The law of small numbers

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This post is a guest contribution by Bennet Sedacca*, President of Atlantic Advisors Asset Management.

I have written many times that the first key to making money in the markets is to not lose, or at least to keep your losses to a minimum when you make a poor decision. There are many ways to express this rather simple concept, but a couple that come to mind are “buy when you can, not when you have to” and “buy low/sell high”.

While I have not been the most bullish guy on Earth for a few years, there was a method to the madness; to be able to buy when others were losing much of their capital.

While investing seems complicated, the arithmetic is pretty easy. If you lose 50 percent in an investment, you must double your money to get back to break-even. Clearly, doubling one’s money in nearly any investment is not an easy proposition, but when prices fall far enough (like the recent experience with S&P 500 in the July 2007-November 2008 period – a 50 percent decline), it is those that have their capital mostly intact that can pounce at low levels to take advantage of what I like to call, “the law of small numbers.”

Consider this. Even after the recent 20 percent move up in the S&P 500, the market remains down nearly 40 percent year to date. To the investor that believed the “buy and hold” mantra of the conventional crowd, the move from 740 back up to 890 in the S&P 500 was nothing more than a move from being down 50% to being down 40% – hardly awe inspiring.

While I have made it very clear that my initial target in the S&P was 750, which we did buy aggressively in the 740-770 vicinity as I mentioned in a couple of alerts last week, yet we sold that position as of this past Friday.

Click here for Bennet’s full report.

* President of Atlantic Advisors Asset Management, Bennet Sedacca brings with him more than 26 years of securities industry experience. From 1981 to 1997 he worked for several major investment banks, specializing in high-grade fixed-income securities marketing, trading and portfolio management. While working for PaineWebber as a Senior Vice- president, Bennet was a member of the Chairman’s Council for four consecutive years. During his years with Salomon Smith Barney as a Vice-president, he established an institutional fixed income presence in Central Florida.

In 1997, Bennet formed Sedacca Capital Management focusing on portfolio management for high-net worth individuals and small to mid-sized institutions. He is also a contributor to the financial website, and is regularly quoted in Wall Street Journal Online, Barron’s and Bloomberg.

Bennet graduated from Rutgers University in 1982 with a degree in Economics and was a member of the International Honor Society of Economics.


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2 comments to The law of small numbers

  • Frank Wordick

    Bennet Sedacca is one of my favorite — perhaps most favorite — financial advisors despite the fact that his articles at times suffer from too hurried composing and the odd vulgar commonplace such as “buy low/sell high”. On the other hand, I must admit that I have been cautioned more than once by a friend, who is a Senior Lecturer in a major university, to “Never underestimate the stupidity of people”. So maybe these vulgar commonplaces need to be uttered, particularly the one about needing to double your money in order to get back to where you started, if you lose half of it. But while I truly do enjoy Pink Floyd’s “Money”, I wonder what this has to do with investing. Some people are really good at trading. Sedacca & Co. actually tossed half their assets into the market a day or two before the Thanksgiving rally began and then jerked them out on Friday when the market peaked! One can’t help but be impressed by such ability and agility. I am quite sure that Sedacca is being overly optimistic when he states that this terrible drop in the stock market over the last twelve months or so has destroyed the “buy and hold” strategy of stock market investing. Only several weeks ago a prominent asset management company put together a defense of “buy and hold” and passed it around. You might have read it on this bogsite. They actually advised investors that if they attempted to avoid downturns such as we have just had that they would actually lower their returns on investments. Other advisors like Gary Halbertson, however, likened getting out before a market downturn to stepping off the railroad track when you see a train coming. Well, we all know that not everyone has sense enough to do that. And, of course, many simply cannot see the train coming. Nor can they recognize good advice to get off the track when they hear it.

  • Frank Wordick

    Continuation of item 1: As I’m sure I said before, advisors who insist that it is not possible to time the market really mean to say that they themselves can’t do it. Since they can’t do it and believe themselves to top class investment advisors, then no one else must be able to do it either. This is their excuse for a mediocre performance. If the S&P 500 just lost 20% and these same investment advisors lost you 20%, then they argue that they have put in a creditable performance. But if they only lost you 10%, then they believe that they did really well for you. This is actually how some people think! And they try to convince you to think the same way for if you don’t, then you’ll take your account someplace else, where it gains rather than loses money. Sedacca confesses that his article is not a happy statement. But it is not less happy than the previous one where he supposes a bottom of 400 vis-a vis the presently stated 500, a reversion to his original downside target, which is the same as Albert Edwards’. Did the dip below 800 make him momentarily more bearish? In any case, 400 is about right taking into consideration the height of the October 2007 top and assuming that the bottom of the 2000-2002 downturn is the major impediment to a market collapse. As to Sting’s belief that “Money is only important, if you don’t have any”, I juxtapose JP Morgan’s “Only a little bit more”, when asked “How much is enough?”

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