How not to do it

There aren’t many bestsellers dealing with how to lose money. I looked up ‘lose’ and ‘million’ on Amazon and got just one hit – ‘how to make millions in real estate and lose it’ by TW Weston. Published in 2002 – it looks like the American public followed the book to the letter.

Prior to that, the best commentary on how to lose money came from Humphrey B. Neill in ‘The art of contrary thinking’ – first published in 1954. In it he lists ’10 ways to lose money in Wall St.’ And they all ring true today;
1. Put your trust in board-room gossip
2. Believe everything you hear, especially tips.
3. If you don’t know, guess.
4. Follow the public.
5. Be impatient.
6. Greedily hang on for the top eighth.
7. Trade on thin margins.
8. Hold to your opinion, right or wrong.
9. Never stay out of the market.
10. Accept small profits and large losses.

Now, my own best efforts at losing money have come from either
a) getting in too early and not obeying the stop (accepting large losses), or
b) trading around too much on low conviction ideas (a combination of 3, 5, 7 and 9 above).

One of the nuggets I got out of ‘The psychology of trading’ by Brett Steenbarger was that the key to successful trading was eliminating behaviour that caused losses. For me that is the mindset that leads me to go too large on low conviction trades. That’s the behaviour I’m trying to edit out right now.

Now my high conviction view is that we’re in a world of crowding out. Larry Summers laid the groundwork in a comment a year or so back – ‘we are witnessing the strongest five year span of global growth, not just in our lifetimes, but in all of recorded economic history’ .

Clearly growth has been great. And naturally, that is putting pressure on resources. Even abundant resources, like Chinese labour, are tightening up. So much so that Chinese unit labour costs are now rising 2% per annum, rather than falling 2% as they were in 2003. That’s natural, and while not as benign as five years ago, it’s not a cause for panic.

What’s much more troubling is where this extreme global demand is running into the failings of the current system of resource allocation.

Anywhere that has an inadequate property rights and rule of law - the African and Chinese 'agricultural commons' are a clear case in point - is seeing a very weak productive performance. Any non-price determined system - power infrastructure in South Africa, global government controlled oil infrastructure, even global water provision - all have suffered gross underinvestment.

This is the heart of my 'crowding out' theme. These resource constraints raise prices and costs, and reduce real wages and aggregate profits. That's the deep reason I went cautious on Monday. This is no 1999; we're not in a free money, disinflationary rerating out of the credit debacle. We're in crowding out. Which tells me to be long the 'crowding', and short the 'out'. And to try not to get carried away with directional equity bets unless we move to extremes.

To that end I’m long resources and infrastructure stocks – all the better if, like the Brazilians, they have above average cost control. And I’m short the banks with Eastern European exposure.

So, over the past few days, I pared down my long commodity and short bond futures, and I cut out the stocks I bought to play the bounce from mid-March; Lloyds, Credit Suisse, Wal-Mart and Richemont. And I went short Erstebank, Swedbank and Alpha bank. Along with a FTSE short, that has lowered my gross and brought my net back to neutral. I’ll see if I can break the bad habit of trading around in a choppy market – and stick with lower risk and my clearly stated fundamental calls.