Sittin’ in the window singin’ to my love,
Slop bucket fell from the window up above
Mule and the grasshopper eatin’ ice cream,
Mule got sick so they laid him on the green
Stay all night stay a little longer dance all night dance a little longer – Woody Guthrie
It was late January, just about exactly ten years ago today, and I was starting my second full year of running a hedge fund and I was off to an incredible start to the year. I’d come into 2004 steadily scaling into ever larger and more aggressive positions in mostly Internet core equipment vendors like Nortel, JDSU, and Cisco, not to mention my largest position in Apple, which I’d first bought for the fund back in March of 2003 (I held that Apple along with sometimes Apple call options until I closed the fund, by the way). I’d made big money already in my hedge fund which was full of mostly long positions as the markets had been in a big rebound from their October 2002 lows.
As 2004 started, the markets were in what I called a Steady Betty Rally Mode at the time, and Internet equipment stocks were the single hottest sector into the new year. I started trimming some of my biggest winners down, including the aforementioned Nortel, JDSU and Cisco along with any stocks that were up 20%, 30% or even more as January wore on. By late January, I was nearly back up to half in cash and the hedge fund was already up nearly 25% for the year while the broader markets were barely up 5% on the year.
In the last week of January, the markets turned south and the highest-flying winners of the year, like those that I’d just sold down and taken huge profits on, were the hardest hit. I’d previously learned the hard way over the years that you should never confuse a bull market with genius, but I’d even nailed the near-term top and my whole year was already in the pocket. I was feeling pretty good about myself and my trading prowess and listening to Willie cover Woody Guthrie’s classic, “Stay a little longer” chuckling about how I’d left before the party was busted!
By early February, I was “only” up just over 20% on the year as I still had half my fund in stocks and a few options, but the markets were now down year to date and the stocks I’d so smartly sold down at the top had themselves pulled back 20-30% from their highs. They finally were stabilizing and the charts started to turn upward as the stocks were flattish to down on the year.
Here I was sitting on a huge pile of cash and feeling like a genius for having sold at the top and here was a chance to just slowly start re-building and buying some new stocks while they were down. I started to buy back a few shares and to put just a little bit of that 50% cash, along with more cash coming in, to work in the markets.
By the time March rolled around, I was back fully invested and mostly long, up single digits on the year, and the markets were down about 10% or so on the year. One morning as I walked into my hedge fund hotel office that I rented from Bear Stearns on the 40th floor in midtown NYC, I was shocked to see the Nasdaq futures were down huge. I pulled up the Bloomberg terminal and my heart sank as the headline screamed “Nortel admits fraud; Major telecom equipment vendors under investigation” or something along those lines. Nortel was cut in half and most every Internet equipment-related stock in the market was down 20% or more on the day. I puked my guts out that whole day and cried myself to sleep that night.
I spent the rest of the year digging out of that hole and getting back ahead of the market and had a lot of success in that hedge fund from that bottom. Lesson of the week – do not dig yourself a hole, okay?
To bring all this home then, there are certainly a lot of parallels with the set up here in 2014 with that set up I lived through in 2004. So make sure you recognize ahead of time, here while stocks are still up near their highs, that stocks could absolutely crash at any time for reasons you just never saw coming.
But remember that you’ve got to be patient and don’t overload on stocks here on the first pullback we’ve seen in a long-time. In fact, on the flipside of all that, remember that you don’t have to try to sell at the all-time high. There’s nothing wrong with trimming back a little bit of stock if you’ve got a lot of profits and/or you’re feeling too exposed on the long side, even if you were up even more a couple weeks ago.
Apple is wildly cheap relative to the rest of the market and it’s historically cheap. But a lack of hitting an arbitrary guess of an estimate by the Wall Street analysts on the number of iPhones that the company would be able to produce and sell through in the last ninety days hits the stock hard. With Apple down here near $500 a share, it’s trading at less than 10x near year’s earnings while the S&P 500 is trading at 16x next year’s earnings. If I didn’t own any Apple yet or if I’d just started buying it recently, I’d consider buying another small tranche here near $500.