Apr 07, 2022

I want to talk a little bit about my investment process, which is unlike anyone else’s I know.

Last Friday, I DJed at a club in New York. Probably one of my top five gigs of all time. The club was packed, and it was going off. How can you not be sentimental about these sorts of things? I am a big fan of making memories—stepping outside my boring life and doing things I will remember for the rest of my life. Friday night was one of those times—absolutely magical.

DJing is a dark art, for sure. A really good DJ tells a story over the course of a night, taking you on ups and downs, tension and release, until the end, when you are exhausted and happy. It takes some knowledge of mass psychology—knowledge of how to manipulate people’s emotions over the course of a two-hour set. Some people are good at it, and some people aren’t. Some people are no better than hooking up an iPod on shuffle. But when someone is a master at it, it makes for some memorable nights.

You might be surprised to hear this, but the same skills I use to DJ I also use in finance. It’s all about mass psychology and people’s emotions. You won’t hear sell-side strategists talking about this kind of stuff. They can’t—no one would take them seriously. The only people who can do it are the crazy newsletter guys, who can say whatever they want (which is one of the main benefits of subscribing to a newsletter—getting divergent, out-of-consensus opinions).

For example, a few weeks ago, in my newsletter The Daily Dirtnap, I identified what I thought was a turning point in sentiment—bearishness had been exhausted, and I predicted that stocks would go higher, especially the bombed-out tech and innovation stocks that had been getting killed since 2021. It turned out to be correct, people traded on it, and everyone picked up some extra performance. Do that a few times a year, and you can get an extra 400–500bp in returns. Sentiment is always useful, but it is most useful at big turning points, when buying or selling is exhausted, and one side is deliriously happy, and the other side is demoralized and exhausted.

One of the best sentiment trades in history was in March of 2008, around the Bear Stearns bankruptcy. I was getting Bloomberg messages from people saying “SELL,” and I was responding “BUY.” What ensued was one of the greatest short squeezes of all time, as the S&P 500 rallied 17% into June, squeezing out all the shorts, right before the main event in September. A little knowledge of sentiment trading would have saved people from this mistake. The point in time when things seem the worst (Bear Stearns) is actually the point when you want to buy, even though things might get worse later (Lehman). Nothing goes down in a straight line.

That’s true today, also—the war in Ukraine seems to have reached some sort of stalemate, and while it is possible, even likely that things may get worse later, nothing goes down in a straight line. I struggle with this all the time: I am an investor, but circumstances force me to be a trader, which I don’t really want to be. But if you’re not a trader, you’re subject to these huge drawdowns from time to time as sentiment takes over and your positions move against you. It’s tough to just be long (or short).

As I said before, there is a connection here with music—good dance music alternates between tension and release. Tension and release. That’s a little bit how the markets operate, too. There aren’t too many charts that go straight up or straight down over the course of years. There is always doubt along the way. It’s never easy. If you’re long a stock, and it makes a small correction, you experience doubt. If the correction resolves, and it goes higher, you experience elation. You experience a range of emotions over the course of the trade.

The truth is a lot of trades end when people are sick of experiencing emotion—not because they made or lost money. They have just had enough of the drama. I expect this to happen to Tesla (TSLA), at some point, actually.

It’s funny—deep down, everyone knows that emotion drives markets, but nobody takes the time to analyze it. They continue to do stuff that doesn’t work, like fundamentals (which also work at the extremes) and technical analysis (which is better because charts reflect emotion). When I talk to people, I listen to what they say. I listen to how they feel about the market. When I’m on Twitter, I’m always reading and listening. It all goes into the soup. The magazine covers and skyscrapers help, but the real data comes from listening to what people say. It’s voodoo, but as I like to say, in finance, voodoo works. We’ve spent decades trying to quantify the unquantifiable, and it just doesn’t work.

Why not do what works?

By the way, I’m going to share more divergent opinions, more about the voodoo, and more about what works in today’s volatile environment at SIC 2022, May 2–13. Click here to lock in your Virtual Pass at a steep discount.

Jared Dillian

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