My 1st Million At 33 – yes, you can do it too

I’ve blogged about Heebner’s CGMFX & CGMRX fund before. Before 2007/2008, it had a terrific performance. I admired Heebner’s foresight on the builder’s good fortune from 2002 to 2005 (CGMRX), and taking advantage of commodity stocks out-performance from 2003 to 2007 (CGMFX), and the downfall in mortgage/financial companies(CGMFX). But the downfall since 2008 proved that it is very hard to beat the market consistently for anyone even if when they are very very smart.

What went wrong? I remembered that Heebner was shorting Countrywide in CGMFX correctly. Why was his fund falling so hard? Looking at the top holdings of CGMFX at the end of 2008, I can think I can the reasons.

(Stock symbol, Company name, holding percentage, YTD performance)
NLY Annaly Capital Management, Inc. 12.84% -12.41%
FRT Federal Realty Investment Trust 9.08% -33.75%
PLD ProLogis Trust 7.82% -56.65%
HME Home Properties, Inc. 7.11% -32.97%
MAC Macerich Company 6.84% -32.45%
SPG Simon Property Group, Inc. 6.77% -36.36%
ARE Alexandria Real Estate Equities, Inc. 6.38% -33.78%
DLR Digital Realty Trust, Inc. 6.02% -9.01%
TCO Taubman Centers, Inc. 5.99% -38.53%
DDR Developers Diversified Realty 4.84% -39.55%
ESS Essex Property Trust 4.75% -29.12%
EPR Entertainment Properties Trust 4.64% -49.97%
VTR Ventas, Inc. 4.55% -35.75%
CIM Chimera Investment Corporation 2.85% -13.33%
UDR UDR, Inc. 2.68% -42.64%
SLG SL Green Realty Corporation 1.89% -55.14%
DEI Douglas Emmett, Inc. 1.40% -42.42%
SKT Tanger Factory Outlet Centers 1.12% -25.79%
BRE BRE Properties, Inc. 0.95% -32.38%

Apparently, instead of shorting the real estate/financial companies, Heebner went 180 degree opposite and started buying beaten down real estate and insurance companies. Unfortunately, that didn’t turn out too well for the fund holder. Heebner literally caught the falling knife of the market.

No one can exactly know where the bottom of the stock market or a particular stock is. That is especially true when the timeframe is broadened. There is some “truth” in buying ETF and not try to beat the market by market timing or stock selection. The key thing for smart people usually is NOT to out-smart yourself by thinking that if you do it once, you can do it again. Everytime (and anytime for that matter) is always different. Over time, stock markets tend to grind out all the “smart” people.

So is it absolute useless for market timing and stock selection? Well, it’s not like that. Just by looking at the magnitude of 2008 fall, it is fair to question the Efficient Market Hypothesis. If the market is so efficient, why would there be such a big adjustment in such a short timeframe? The middle ground between ETF and market timing/stock selection lies at “sizing your bet” partially based on Kelly’s criterion which I’ve advocated to be much more important than anyone has paid attention to. The moment that you sizes your own bet, you have recognized the your own inability to forecast the market with 100% accuracy. When you believe that your stock market forecast is as good as throwing darts at random, you should go 100% in ETF. When you believe that your forecast has some validity, then you should step out of the ETF comfort zone, and bet accordingly.

The problem with market efficiency is that it is only true in the short term, and very long term, but probably not in the intermediate timeframe. At the time of financial bubbles, you can almost always identify it. Bubble is an technical imbalance with the fundamental picture, which tends to last for some duration. Financial panic on the other hand can be felt and identified, but usually, it’s hard to take advantage of because of its much short duration relative to the bullish phase. Anything that you can identify is REAL information that you can take advantage via sizing your bets. Yes, you may not get the timing correct exactly, but you could get it partially correct. The thing to remember is that bullish phase tends to drag on longer (than any “smart” people expects), while the bearish phase tends to come very swiftly once it begins.

So never bet the farm on anything. Give yourself some breathing room for mistakes. This is not to mention that you should try not to leverage (like those investment bankers who bet 20X to 40X of their AND OTHERS’ money). Understand that the stock markets can stay irrational longer than you can stay solvent (because the bullish phase tends to last longer). Stepping out of the market doesn’t mean that you should go short right away. Also understand that you should never try to catch the bottom of the stock market when it falls. And if you try, sizing is extremely important. Go very small with stop loss. Ideally, you should place majority of your bet AFTER it stops falling, not before. And forget about dreaming to catch the bottom and buy Citigroup at 0.97, and missing out the 200% gain in the rally to $3. You should be glad that you didn’t buy at $5, and suffer a horrendous 40% loss to $3, or buy at $4, and suffer 25% loss. Panic is usually short in duration. The chance of you catching the bottom is slim to none, even for professional traders. Doesn’t mean that you shouldn’t try, but if you try, you may want to bet very small. Do you spend $100K to buy lottery tickets? NO. So for an event of this tiny chance that you may actually catch the bottom, you should not bet big either. It means that you won’t get rich quickly from it, but it also means that you won’t get bust from it.

In summary, size your bets. Give yourself some room for mistakes. And don’t go 180 degree opposite on your portfolio like Heebner did. Yes, you may get it right once or twice. But the mythical “swing trader” will remain forever a myth. In practice, you should ALWAYS go to cash first, before you swing to another direction. How long you wait depends on the market risk.