movements in stocks.
At Cabana, we are investors and are seeking to grow accounts through allocation of money to the major asset classes at times during the repeating economic cycle when it is deemed by CARA (our Cyclical Asset Reallocation Algorithm) that those particular asset classes are appropriate. It is the long-term growth in our economy through many bull and bear cycles that has resulted in the major stock indices multiplying many times over and investors who have participated in this process becoming wealthy. In a nutshell, I believe this is what investing is all about – putting money into an idea or opportunity that will grow and prosper over time and generate a return on hard-earned money that exceeds the amount put down. The investing opportunity I am talking about is the same ingenuity and work ethic of the human beings who make up the United States (and the world). I think there are many parallels between the markets and real life. I would go so far as to argue that what we call the “stock market” is merely a reflection of ourselves. Humans have been evolving and developing for a long time and the path to date has always been forward. Despite wars, plagues, dictators and the like, we have persevered and pushed the ball forward, with each generation reaching new heights in medicine, living conditions, technology etc. Just in my lifetime, think of all that is new. The advancements in all areas of the human experience are mind boggling. Investing is believing that this will all continue and over time our having supported these advancements will pay off. So far, this has been true. Over every rolling 20-year period since the inception of the United States, the stock market has ended higher than at the beginning. Imagine that. No matter when you invested, if you waited 20 years, the ingenuity, grit and determination of human beings pushed the stock market higher.
At Cabana, we recognize this and try not to overcomplicate things. We do, however, acknowledge that during the cyclical nature of things, there are times when stocks (and other assets) take a step back and re-group. Just like people periodically need to take a step back and re-group. We call this re-grouping a bear market. When this occurs, we try and smooth things out and get off the tracks while things get cleaned. This is how we strive to minimize the losses that inevitably occur as companies are re-priced lower. It’s our view that this not only makes for a happier experience as an investor, but puts us in the best position for when a new bull market begins. If we have saved some of our money during the bad times, we have more money to grow during the good times. This is what CARA’s process is all about. It is not quick, clean or sexy. It is what we call investing, and we are investors.
Now back to what I call “trading”. There are many large institutions and other market participants who are using a variety of technologies and products in an attempt to take advantage of the day-to-day machinations within the process I have outlined above. They are not interested in the forest but rather the two or three trees in front of them. I think it is the activity of these market players that often causes violent movements in both directions during larger cyclical transitions. These are called counter-trend movements and can result in the confusion between investing and trading. We have seen quite a bit of this during the current bear market, which began at the beginning of the year. We have seen several daily, weekly and even monthly reversals whereby the major stock indices have rallied 3, 5 or even 10%. Up to this point, each time the rally failed and a new low was subsequently reached. This tells us that the bear market cycle is still intact, and we are still in the process of “re-grouping”. This also tells us that the bounce in stocks that we have seen this week is due to traders working to take advantage of short-term opportunities. There is nothing wrong with that. In fact, it is quick, sexy and sometimes clean. It can also be dangerous. Trust me on this last point. I have personally made and lost thousands of dollars trading over the course of a few minutes.
On Thursday of last week, we saw a really great example of trading within the larger cycle. The September CPI (inflation) came in higher than expected, thus reinforcing the notion of higher interest rates to come and more pain for all of us. The stock market immediately sold off with the DOW down some 600 points. Within a matter of minutes, the selloff reversed, and stocks exploded upwards, with the major indices all ending up in the black by more than 2%. Did something get better to justify one of the largest one-day reversals in history? Did something happen to suggest that we are out of the bear market cycle? No. What happened is that we got more bad news and confirmation that there is more work to do to turn this bear market around. What also happened is traders began taking profits on their bets that the market would continue down. The term for this is “buy the rumor, sell the news”. To do that they needed to buy stocks to “cover the short position”. As more and more traders took profits, more and more buying occurred. Like an avalanche melting up, traders within the markets pushed up more than 4% from the lows of the day to the closing highs. Somebody made a bunch of money on Thursday. And somebody lost a bunch of money on Thursday. Those somebodies are called traders.
As we will likely continue to experience these market ups and downs over the next weeks, and perhaps months, it is worth considering whether you are an investor or a trader.
