April 13, 2009

Many readers have asked me to review my recommendations of the last three months, so here is The Mad Hedge Fund Trader's Q1 report card. I have reprinted by January 4, 2009 Annual Asset Review and followed with comments in bold type.

Equities: UP

The collapse of the volatility index (VIX) is telling us that the horrific, gut churning, 10% daily moves are over. But equities are no longer a US play. Extracting the insane leverage of the last decade means chopping the US growth rate down from a booming 5% to an anemic 2%. This is not a strong argument to buy American companies, which is why most analysts only see the indexes recovering 10%-20% this year. You might just get tedious range trading after the late 2008 dead cat bounce. The real action will be in the BRIC countries, which will see upside returns double what you will get with the S&P 500. Buy Brazil's Bovespa ($BVSP), Russia's RSX (RSX), India's Bombay Sensex ($BSE), and China's FXI (FXI) or Hang Seng. And it may be time to spell BRIC with a 'K' by throwing in the Korean Kospi ($KOSPI) as a sweetener.

Grade: A After one more spike, the VIX collapsed from 50% to 36%, so a ton of money was made on short volatility and time decay plays. My call that the export sensitive BRICK's were a 'Buy' was a total home run, as they massively outperformed the US. Brazil is up 18%, Russia 29%, India 20%, China 18%, and Korea 20%. The S&P 500 is still down on the year by a miserable 3%. With 80%-90% of the world's economic growth expected to come from emerging markets over the next ten years, this trade has much, much further to run. If you want to be conservative and diversified, buy the iShares MSCI Emerging Market basket ETF (EEM), up 21% on the year.

Bonds: Treasuries Down, Private Debt Up.

As I have been vociferously arguing in these pages for months, US Treasury bonds are witnessing the final stages of an overinflated bubble, and you don't want to be anywhere near this asset class when it bursts. Take out the flight to quality and year end balance sheet window dressing bid from this market, and you have an accident begging to happen. Take in the long term inflationary impact of Obama's plans, and you have a 30 year contract which peaked at 142 last week that is really only worth 70. It's just a matter of time before massive government issuance buries largely foreign buyers. Throw in the 50:1 leverage offered by a long bond futures contract, and the profit potential of a short position is so enormous, there are not enough zeros on my calculator to total it up. Buy the Lehman 20 year plus ultrashort bond ETF (TBT). Unfreezing of the debt markets will move the prices for every other type of debt off of their current throw away levels. Buy corporates of every grade with a heavy weighting in junk, or fixed income securities backed by REIT's, emerging markets, credit cards, student loans, or subprime loans. A convenient way to do this is to buy the ETF's for the Lehman High Yield Bond Fund (JNK), the PS Corporate High Yield Bond Fund (PHB), and the iShares iBoxx Fund (HYG).

Grade: A+ My recommendation to short the Treasury's long bond was spot on, with the US Lehman 20 year 200% short ETF (TBT) soaring by 25%. With the government's printing presses running overtime, this is going to be your new free lunch. The junk bond ETF's PHB (up 6%) and HYG (up 1%) also were profitable, but did less well, as credit concerns linger.

Commodities: UP

After giving up almost all of their 21st century gains, virtually all commodities, including grains, softs, energies, and metals, are due for a recovery. A good part of the sell off resulted from the disappearance of financing, which is now slowly working its way back into the market. Now that newbie investors who never should have been involved, like pension funds, have bailed on this asset class, conditions are set for some serious base building. Commodities will be the principal beneficiaries of an epochal trend away from paper assets, towards hard assets, that will be the dominant investment theme for the next decade or two. Chinese and Indians still want to raise their standard of living faster than these substances can be grown, or ripped, or pumped out of the ground. Now Obama is adding America to the infrastructure build out story. A safe way to play this is through beaten down, dividend yielding, producing equities like Freeport McMoran (FCX) for copper, Chesapeake Energy (CHK) for natural gas, and US Steel (X) for steel and iron ore.?? But don't expect huge gains until we see signs of a global economic recovery by the middle of the year. Then watch out.

Grade A+ Commodities and their underlying stocks have been the place to be in 2009. You really couldn't miss, with grains, softs, energies, and metals all doing well. Freeport McMoran rocketed by 92% on a 45% move in copper.?? Oil is up 28%, and gold ran 17% before its current pullback. The only letdown has been natural gas, which due to supply and storage difficulties unique to this one energy source, has fallen by 30%. However, my stock pick in the area, Chesapeake Energy (CHK), jumped by a robust 23%. Again, this trade has a long way to run. While they stopped making almost everything in this recession, the world hasn't stopped making more people. They are all going to need to eat, travel on more roads, and live in more houses. The emerging market thirst for a higher standard of living is as strong as ever. Look for crude to move to $200/barrel on the next spike. Move your portfolio out of paper assets into hard ones.

Currencies: Dollar and Yen Down, Everything Else Up

Since we are smack dab in the middle of a six year trading range, I don't really have a handle on what the buck is going to do short term. Could we see $1.20 or $1.00 for the greenback in an event driven overshoot short term? You betcha! But longer term, the trend is still down. Obama's highly inflationary reflationary policies will eventually lead to an utter collapse in the dollar. If they are successful, the economy will recover, bringing Americans back to their old low saving, high consumption, high importing ways, adding fuel to the fire. Don't bet against the 45 year trend. No one ever got rich betting against the US consumer. Expect to pay $2.00 for a Euro in the years ahead. Take that European vacation now!

Grade: Pass Since I really didn't take a view, I don't deserve a grade. In fact, the euro is dead unchanged year to date at $1.33, keeping to a pretty boring range of $1.25 to $1.37. But the collapse of the dollar is a mathematical certainty resulting from current US government policies, and may be the trigger for the world's next big financial crisis.

Real Estate: Down

With markets still deleveraging, and the son of subprime, the Alt-A loans on our
doorstep, real estate is dead money at best. Although the cost of carry for home ownership is rapidly approaching equivalent rental costs on an after tax basis, fewer and fewer buyers are qualifying for loans. Add 1.2 million unsold homes from builders, to three million existing homes already on the market, and you have a staggering 4.2 million homes for sale in the US. There are at least another two million homes being held off the market waiting to smack down any recovery in prices. This is 7% of the total American housing stock. Probably 20% of US homeowners are underwater on their mortgages, and they're not buying anything anytime soon. We also have an impending crisis in commercial real estate generating lots of mall bankruptcies and empty retail space to deal with. Remember, 'debt' is a four letter word. I don't see a meaningful recovery in residential real estate for five years, and then it will be a slow claw back at best.

Grade: A+ Although we don't have the benefit of a daily closing price in the Wall Street Journal every day, I think it's safe to assume that all sectors of the real estate market have continued their death spiral this year. Stay away. Rent, don't buy.

Final Grade: A I am sticking to my guns on all of my core trades for 2009. Call me what you want. You can even call me 'Mad'. Is anyone looking for a new money manager or financial advisor?