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Learning to Live With Volatility and Disorder

Investment Conclusion: How Should We Operate?

Generally speaking I would err on the side of conservatism.

  • Maintain lower than typical long exposure. For example, if your normal invested position is net long 70%, think about maintaining net longs of 40%-60%, depending on your risk tolerance.
  • Be careful of large, maturing companies whose time has passed. More often than not, they are value traps subject to disruptive competition. (See Taleb's rule No. 3 above.)
  • Be receptive to committing an expanding part of your investing portfolio to smaller and more disruptive stock positions -- Sourcefire (FIRE) comes to mind. (Again, see Taleb's rule No. 3.)
  • Reduce the amount of investing you do while expanding your short-term trading activity. Be more active in long and short rentals.
  • While being more active in trading, be more patient than usual in your longer-term investing and wait for your right pitch, both with regard to an earnings and price timing set up. Volatility and disorder are accompanied by repeated opportunities to capture attractive entry points.
  • Be more active on the short side. Volatility encourages disappointment for those companies' managements that are inflexible, that are unable to respond to shorter economic cycles, whose margins might come under pressure (and pricing power limited) and whose profit stream is vulnerable to an economic wind no longer at the global economy's back.
  • Avoid concentration by diversifying your portfolio across industry lines, and keep individual equity commitments lower as a percentage of your total investment book.
  • Learn to trade based on specific catalysts, ranging from generic industry developments, earnings and other factors.
  • In order to be a nimble trader you must learn how to buy red and sell green. To do that, you have to overcome your emotions and learn to acquire more of a contrarian streak.

The next thing investors can consider in terms of dealing with volatility, disorder and possibility of the emergence of more black swans is to be long gamma, but that will be the subject of a future column.

In summary, looking out over the next few years, as unappetizing as it appears to some, we must learn how to operate successfully in a trading-sardine market, not in an eating-sardine market.

At the time of publication, Kass and/or his funds had no positions in the stocks mentioned, although holdings can change at any time.

Doug Kass is the president of Seabreeze Partners Management Inc. Under no circumstances does this information represent a recommendation to buy, sell or hold any security.

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