The storyline matters too…

It’s been a while since I have posted, something that reflects the fact that while the market has moved around recently I feel it’s been of the “full of sound and fury, signifying nothing” variety as market participants prepared for and are now digesting the Fed’s QE announcement.  However, just because the market's movement over the last couple of months may determine little over the medium-term, it doesn’t mean they should be ignored or that one shouldn’t seek to profit from them.  Unfortunately, that’s not something that Our Man has succeeded in during recent months.

When we think about investing we spend a lot of time thinking about the end or the final scenario; for example, will we see deflation or massive inflation?  Is China a bubble?  What’s the target price for Stock X?  However, much like reading a book, while the end is important…the story-line matters too.  It’s the twists in the plot that make markets (and books) interesting.  For an investor, this means that one should think about the twists in the plot that one might encounter on the way to reaching end; there’s little point having a portfolio today that’s perfectly set up for the end, if you can’t continue to hold it through all the twists in the plot to get there!  This is far from easy since it means thinking and weighting information (and your beliefs) about different time horizons and then using this information to help structure a position and the portfolio in general.

Why mention this?  Well, it’s not something that Our Man has done well, especially recently.  As you know Our Man doesn’t trade (i.e. do anything in the 30-day time horizon window) but that should not stop me from taking advantage of short-term factors to exit investments (with the opportunity to reinvest later) or change the composition of the portfolio.

The biggest example of this has come in the last few months, with regards to the Treasury holdings.  While they have been strong contributors for the year, they have hurt in recent months and Our Man missed an opportunity to take advantage of some short-term factors to exit the position even though the long-term view is unchanged.

The graph above (courtesy of Mish Global Economic Trend Analysis) shows the movement in Treasury yields.  As we can see, leading into Bernanke’s Jackson Hole speech there was a tightening of Treasury yields (including at the long-end, where Our Man is invested) as investors began to fear a double dip in the economy.  These yields remained largely steady, though off their lows, following the speech in which Bernanke hinted at the possibility of QE2 as investors “bought the rumour”.  However, following the Fed announcement of QE2 these spreads have widened as investors “sold the news”.  For Our Man this has meant that much of the Treasury gains from the summer have been given up but it need not have been this way.  While my long-term view hasn’t changed, I should have taken both my short-term understanding of the “buy the rumour, sell the news” phenomenon and the fact that the returns had become more front-end loaded (as a result of the tightening around/before the Jackson Hole speech) as a sign to at least reduce the position.

Hopefully, this is something that Our Man will learn in the coming months and years.  While it's great to have conviction, especially in long-term ideas, Our Man's got to a better job of taking into account some of the short-term factors.  Remember, it's not just the ending...the storyline matters too!