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Hi everyone and welcome back to The Spark Newsletter. This week, I thought I would share three harsh lessons I’ve learned from investing in the financial markets over the last four years, alongside some market analysis at the end of the article. This is a painful article for me to write, but I hope you find some value in it – and I hope you don’t repeat the same mistakes I did!

In this week’s article I will unpack:

- My three biggest mistakes

- Mistakes new investors are making today

- Recent news and market movements

Mistake #1: Buying into Weakness

Momentum. You either love it or hate it. More recently I have learned to respect it. This year we have seen a steep repricing of interest rates due to heightened inflation. This has caused a ‘Tech-Wreck’ and demolition of the bond market. ‘Long duration’ assets – I.e. those with cash flows promised far in the future, like a 30-year bond or a technology stock that says it will be profitable in 2030 – have been pummelled.

With this, there seem to be many ‘bargains’ today. As mentioned before, the current valuation of many of these stocks does not account for the incoming earnings downgrades which are bound to arrive as we enter a recession. Alongside this, negative momentum is with a lot of these stocks, so further downside is more likely than a reversal. The recent research I have conducted has concluded that there are only two movements in markets – mean reversion and momentum. This year has taught me (the hard way – down 68% of Digital Turbine!) that momentum is a force that you should not bet against. Cheap can always get cheaper, as anyone heavily invested in technology stocks now knows.

An easy way to measure momentum is using a 50-day (Blue line - chart below) and 200-day (red line) moving average. If both are rising and the 50-day is above the 200-day, the stock is in an uptrend. But as the 200-day crosses the 50-day (known as the death cross), it shows the stock is entering a downtrend. You can see from the chart below, the death cross occurred for Digital Turbine in January 2022, and since then the stock is down over 70%. One thing I have learned from this is that you don’t have to pick the exact bottom to make money, it’s safer to wait for the stock to turn up before committing capital.

***Digital Turbine (APPS) - Just because it’s cheap doesn’t mean it can’t get cheaper, Source: TradingView***

Mistake #2: Trading with Emotion

Emotions kill you as an investor/trader. I have only recently come to understand that not everyone should invest. Unfortunately, some people do not have the temperament, and for most people, it is suitable just to buy a diversified portfolio of indexes (which I wrote about in my last article) and forget about short-term market moves. The ups and downs of markets will hurt them more than it will benefit them.

For me, a lesson I had to learn the hard way was not to invest based on emotion. The market doesn’t know you own a stock, nor does it care. The market will do what the market does, and you must flow with her, or she will chew you up and spit you out (more on this later). I have entered many emotional trades in the past, only to recognise my mistake and exit the trade - the majority of the time at a loss. Not only is this costly financially, but it also takes a toll emotionally when you recognise how stupid you have been. Getting FOMO (Fear of Missing Out) is very costly in financial markets, and you must recognise when you are acting with emotion. This comes with experience and thankfully writing this newsletter has helped me recognise when I am acting emotionally, as I can’t jump in and out of positions. Another thing to remember is not to get frustrated when you leave money on the table. Missed profits are not the same as portfolio drawdowns. There will be thousands of opportunities over your investing career.

As humans, we are riddled with biases and imperfections. Two books I recommend everyone read are ‘Thinking: Fast and Slow’ – By Daniel Kahneman, and ‘Trading in the Zone’ – By Mark Douglas. These books will help you understand the many issues we face as discretionary investors. This is why I am learning to code, so I can incorporate machine learning models into my trading, aiming to remove such biases.

Mistake #3: Not understanding the Regime

This is a function of Mistake #1, but is important for every market. Believe it or not, the first investment I ever made went down! I invested in Melrose Industries (LSE: MRO) in 2018, which is a turnaround business focusing on companies in cyclical manufacturing sectors. The slowdown in growth and taper tantrum in the US didn't help MRO, and I ultimately sold at a 30% loss. I lost money because I didn’t understand the macro environment.

Fast forward to 2020, I was slow to commit capital as I was unsure of how lockdowns and money printing would impact the global economy. I didn’t understand how big a role liquidity played in the financial system and therefore missed out on major profits. In March of 2022, I misinterpreted just how severe central banks would tighten, and was therefore too quick to add technology stocks. Thankfully, I corrected my mistake quickly enough not to cost me much money – Airtel Africa (AAF) and Meta Platforms are down 20% and 30% respectively since I sold on the 25th of September (sign up to email subscription for live updates). Here is the simplest way I have found to help guide me in deciding what economic regime we are in, and how I can position my portfolio.

Rookie Investor Mistakes:

#1: Letting price dictate your outlook

The number one mistake many new investors make is letting price movements affect their judgement. As investors, we must be as subjective as possible in our decision-making. Following the recent CPI print, and after an awful week of earnings for the FAANGs, the S&P 500 still rallied and has ended this week at a high of $3900 (see below). “Is the bottom in?”, I hear you ask. Ignoring price for a moment, ask yourself - “Has anything changed?” The Federal Reserve is still tightening policy, and forward-looking indicators are still pointing to a severe slowdown (if not a recession), yet the market is going higher. Don’t chase the market. Many newer investors tend to jump in and out of positions as the market moves. I was guilty of this once, and it costs you a lot of money in transaction costs if nothing else. As discussed here, bear market rallies can be brutal, but you have to understand that the market is nothing more than the emotions of a crowd, and in the short-term it can go anywhere. So sit on your hands and do not overtrade.

#2: Being Fearful and Being Greedy

The more you read and learn about markets, the more you realise you know nothing. This is a realisation I have come to over the past year. This has humbled me and opened my eyes to the fact that no matter how much you know, there is always uncertainty you cannot account for. This should not cause fear but should make you realise that correct size positioning is paramount to ensure you are not over-exposed to market falls or poor judgment. Imagine the effect a 20% allocation to Digital Turbine would have had on The Spark’s portfolio! Thankfully due to correct position sizing the portfolio is still positive since inception. Being too greedy and thinking you know more than the market is a quick way to go broke, as any tech-heavy investors now understand.

Finally:

Remember: If you do not manage your risk, the market will do it for you.

Market Update

Pivot here, Pivot there…

The US Dollar Index is up 17% Year-to-Date. If it had not been for this strength, inflation would be well into double digits in the US. Recently, we have seen several central banks – Canada, Australia and the ECB – either pivoting on their hawkish stance or moving to slightly less hawkish guidance than before. This mainly comes because such countries have significant systemic risk, for example in the case of Canada Private Debt to GDP stands at 230%! This means a continued rise in rates could lead to a collapse of their financial system… and financial stability is certainly a priority of the central bank!

The Federal Reserve’s (Fed) next meeting is on the 2nd of November, where they are expected to raise interest rates by 75bps (0.75%) once again. It is not the rate rise that markets will focus on, but the words of Fed Chair Jerome Powell. If the market smells any hint of a Fed ‘Pivot’ to a less hawkish stance, the US Dollar will tank, and stocks are back to the races (in the short term). What will that do to inflation as the US Dollar weakens? Inflation to the moon once again. Either way, longer-term the equity markets are not a place to be. If Powell pivots, Gold will roof, benefitting The Spark’s currently holding in Precious Metals. Although this is not my base case, if Jerome Powell does sound less hawkish in his statement, I will sell the position I currently hold in TIP5. With Core inflation in the US accelerating to 6.6%, I cannot see this happening.

…China Sends a Signal…

The Chinese markets are tanking. China’s President Xi Jinping has removed the last three remaining cabinet members with Finance or Markets experience and replaced them with socialist leaders with military experience. Xi Jinping sent a clear message to the world that he was not messing when an official physically removed the former Chinese President, Hu Jintao, from the stage on Live TV.

After this move, there were over $2.5 yards (billion) removed from Chinese markets, and the Chinese Yuan plummeted against the Dollar. It appears Xi’s ‘Great Struggle’ is coming, as he aims for ‘reunification’ with Taiwan. This is a very worrying sign for the world.

On an aside, China is continuing to lock down. This is clearly a coordinated move, and my guess is that they don’t want to open up as it will lead to a huge surge in inflation much like the west is currently facing. If they do open, inflation will be an even more existential problem for the west as Chinese consumers enter the market. I believe we are entering an age of secular stagnation. Once again, precious metals are set to benefit.

…and the Face Ripper Returns

Finally, the short covering rally that I have been waiting for seems to be here. The Put/Call Ratio is as high as March 2020, as investors yearn for protection from further equity falls. Such moves usually mark a short-term bottom for markets, and even with the poor earnings reports from the FAANGs (Facebook, Amazon, Apple, Netflix and Google), the market still finished the week higher. Bear market rallies are always faster and more severe than declines. If you are caught on the wrong side of one (buying short positions too soon) you ‘get your face ripped off’ in the words of famous trader Stan Drunkenmillar. Short positions I am currently pondering include the Taiwan Index, the NASDAQ 100 and the S&P 500, which will be added when I believe the time is right. I am also considering a short position in the US Dollar, to hedge the current exposure The Spark’s portfolio has to the world reserve currency. Any significant fall would be detrimental to performance. But for now, I am sitting on my hands.

***Portfolio Return Year-to-date: -2.7% vs S&P500: -19%***
***Total Return since inception (20/09/2021): 3.1% vs S&P500: -10%***

Let me know your thoughts by emailing me at thesparknewsletter@gmail.com

See you next time,

Peter

Disclaimer

This communication is for informational and educational purposes only and should not be taken nor used as investment advice, as a personal recommendation, or solicitation to buy or sell any financial instrument. This material has been prepared without considering any particular recipient’s investment objectives or financial situation and has not been prepared in accordance with the legal and regulatory requirements to promote independent research. Any references to past or future performance of a financial instrument, index or structured product are not, and should not be taken as, a reliable indicator of future performance. I assume no liability as to the accuracy or completeness of the content of this publication.