Today's Investing Strategies: Buy & Hold, FIFO & LIFO

Explanation for Jumpy Markets

Want a(nother) reason for heightened stock market volatility?

More investors are switching from buy-and-hold to "FIFO": first in, first out -- and ask questions later.

Such is the aftermath of a decade-plus of negative overall stock market returns. And that's before inflation.

As I've blogged before, welcome to "risk without return."

Risk Without Return

When stocks are trading on momentum and liquidity rather than fundamentals -- as now appears to be the case -- you never know when the "jig" is going to be up.

All you know is that the exits are narrow, and that the penalty for getting out late is horrific (ask tech stock investors from a decade ago).

So, every "dip" and reversal sends skittish investors looking for daylight.

When the scare passes, these same, jumpy traders have to buy back in again.

LIFO: FIFO for Experts

Of course, there's an even higher stakes trading strategy than FIFO for profiting from precarious markets -- albeit one best practiced only by experts: 'LIFO,' or last in, first out.

Also known as short selling, it consists of betting against bubbles just as they're about to deflate.

Whereas investors who "go long" make money when something goes up, short sellers profit when whatever they short goes down.

In fact, little-known hedge fund investor John Paulson (no relation to Henry) pocketed something like $20 billion the last three years betting that housing would collapse.

As Wall Street has just demonstrated (again), the best way to profitably short-sell a bubble is to know when it's about to pop, for real.*

And the best way to do that is to have helped inflate it.

*What do you call a short-seller who is right but early (like all the pro's who shorted overvalued tech stocks in '98 and '99)?

Wrong . . . and busted.

That's because if you short-sell something that keeps going up, you face wave after wave of margin calls requiring you to put up more money.

Biggest U.S. Export? Bubbles

FIFO, LIFO & LILO

"Where is the money [created by the U.S.] going? Where the problem's going to be: Asia. You can see asset prices going up, not only in Korea, in Taiwan, in Singapore and in Hong Kong, going up to levels that are incompatible or inconsistent with the economic fundamentals."

--Donald Tsang, Hong Kong executive; "A Dollar Warning From Asia," The Wall Street Journal (11/17/09)

Cheap U.S. money is stimulating the economy, all right.

It's just that the economies being stimulated the most . . . aren't in the U.S.

Rather, they're in places like China, India, and Brazil.

Like flood waters flowing over already saturated land, a tsunami of U.S. dollars is pouring into those economies because . . . that's where the growth is.

A dropping dollar makes this play even more profitable.

ABC's of the Carry Trade

Through the magic of something called "the carry trade," sophisticated investors can borrow depreciating dollars, make a higher return elsewhere, then essentially re-pay less than what they borrowed (that's what depreciation means).

Say it all at once: 'last one into the carry trade pool is a rotten egg!'

The only problem with that is . . . all the splashing.

The carry trade magnifies the downward pressure on the dollar, creating a vicious, bubble-inflating cycle.

Its balloon-inflating effects are most pronounced on the smaller, developing and emerging economies, where capital inflows can "move the dial" more than they would in a bigger economy.
Just think of it as the sovereign equivalent of the stock market, where "mega caps" like the U.S. and China typically are harder to move up -- or down -- than "small" and "micro-cap countries" like Malaysia or Peru.

Also inflating: many of the old bubbles, including worldwide stocks, gold, and other commodities such as oil and silver.

"FIFO and LIFO"

Who are the losers?

For starters, all the casualties of the old bubbles, including residential (and coming soon) commercial real estate, and before that, high tech stocks.

Next come all the risk-averse savers, whose money market yields and interest on savings have vanished.

Most at risk now?

Anyone who's last into any of the new bubbles.

Call them the Last-in-Last-Out's, or "LILO's" (vs. the more connected and favored FIFO's).