While the book’s strategic positioning has broadly been a positive during the first half, there has been little contribution from any tactical trades or elements of the book. To look into this disappointment a little more closely, let’s touch on a couple of trades that we have clearly missed in the first half:
- Short Spanish Banks (e.g. Banco Santander)
If we go back to late 2009, when the sovereign problems came to attention in Dubai and then in Greece, one of the prevalent strains of commentary was the fear of contagion from Greece into other European countries. Of these countries, Spain was the one that people were most concerned about due to its size making it difficult to bail out. A consequence of sovereign and financial stress (or its perceived likelihood) is often funding difficulties for the nation’s financial institutions. Thus Spanish banks presented an opportunity where the potential stress (or its perception, at least) was predictable but not particularly priced in. It’s always frustrating to miss a trade that you could and should have seen, especially one that had a strong probability of happening within H1-2010.
- Long Exide (XIDE, Lead-Acid Battery Theme)
Sadly, this one’s entirely down to my failure to get organized and write up the Lead-Acid battery theme, which I had spent a lot of time working on at my previous job. The point of writing up the underlying ideas behind a theme is so that I can move quickly to investigate, document and act should unexpected opportunities appear. Well, an unexpected opportunity did crop up in Exide, my favourite of the lead acid battery companies, during May 2010 just prior to their results. Unfortunately, despite having talked about writing up the theme back in March, I never got around to collating my mass of notes and data and actually doing it and as such, wasn’t in shape to take advantage of the opportunity. Doh! Exide is now up >30% from its lows, double doh! While Part A has now set the scene, expect further posts on Lead-Acid Batteries in the next week or two, so I don’t miss the boat again!
Positioning and Thoughts
The positioning is largely unchanged since I wrote about it in May and so I’m going to try and touch on some different things in this piece rather than repeating myself.
My current expectation is that the day-to-day and week-to-week summer market movements will be “a tale told by an idiot, full of sound and fury, (but) signifying nothing”. The data points will likely be variable enough that the market will continue to be driven by sentiment, though likely trapped broadly in its current range (S&P: 1,000-1,150). Given the limited equity exposure in the book (due to the market hedges, and the Short China thesis), the portfolio’s NAV will continue to be dominated by the movement of long-end Treasuries. I’m prepared for this to prove frustrating on a daily/weekly basis, but it is probable that the bond market direction will lead the equity markets. As such, I’ll be focusing on whether yields continue to crunch lower or whether the (seemingly unlimited number of) bond bears will finally have something to cheer about.
Given this short-term outlook, ‘trading time’ is likely to be slow and there are unlikely to be significant changes to the portfolio until the data helps provide some clarity on the economic situation. That said, looking at the rosy current expectations (the below is from a couple of weeks ago), I’d be surprised not to see GDP forecasts continue to be lowered.
As an aside, it is noticeable how many now simply equate the market with the economy (i.e. market is up 60%+ from last year/5%+ this month, thus the economy has rebounded strongly/is not going to double dip) but the level of confidence in the economy remains the key for the market. Thus, I worry that the economic data over the next 3-4 months could risk setting off either a virtuous or vicious cycle, as the information flows through the feedback loop between the market and the (real) economy that results in stocks moving in a binary fashion to price in either Armageddon or Utopia. When that starts to happen, is when the trading time will speed up and the real opportunities will arise. Until then our job is to continue to eke out a small profit and protect capital so that the portfolio is positioned (and our reserves of mental strength and confidence are intact) so that we can take advantage of the quicker ‘trading time’.
Things I’m looking at for the Second Half
I’ve broadly split the ideas into two camps those that would increase or reduce the book’s existing biases (profiting from tightening long-term Treasury spreads and a noticeable fall in the equity markets). Those that would increase the existing biases are first:
- Zero-Coupon 20Yr+ Treasury Bonds (ZROZ)
A clear increase in the long-end Treasury exposure, through a higher beta instrument. It’s just the kind of tactical trade one would look to put on, if fear had passed through panic and was looking at capitulation (i.e. bad GDP numbers, equities tumbling and people realizing that the expiration of the Bush tax-cuts means 2010’s a great time to book your capital gains).
- 2x Short Euro (EUO)
Generally, I’m not a fan of levered short ETFs as the combination of leverage and the inverse compounding kills you. However, there are signs of complacency amid the belief that Europe’s problems are done/priced-in/etc and the technical signs in the recent bounce in the Euro (this video neatly captures most of them) I am tempted by this one. My skepticism goes back to its launch and my days as wide-eyed Econ undergraduate who irked his professors by failing to comprehend how it could possibly work in the long-term. In short, the Euros flaws (to name the first 2 that come to mind; there’s no stick to punish countries that cheat, in reality there was no requirement for any meaningful convergence) are in its politically-driven construction and unless the sovereign countries join to form a federal Europe there’s little prospect of these flaws being corrected. A weak foundation becomes apparent when it’s stressed and, while the ECB can try and reduce the stress in the short-term without major changes (starting with debt and budget restructuring) and pain (likely significant deflation and entitlement reductions in periphery countries) the stress will only increase over time.
- Rolling the maturities of the market hedge puts
In the absence of a market collapse the market hedges will need to be rolled. The timing of this is flexible, though likely to be end of Q3/start of Q4 (before the theta decay really impacts them too much). There’s the potential for both sets of puts to be on the book at the same time, if economic data shows noticeable weakness, and the market show some weakness but manage to hold up.
- NCAV Portfolio updates
With Q2 reporting season upon us, it’s likely there may be some new names for the NCAV bucket in the coming weeks after companies file their results with the SEC.
- Water Thesis
As this is a long-term strategic theme, it’s something one should be very comfortable starting a small position in and scaling into should it fall with the market. The first step is likely to be through some of the utility-orientated ETFs, before considering adding risk (through more Industrials-focused ETFs, and potentially individual names) only when the timing is more favorable.
- Lead Acid Battery Cos
As mentioned above, we missed out on Exide once and I don’t intend to a second time. As such, expect more on the Lead Acid Battery Co write-up (Part A) to be completed sooner rather than later, so that we’re in a position to put Exide (and other names) into the book should the chance arise.
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