Our next round of investments is about to begin. The arrival of the Blooomberg a week ago ended our short period of operating in degraded mode. Now we are about to unleash the full operational power of this process. OK, that is a little dramatic. Let's just say we've got all the tools that go in the toolbag now.
On a broader note, the market is looking like it will finish January down about 6.5%. That's better than the -13.5% it touched intraday about ten days ago, but all is not well with the economy. The Fed has cut rates 1.25% in the last ten days, which has provided most, if not all, of the comeback. But the effects of those cuts will take a lot of time to ripple through to income statements, and in the meantime, it could be choppy. As it turns out, we like choppy. We make more money in general when the smooth sea turns into a rough storm. But choppy normally means that most people are hurting for awhile.
We called a range for the S&P for 2008 between 1300 -1550. We haven't closed below 1300 yet, although we've been there twice intraday. Hopefully we can get closer to 1400 soon. I have a feeling that the market will finish slightly positive for the year even given this rocky start.
Thursday, January 31, 2008
Monday, January 28, 2008
The Roof Is On Fire
More negative news came out this morning about the sales of new homes, about how they are at their lowest level in 12 years, blah blah blah. Well, we all knew this was coming in 2005. There is no free lunch. Things got ridiculous, everyone jumped in, things went sour, now people are scared and want answers. In other words, the same old story of any bubble.
So here's an answer: The time to invest in residential real estate, whether for your personal home or for you investment portfolio, will be in the next 18 months. That's not the answer most people want to hear, because many have been left holding the bag (or the deed, or whatever). But if you want to make a good investment, 2008-2009 is the time to buy fairly low. We need to see blood in the streets. We need to see grey matter oozing out of people's ears. We need unearthly shrieks of pain. And we are starting to get near that point.
Homebuilders are laying off people right and left. Many subcontractors are waiting for phone calls that aren't coming. Rate cuts and refinancing aren't going to save a lot of people; they are going to have to dump their home at the worst possible time and at the lowest price. We aren't taking any pleasure in this, it's an awful thing for people to endure. But they knew what they were signing up for when they got their 5/1 ARM at 3.85%. There is always a day of reckoning.
So here's an answer: The time to invest in residential real estate, whether for your personal home or for you investment portfolio, will be in the next 18 months. That's not the answer most people want to hear, because many have been left holding the bag (or the deed, or whatever). But if you want to make a good investment, 2008-2009 is the time to buy fairly low. We need to see blood in the streets. We need to see grey matter oozing out of people's ears. We need unearthly shrieks of pain. And we are starting to get near that point.
Homebuilders are laying off people right and left. Many subcontractors are waiting for phone calls that aren't coming. Rate cuts and refinancing aren't going to save a lot of people; they are going to have to dump their home at the worst possible time and at the lowest price. We aren't taking any pleasure in this, it's an awful thing for people to endure. But they knew what they were signing up for when they got their 5/1 ARM at 3.85%. There is always a day of reckoning.
Thursday, January 24, 2008
Positive!
We don't talk about exact performance here, but I'm happy to report that our first month will be a positive one, even with all of the market turbulence. Our hedges were bent a little, but unbroken, and we will be positive. How do I know this, with a full week left in the month? Because our Bloomberg just got here today, and we are sitting in cash while we run the analytics to put together our positions. This will take a few days, and we want to make sure we are following all of the procedures that have worked in the past. Plus, Bloomberg has upgraded lots of the analytic tools, and there is a small learning curve in place.
Rogue Trader or Rogue Firm???
One trader wiped out $7.1 billion of capital from Societe Generale over the past two years.
They just noticed it this week, when the turmoil in the markets forced the trader to cover his bets.
You would think that after all of the rogue traders that have brought down firms (Jett, Leeson, etc.) that institutions would have tightened up these risk controls. Ummm, not a chance. This guy was allowed access to systems that allowed him to cover his tracks for years. The firm never questioned anything until it was too late. That's why compliance is so important, but especially to the big firms. It's easier to hide a mistake in a big firm than a small one. The best firms keep insanely tight controls in place, and they just happen to be the same firms that are holding up fairly well in this tumultuous market.
When the wheels are coming off the market, you've got to know that your vehicle is sturdy. The best firms have reviews of individual trading positions frequently, and at the management committee level. You would think that all CEOs of major firms would do this, but only a few actually do it. The rest of them get fired when it all goes down (Merrill, Citi, Bear).
You have got to MICROMANAGE EVERYTHING when it comes to trading positions.
They just noticed it this week, when the turmoil in the markets forced the trader to cover his bets.
You would think that after all of the rogue traders that have brought down firms (Jett, Leeson, etc.) that institutions would have tightened up these risk controls. Ummm, not a chance. This guy was allowed access to systems that allowed him to cover his tracks for years. The firm never questioned anything until it was too late. That's why compliance is so important, but especially to the big firms. It's easier to hide a mistake in a big firm than a small one. The best firms keep insanely tight controls in place, and they just happen to be the same firms that are holding up fairly well in this tumultuous market.
When the wheels are coming off the market, you've got to know that your vehicle is sturdy. The best firms have reviews of individual trading positions frequently, and at the management committee level. You would think that all CEOs of major firms would do this, but only a few actually do it. The rest of them get fired when it all goes down (Merrill, Citi, Bear).
You have got to MICROMANAGE EVERYTHING when it comes to trading positions.
Thursday, January 17, 2008
Break Out The Vaseline
If you woke up on Christmas morning and looked at your portfolio and smiled ... well, you probably aren't smiling now. The market has lost over 10% in the last three weeks, and is down over 8% for the year. That's not good, considering it's only January 17. They've got the market out behind the woodshed right now and are having their way with it.
So what to do? Consumer staples are doing well right now, but nothing else is. When people start getting panicky about their finances, they tend to focus on the basics (food, drinks, cigarettes, guns) and sell off everything else. Yes, guns are a consumer staple to some people. Some financial firms have been getting pummeled for too long and are worth a look. BB&T had little to no exposure to the sub-prime problems, got taken down with the others, but is now starting to stabilize as people realize that the write-downs won't happen there. Same with Goldman Sachs, which doesn't rely on the consumer nearly as much as most other financial firms. Take a look at MO and BUD, stocks that always do well when times appear to be rough. Hey, if you're going down in flames, might as well drink and smoke on the way down.
What are we doing? Well, I can't tell you exactly of course, but I will say that everything we do will be hedged. If we are wrong, we won't be very wrong. If we are right, we will do very well. Sort of what a hedge fund is supposed to do.
Johnson & Johnson (JNJ) is actually up since Christmas Day. Guess who makes Vaseline?
So what to do? Consumer staples are doing well right now, but nothing else is. When people start getting panicky about their finances, they tend to focus on the basics (food, drinks, cigarettes, guns) and sell off everything else. Yes, guns are a consumer staple to some people. Some financial firms have been getting pummeled for too long and are worth a look. BB&T had little to no exposure to the sub-prime problems, got taken down with the others, but is now starting to stabilize as people realize that the write-downs won't happen there. Same with Goldman Sachs, which doesn't rely on the consumer nearly as much as most other financial firms. Take a look at MO and BUD, stocks that always do well when times appear to be rough. Hey, if you're going down in flames, might as well drink and smoke on the way down.
What are we doing? Well, I can't tell you exactly of course, but I will say that everything we do will be hedged. If we are wrong, we won't be very wrong. If we are right, we will do very well. Sort of what a hedge fund is supposed to do.
Johnson & Johnson (JNJ) is actually up since Christmas Day. Guess who makes Vaseline?
Wednesday, January 16, 2008
Getting Juicy Out There
With the Dow under 12,500, the S&P under 1400, and the NASDAQ under 2400, things may be looking grim. Unless you have hedges in place, that is. Our market-neutral stance has worked well in this environment. However, our hedges roll off on Friday and we are busy planning the next round of investments. It helps that a bunch of money came in in the last week or so; we have more to put to work.
The Vix is at 24 right now. Since it's that high, there is an opportunity to do very well in the next month or so. We are carefully studying potential ranges on a number of securities before making our final decisions. We will not be short-biased this month; we will either stay perfectly market-neutral or go slightly long in certain areas. That decision isn't going to matter too much in the end, but the decisions on the hedges will.
The S&P is down 6.50% in the first two weeks of the year. So much for January being a good month. I used to try and outperform the S&P by 7% over the course of a year in my old job (and succeeded). We are that far ahead in the first two weeks.
The Vix is at 24 right now. Since it's that high, there is an opportunity to do very well in the next month or so. We are carefully studying potential ranges on a number of securities before making our final decisions. We will not be short-biased this month; we will either stay perfectly market-neutral or go slightly long in certain areas. That decision isn't going to matter too much in the end, but the decisions on the hedges will.
The S&P is down 6.50% in the first two weeks of the year. So much for January being a good month. I used to try and outperform the S&P by 7% over the course of a year in my old job (and succeeded). We are that far ahead in the first two weeks.
Tuesday, January 15, 2008
The $18 Billion Writeoff
Sometimes you just have to MICROMANAGE EVERYTHING. Chuck Prince let a few idiots load up several dozen trainfuls of sub-prime loans while he had his back turned, and it came back to bite him hard. $18 billion is a lot of money for one mistake. 10% of the countries on this planet don't have an annual GNP that large. Fewer than twenty guys in the world are worth that much. That's like feeding $574 into a woodchipper, every second, for an entire year. Ok, you get the point. Probably fewer than 50 guys at Citi screwed the other 350,000 employees out of any sort of real bonus in 2007, as well as making their options worthless and their dividend checks a lot smaller.
It's funny how the firms that have aspired to be the financial supermarkets (like Citi, B of A, and Merrill) are the ones who are being hit the hardest. Managing that many pieces of the financial puzzle is tricky during the best of times; being the buyer of last resort for other firms' sewage is sheer stupidity. Hey, I'll hook a hose up to the bottom of my toilet and send whatever comes down the pipe over to those firms too.
There will be a point in time, however, where buying Citi will be a smart investment choice. I've met with Vikram Pandit one-on-one a couple of times back in the 1990s. He is as smart as they come, and he will not allow Citi to make a mistake of this size again. Breaking up the company is the best option for most CEOs. Sandy Weill was able to hold it all together, and Pandit also has that ability, especially as a manager of risk.
But for the moment, Citi needs all the Vaseline you can send them.
It's funny how the firms that have aspired to be the financial supermarkets (like Citi, B of A, and Merrill) are the ones who are being hit the hardest. Managing that many pieces of the financial puzzle is tricky during the best of times; being the buyer of last resort for other firms' sewage is sheer stupidity. Hey, I'll hook a hose up to the bottom of my toilet and send whatever comes down the pipe over to those firms too.
There will be a point in time, however, where buying Citi will be a smart investment choice. I've met with Vikram Pandit one-on-one a couple of times back in the 1990s. He is as smart as they come, and he will not allow Citi to make a mistake of this size again. Breaking up the company is the best option for most CEOs. Sandy Weill was able to hold it all together, and Pandit also has that ability, especially as a manager of risk.
But for the moment, Citi needs all the Vaseline you can send them.
Monday, January 14, 2008
Bank of America Buying More Manure
If you put down a $2 bet in poker and then back it up with another $4 on the next betting round, spectators might think you have a good hand. But if you put down $2 billion and then back it up with $4 billion in an attempt to buy the pot, you had better know exactly what you are doing. Countrywide may be a good fit for Bank of America in name only, since the financial behemoth is the country's only true coast-to-coast bank.
The bank has a long, sad history of overpaying for institutions that ultimately deliver less than promised. Over the years, B of A has acquired many firms that were meant to shore up areas in which it was weak. Each time, it succeeded in bringing in more deposits from the customers of those firms, but alienated the core members of the acquiree. As a result, Ken Lewis has been forced to admit over and over that the expected results in the weak areas have not materialized.
Well no kidding, Ken. When you try to force a bank culture down the throat of another industry like investment banking, mortgages, insurance, hedge funds, wealth management, etc, it will never work. The only way to make it work is to let them run things under their own brand, business as usual. When you get bank people out of their element, you wind up with trouble.
Countrywide is a steaming pile of dung fresh from the bowels of the American consumer. It is what is left over from a series of poor decisions on credit (meaning millions of poor decisions, really). There may be a few diamonds in the rough there for B of A to scoop up. But it will get its hands very dirty in the process.
The bank has a long, sad history of overpaying for institutions that ultimately deliver less than promised. Over the years, B of A has acquired many firms that were meant to shore up areas in which it was weak. Each time, it succeeded in bringing in more deposits from the customers of those firms, but alienated the core members of the acquiree. As a result, Ken Lewis has been forced to admit over and over that the expected results in the weak areas have not materialized.
Well no kidding, Ken. When you try to force a bank culture down the throat of another industry like investment banking, mortgages, insurance, hedge funds, wealth management, etc, it will never work. The only way to make it work is to let them run things under their own brand, business as usual. When you get bank people out of their element, you wind up with trouble.
Countrywide is a steaming pile of dung fresh from the bowels of the American consumer. It is what is left over from a series of poor decisions on credit (meaning millions of poor decisions, really). There may be a few diamonds in the rough there for B of A to scoop up. But it will get its hands very dirty in the process.
Wednesday, January 9, 2008
Bloomberg
You might be thinking this is a political post. Not at all - we will be getting our first Bloomberg financial terminal within a month. If you are a financial newbie and don't know what that is, maybe you will understand this analogy. No Bloomberg:Bloomberg::abacus:Cray supercomputer. While it probably won't change our thought process at all, it will save us a great deal of time and effort. At that time we can crank up our strategy into full-throttle mode. We can definitely make money without a Bloomberg, but it is a lot easier and faster to make money with it. Our initial positions are working out well. Normally I don't like to do short-term trades (less than a month), but in this case it absolutely makes sense. Starting off the year up while the market is getting its ass kicked can only help us. Soon we will unleash the power of this fully armed and operational Death Star - wait, bad analogy, the Empire lost in the end. Never mind. Let's just say we are optimistic about our prospects this year.
A random rant: I freak out every morning when I look at our position reports. Even though we are perfectly hedged, I always see a small loss in the mornings. Why? Because options market makers remove their bids/asks after trading ends for the day. So I see things like: Bid = $.05, Ask = $6.70 every morning on the options positions, and of course we are always seeing the worst case when the positions are "marked to market", which in this case is really "marked to insanity". Once trading starts, things brighten up and the true value is reflected and I am happy again. Using the last price of the day is a good idea; using a spread that Evel Knievel couldn't clear on a 600hp Harley is not.
A random rant: I freak out every morning when I look at our position reports. Even though we are perfectly hedged, I always see a small loss in the mornings. Why? Because options market makers remove their bids/asks after trading ends for the day. So I see things like: Bid = $.05, Ask = $6.70 every morning on the options positions, and of course we are always seeing the worst case when the positions are "marked to market", which in this case is really "marked to insanity". Once trading starts, things brighten up and the true value is reflected and I am happy again. Using the last price of the day is a good idea; using a spread that Evel Knievel couldn't clear on a 600hp Harley is not.
Monday, January 7, 2008
Group Meeting
A quick update - Today we had our first group pow-wow of the new year. We discussed likely trends for 2008 and ate massive amounts of cheeseburgers. The iced tea was flowing as well, all the way through. I know, more detail than you needed. But hey, you will never get anything less than full disclosure from me.
The good news is this - we are on track to have a very good year. The bad news is that not everyone will share our good fortune. Funds that are biased in certain sectors or directions are going to get hammered, unless they see it coming and are able to make some very quick adjustments.
The good news is this - we are on track to have a very good year. The bad news is that not everyone will share our good fortune. Funds that are biased in certain sectors or directions are going to get hammered, unless they see it coming and are able to make some very quick adjustments.
Friday, January 4, 2008
Market Falls Flat On Face
Well, the market has had its worst start to a new calendar year in as long as I can remember. Three trading days into 2008 and the S&P 500 is down nearly 4%. These three days have wiped out ALL of the S&P gains from 2007.
The Fed will certainly cut interest rates this time around, but it probably won't be enough to reverse the market and send it shooting upwards. What the market needs is a real catalyst, and I don't see one lurking around the corner. Many economists are saying that we are probably in a recession, and I agree with them. All indications are that business is slowing down a little bit. That means all of the up and down movements in the market are just noise.
However, that noise helps our strategy a great deal. We are pointing towards an up month so far. What we don't need now is for the S&P to blow through 1400 and head straight for 1300. While our strategy would do fine, it could potentially scare off other investors from the market.
There will come a time when the big financial institutions that have been getting crushed for months will be a slam dunk buy. But there is probably more blood running in the streets before we get to that point
The Fed will certainly cut interest rates this time around, but it probably won't be enough to reverse the market and send it shooting upwards. What the market needs is a real catalyst, and I don't see one lurking around the corner. Many economists are saying that we are probably in a recession, and I agree with them. All indications are that business is slowing down a little bit. That means all of the up and down movements in the market are just noise.
However, that noise helps our strategy a great deal. We are pointing towards an up month so far. What we don't need now is for the S&P to blow through 1400 and head straight for 1300. While our strategy would do fine, it could potentially scare off other investors from the market.
There will come a time when the big financial institutions that have been getting crushed for months will be a slam dunk buy. But there is probably more blood running in the streets before we get to that point
Thursday, January 3, 2008
Initial Market Strategy
I mentioned at the beginning of this blog that I wouldn't be going into any detail on individual positions. However, I think it makes a lot of sense to talk in more general terms about the market. We had one of our investment team pow-wows yesterday morning and we agreed unanimously that the market would probably go sideways for a while. I think we are going to see a range of 1400-1550 for the S&P for quite a long time, probably for more than half of 2008.
There is no real catalyst in the near term to move the market out of this range either way. On the downside, the specter of the credit crunch still weighs heavily, as does the likelihood that we are already in an economic recession. Most of that is already priced into stocks in many sectors. On the upside, there are many companies that are growing like gangbusters right now, but their access to capital is tightening more every day. That growth will inevitably slow in a more pronounced fashion because of the aforementioned pressures.
So we are starting out exactly market neutral. We have built the portfolio so that movement in equity prices should have little to know effect on portfolio value. Volatility remains high, however, and we should be able to do very well with our use of options. With portfolio risk essentially removed, the real risk now is simply opportunity cost, which we are more than willing to accept for the time being. The ability to crank out medium-sized (but consistently positive) returns for awhile is not a bad thing.
There is no real catalyst in the near term to move the market out of this range either way. On the downside, the specter of the credit crunch still weighs heavily, as does the likelihood that we are already in an economic recession. Most of that is already priced into stocks in many sectors. On the upside, there are many companies that are growing like gangbusters right now, but their access to capital is tightening more every day. That growth will inevitably slow in a more pronounced fashion because of the aforementioned pressures.
So we are starting out exactly market neutral. We have built the portfolio so that movement in equity prices should have little to know effect on portfolio value. Volatility remains high, however, and we should be able to do very well with our use of options. With portfolio risk essentially removed, the real risk now is simply opportunity cost, which we are more than willing to accept for the time being. The ability to crank out medium-sized (but consistently positive) returns for awhile is not a bad thing.
10 bips a day
That is one of the targets we are shooting for, anyway. Doing that would mean a gross return of about 25%. Naturally, we want to do better. Of course, with a carefully constructed portfolio such as ours, we are just as focused on having low volatility, so a Sharpe ratio in the 2-3 range would be nice.
Apparently, there was another investment group years ago with a name similar to ours. Although they are long gone, they still owe the NYSE some money. How do I know all this? Because the NYSE put a temporary freeze on our ability to trade until they were sure we weren't the same folks. So our initial trades haven't taken place yet. There's always something. At least yesterday we were in cash while the market was down 220 points, so we already look good on a relative basis.
I'm also doing an interview today or tomorrow for an online group; I'll post more on that after it happens.
Apparently, there was another investment group years ago with a name similar to ours. Although they are long gone, they still owe the NYSE some money. How do I know all this? Because the NYSE put a temporary freeze on our ability to trade until they were sure we weren't the same folks. So our initial trades haven't taken place yet. There's always something. At least yesterday we were in cash while the market was down 220 points, so we already look good on a relative basis.
I'm also doing an interview today or tomorrow for an online group; I'll post more on that after it happens.
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