market stocktake III

It's been almost exactly a year since the last time I tried to clearly articulate my investment strategy. It's interesting to look back at the last one, since I timed the market bottom almost perfectly and all my picks did very well. Unfortunately I exited way too early, so while I recouped most of my losses from the crash of 2007/2008, I probably could have made much more if I had greater confidence.

I guess the bottom line is, I'm still a bear. And while I've ridden some of the subsequent rallies, I'm still waiting for the final correction. But first let's take a quick glance at the opinions out there.

The Pragmatic Capitalist has a very nice summary of 2010 investment outlooks from a variety of sources. Among Investment Banks, most are predicting a slightly positive year, probably in the 10% range. The notable exceptions are Morgan Stanley and Credit Suisse. Among the Hedge Funds and Investment Gurus, the sentiment is far more negative. Probably the most extreme prediction is by Elliot Wave Theorist Robert Prechter, who is now saying that we will see a crash that will bring the market to an even lower point than we have seen so far.

I've been building up short positions since January, and over the roller coaster of the last month have been reducing long holdings. While a crash seemed quite possible a week ago, the last 5 days have seen the Dow and S&P recover more than half their losses for the month. But the volume is less convincing with higher volume on the declines than the rallies, so next week should be interesting. There remain a few black swans on the horizon: sovereign debt, consumer credit, (if I could name all of them they wouldn't be black swans) and unemployment and consumer spending are still far from comforting. But if we make a new high it's probably time to go back into waiting mode.

So what I have now is a portfolio of mutual funds and stocks in the hands of my financial manages (who are both still bulish). I am hedging the downside with short options, having sold almost all my own long positions. And by gut feel, this is how I should fare based on the following market outcomes for 2010:

• +20% or better: Profits on my long holdings should exceed short losses for a moderate profit
• Between -10% to +10%: Will probably have a slight loss due to the options expiring out of the money
• -20% or worse: Should make a pretty bundle due to the very high leverage on my short options

Well this should be an interesting year to test my understanding and application of some new financial instruments, maybe in another year's time I can look back and have another good laugh.