Cody on RM: Similar Setups, but Yes, It's Different

Similar Setups, but Yes, It's Different
08/16/2006 2:33 PM

Where's that playbook from last summer? It's pretty much the same one I used the summer before that. And isn't this current setup awfully similar to the one we had when I used those playbooks? So, as many an emailer has been asking me lately, what's the diff, man?

Good question, and perhaps the difference is only in me, not the market or the economic setup.

I don't know if you remember the pain that the market doled out to the tech bulls in the summer of '04, but I sure do. My approach at the time had been to trim into strength and buy into weakness. As the market took off at the beginning of the year, most of my stocks exploded higher, and I had double and triples in some of my biggest positions before January was even over. I sold down a ton of stock and hedged aggressively to try to protect those gains.

Into spring, most of my favorite stocks at the time, which included Tellabs, Apple, JDSU and F5 among others, were getting pummeled on concerns about inventory levels and the strength of the consumer. As the stocks came down 20% and 30% in a straight line, I started buying many of them back, only to watch them go lower -- and my gains on the year start to evaporate.

By late spring, I had bought back a good bit of my positions and taken off almost all of my hedges, as I was confident that the economic "soft patch" was, indeed, only a soft patch, and I wanted to be long and strong when the rebound came. I have written before about persevering through the day when Nortel announced that all of its numbers were wrong and perhaps fraudulent. That day crushed me and took away almost all of my gains on the year, as anything telecom or tech related was smashed in the selling frenzy that ensued.

I held on through the summer and continued to buy on weakness and build up my positions. By the time the market bottomed that summer, I was in a horrible drawdown (some might call it a hole). As the Nortel problems faded from memory and the tech inventory concerns proved to be only a temporary wrinkle, tech stocks went on a tear, and I was positioned to catch a big move to the upside.

Burn me once, right? Well, heading into spring last year, tech was trading ugly, as tech inventory concerns were once again front and center of the market's mind. Tech was sold down, and I'd been too long and was in another drawdown by the time the dog days of summer settled the market into a gentle malaise. I saw the setup as binary, and again my analysis told me to stick it out because the economy was strong and the inventory concerns would again work out fine, despite many permabears being certain at the time they'd roil the industry in the second half of the year. The market took off and killed the shorts, while rewarding the bulls.

Here we are in 2006 and what's the setup? Well, once again, there's concern about tech inventories (along with the standard ol' lines of "consumer is dead," "twin deficits are going to collapse our economy," etc.) and the Nasdaq has been crushed from its spring highs. Perhaps those inventory concerns will work just fine again. But I have to say that housing's downturn is no longer "looming" as it was in 2004 and 2005. And oil and energy have been awfully high for how long? And we had a blow-off top in commodities. And the market's been crushing every cyclical without pause for months on end. And rates have gone from pretty much "please take this money" to "it'll cost you if you want this money."

I went almost entirely to cash before this crash in the semiconductors and other techs that I usually love to be long. And let's keep it real -- that is a factor in the risk/reward analysis I must do when trying to decide how long, short or underinvested I should be.

So, yeah, I agree that there are lots of similarities between the setup in tech (and the economy and the broader markets) to each of the last two years. But there's a lot that's different, too. And I'm going to stay patient. The binary outcomes of tech spiking back because the fundamentals work out great or tech tanking because the inventory problems really get bad aren't something I want to make a big directional bet on right now.

It is what it is, and that's my stance -- at least until my analysis changes because I will strive to be flexible and disciplined above all else.