Now, I have a lot of people asking, "then why were you franticly buying stocks the weeks
before the worst 3 days in history?"
The reason was to position a certain amount of assets in a "hedged contrarian position."
So, now we're back to the beginning question, "what is a hedged contrarian position?"
A hedged contrarian position is a diversified portfolio in which you hedge both a cash
position and own a small group of diversified stocks that
are "contrary to the market's opinion."
cash
- literally "cash" - United States of America's currency in $20's, $50's and
$100's
- federally insured bank and checking accounts
- credible money market funds
- US Treasury Bills
- accounts receivable (though they shouldn't be counted as money, they should
be considered in a deflationary environment.)
- foreign currency
However, 100% cash is not a very diversified portfolio... ask any
Russian. Of course, having a mix of the "cash" types listed above will give you
some diversity. What would happen if their was a deflationary period? It would be good
news/ bad news. The good news -- the longer you hold on to your cash, the less you will
need to spend... at least in the short term. The bad news -- interest rates would likely drop,
and your rate of return would diminish. As our interest rates fall, investors will look
around the world for better interest rates causing the dollar to fall in value.
Deflation leads to Depression leads to Devaluation leads to Inflation.
Let's hope the Chairman of the Federal Reserve Board, Alan Greenspan,
can continue his excellent record. It will be a hard road ahead. Lowering
interest rates could cause the deflation/inflation cycle to
accelerate. Not lowering interest rates could cause a recession.
What is a contrarian stock?
Having some assets in a variety of contrarian stocks and hedging the position by selling
call options, might further help divert risk. What is a contrarian stock? A contrarian stock
can take on many different forms. An easy example that will work in many types of
markets is a stock that has been declining in price. The average investor would say,
"I don't want to buy a stock that is falling in value." The contrarian would say, "This
stock has already been hammered... perhaps it is even near its 52 week low. Now is a
good time to buy it... for it is likely to regain at least some of the old value." There are
many other contrarian views, including y2k, terrorist threats, global weather trends,
etc.
The Lyonvest portfolio consists entirely of contrarian stocks. At the time of their
purchase, the following "contrary" attributes held true:
- ARCO - the price had been declining for months, the oil glut looks prolonged, and
contrary to popular belief the threat of terrorists driving the price of oil up looms.
The yield at the time of the purchase was about 4.75%... about the same as the interest
rate on a money market account.
- Ralston Purina - the price had been declining for months, commodities glut looked
prolonged, and they own Eveready. Because of y2k and extraordinary weather events, the
population is likely to "shift the demand curve" for batteries.
- Nord Resources - they mine copper, nickel and other metals used in making batteries.
They also explore for gold. Gold can be a nice supplement to cash in times of uncertainty.
It was purchased during a price decline.
- Brush Wellman - manufacture beryllium, which gives copper additional qualities. It
was also purchased in a declining price mode.
- Hines Horticultural - this one was bought for a real "worse case" scenario. They have
a division that deals with peat. In the event of food shortages caused by y2k or climatic
events, high intensity gardening will likely increase dramatically.
- Ruger - another worse case scenario stock. In the event of terrorism on US soil, gun
sales will likely sore.
- Veridien - they make and/or distribute antibacterial products. As the recent floods in
China show, hundreds of thousands of people can become sick from weather or terrorist
activities.
What can you do with your savings that contains no risk?
What can you do with your savings that contains no risk? Once you think through a few
scenarios, you're likely to come to the conclusion that there is nothing you do with your
savings that contains no risk. True. But, by implementing the Lyonvest strategy of a
hedged contrarian position, you will actually reduce your overall exposure... and drive the
risk factor quite near to zero.
How do you hedge a contrarian position?
First, you must have a position.
Well, it is important to remember what a contrarian position is: a point-of-view which is
contrary to popular belief. Therefore, the first rule is to obtain your position
before public sentiment shifts. Once the volatility begins, smart
investment quickly turns into a "crap shoot." By preparing ahead of time, you can first
obtain a portfolio consisting of about 95% cash. Then, over a period of 1 to 2 years, you
can periodically obtain diversification in your holdings. Finally, prior to
the volatility, you should have moved to about 80% cash and 20% in your diversified
contrarian stock portfolio.
Remember, we are just talking about your liquid and semi-liquid savings. The Lyonvest Portfolio is a group experiment and that offers but a
glimpse of what a personal portfolio should look like. However; it can be used as a
model for the "diversified stock portfolio" portion of your overall financial plan.
Remember, an individual should only invest money using this strategy
if they plan on being in for the long haul.
This means you must have a savings plan that includes:
- saved money
- and, a preconceived notion for:
- the preservation of value
- the potential for capital appreciation
- guaranteed income
Then, you hedge the position.
To reduce risk even further, there are several additional sub-strategies that can be
implemented. The sub-strategies often include "hedging" your position. An easy way to
discover some good ways to hedge your position is to ask "what if?" questions, such as,
"what if the Federal Reserve Board lowers interest rates? What if the Federal Reserve
Board does nothing with interest rates? What if the Federal Reserve Board raises interest
rates?"
By doing enough of these "what if?" scenarios, you will be able to see some
"contrary to
the contrarian" patterns develop... what happens when you were right with a your original
contrary position... and what happens when you were wrong... and what happens if
nothing happens. Once you have run though the different scenarios, it will be easier to
devise a plan to make money in nearly every case. And at the very least, you will be able
to devise a plan not to loose value in your savings. When you make a plan
that helps limit your worse case scenerio, it is called hedging.
The Lycos acquisition is a good example of how a hedge can be accomplished in the real
world.
- First, start with a good underlying company. When it comes to Internet companies,
there are only a few publicly traded companies that "really have something." Yahoo,
Spyglass, Netscape and Lycos are a few that come to mind. They have either developed
technologies with lasting value or built services on the reality of the world wide web.
Lycos invented the spider. They have pursued their ownership rights over this technology.
- Next, you should try to time your purchase appropriately
in the stock's trading cycle.
This could mean purchasing the stock near its 52-week low, or well below its
52-week high, or immediately prior to a
spike in the price, etc.
Lycos represents the later two. It was purchased
at 57% of its 52-week high, as well as, immediately prior to an upward
spike in its price. Of course, you must take advantage of the spike by
either selling at its peak, or selling a coverd call during the frenzy
of the upside, or....
(On the point of "trading cycles," you should determine the amount of time you want to spend monitoring
the stock's price. Trading on shorter cycles will require a greater amount of time. Since
we wanted to show an example of a complete life-cycle, we choose an Internet stock that
has a short trading cycle. But since we don't have that much spare time, we generally like
longer trading cycles.)
- Finally, you add a twist... or two. The twist can vary. (Some of our stock picks took
the dividend yield into account. For instance, ARCO's yield was 4.75% when money
market interest rates were the same. This would represent a hedge against
falling interest rates. ) The twist with Lycos was to instantly sell a covered call.
We received an 18.9% return on
our investment the first day.
Ideally, the "call option" would have been exercised by the buyer before we reached the
downside of the price spike (see the example graphic
above. By the way, another good time to buy is at the bottom of the spike's
other side.) Then, we would have received another 5.5% on our money and
been back into a cash position... all within two weeks. That would equate to an annual
rate-of-return of about 634%. Too bad it isn't a perfect contrarian world.
In any event, we have made money and continue to have the opportunity to make more.
And, by combining this individual acquisition into a group of unrelated stocks, the risk
factor will approach zero.
Post-mordant
Should you still be able to have a clue of what I'm saying to you,
I would suggest that you also diversify further.
In my personal portfolio, I have reduced the overall stock holdings to less than 10% of my net
worth. Then, I positioned as many stocks as possible with covered calls... locking in
thousands of dollars in profits prior to the market drop. I've also increased the diversity
by adding stocks like Coleman (camping/survival gear/generators) and Royal Dutch (a
foreign oil company).