I want to expand on an idea that I talked about on Twitter/X this week explaining the difference between being early and being wrong.
For as many people as there are involved in the financial markets that make buy or sell calls on stocks, there are even more that are ready to pounce on those that they deem “wrong”. Unfortunately, there’s not one universal definition of what qualifies as “wrong”. It’s usually a subjective opinion borne by the person making it. And that’s what makes it so problematic.
Here’s an example. If I say that Microsoft is going to drop by 20% and it doesn’t happen one month after I make the prediction, am I wrong? If it does happen at the six-month mark, am I right? What if the stock rises by 15% before dropping by 20%. Am I both wrong and right?
With respect to the last scenario, you’ll find people taking both sides. I’d argue that you can be both early AND right. The reason is that it all depends on the context and what happens around those events.
Let’s say I turn on the weather report and it says that a hurricane is going to hit my city in three days. I decide to get in my car that minute and head out of town without packing a thing. In that scenario, a lot of people would probably say that I was early. I could have taken the time to pack up my things and board up the windows and I still would have gotten out of town just fine. Maybe that’s true. I may have left too early, but I was right in getting out of town before the storm hit. In the grand scheme of things, the extra day or two won’t matter. The fact that my family and I are OK does.
Now, let’s look at the flip side. Someone sees that he’s got three days and decides he won’t worry about it for a while. Maybe he thinks he can swing by Home Depot to pick up some supplies later or whatever. Doesn’t matter because he’s got time, right? But it turns out the storm got there sooner than he expected. The store is out of supplies and the roads are clogged with people looking to get out at the last minute. Now he can’t get out in time and he’s stuck simply trying to make it through.
That might be an extreme example, but you get the point. As I said both on Twitter/X and in other media, I’d rather be early & wrong than late & right. At least if I’m early, I can manage my risk on a go-forward basis. I can’t go back in time.
I practice this in real-time through my risk rotation strategies. I’m not one who “gets out of the market” when conditions get worse like most investors do. I choose instead to manage risk. If my signals indicate that it might be time to take some risk off the table, I don’t push into cash. I rotate into Treasuries. I do this for a couple of reasons. First, if conditions do turn risk-off, Treasuries have historically demonstrated that they can generate positive returns while stock prices are falling due to the flight to safety trade. Second, rotating into Treasuries instead of cash still gives me the opportunity to generate positive returns even if the signal turns out to be wrong.
If I’m early & wrong, I can still make money. If I’m late, does it really matter? I can say that the S&P 500 is going to drop 30% tomorrow. If it does, but I haven’t done anything with my portfolio, does it matter that I’m right? It does not. Because I was late.
I’d rather be early & wrong than late & right.
Michael Burry of The Big Short fame is probably the best example of this. He started shorting the housing market as much as a year before it collapsed. As the movie showed, everybody thought he was nuts and tore him to shreds both personally and professionally. And he lost money for a while.
But he stuck to his guns and held on to his position. And people laid into him either further.
Until he was proven right and he was able to write this number up on his board.
Would Burry be considered right or wrong? Yes, he was early. Yes, it cost him money. In the end, he was up HUGE on his investment and turned out to be right.
Keep reading with a 7-day free trial
Subscribe to The Lead-Lag Report to keep reading this post and get 7 days of free access to the full post archives.