How to Prudently Play the Market

``Safety is something that happens between your ears, not something you hold in your hands."- Jeff Cooper, Celebrity (1920-2006)

So how does one today face to the markets?

First we are in deep uncertainty (Knightean uncertainty or incalculable outcome) whether the actions taken by policymakers will have substantial remedial effects to the US markets and the economy or not, a very important driver of global markets today. My bias is towards the latter given my predilections for the Austrian’s perspective.

The markets could continue to rebound in the coming sessions but fall hard if measures taken will be insufficient to mitigate the present circumstances. So a dose of caution is warranted.

Second, to assess on Standard & Poors’ Sam Stovall’s projection (for a yearend target of the S & P 500 at 1510 or 2.44% from Friday’s close) appears inclined towards unfavorable conditions for investing today since markets appear to have interim greater downside than upside prospects (again using the US benchmark as bellwether to global equities and in the assumption that US and global equities would continue to move congruently).

Next, the Economist laid out its cards for a probability scenario where it says that 60% is likely to be odds where the credit crisis would be resolved in a gradual and orderly manner. It weighted 30% for the US to enter a recession while 10% for the world to enter into a “severe economic repercussions…with devastating effect”…a.k.a. depression.

So let us put it in a table and weigh the asymmetric odds and outcomes…

Here we purposely omitted the depression scenario as not to skew the bias towards the pessimists.

Gains are likely to be favorable if we look on this equation from the frequency standpoint.

However, how much is made or the magnitude of the gain or loss is what matters to us, investors.

As such we see that in the above table, the risks side is likely to significantly outweigh the benefits. Or if the risk scenario materializes, it would costs us more in terms of losses (in Pesos) even if it has lesser chances of happening.

So under such conditions a defensive stance would be most judicious, either by raising a significant cash position relative to overall portfolio or to undertake short term “small” or “position-sized” trades backed with stop loss measures (for those with irresistible temptations to tinker with the market).

Now for those who can afford the volatility may close their eyes and stay long because we believe the Phisix should recover and move advance over the long term.