Performance Review
October proved another strong month for equities as the economic data continued to point towards lackluster (but positive) growth and there were further signs that the FED will launch a second quantitative easing program (QE2) in early November. Unlike September, the portfolio was unable to perform positively spending the majority of the month fighting to stay around flat before succumbing in the final week, ending the month down 1.65% (putting the YTD at +6.9%).
The Treasury Bonds bucket drove the negative performance during the month (-156bps) as the long-end of the curve suffered throughout the month as a result of the various discussions on both the size of QE2 (ranging from $100bn/month for a number of months, to a shock-and-awe $1trn+ in the short-term) and where it would be focused (with consensus being that it would likely not be heavily in long-end Treasuries). Furthermore bonds all suffered from proclamations of an end to “bull market in bonds” but various market participants, most notably by Bill Gross (though it should be noted that he also proclaimed a bear market in bonds in mid-2007). Unlike the Treasury bucket, the Bond Funds (+8bps) managed a small positive gain, in part due to their exposure to shorter duration instruments.
In contrast the fund’s equity positions again benefited from the rise in the markets. The Value Equity bucket (+37bps) was the primary contributor, on the basis of a strong performance from DRWI following decent guidance from management. The Other Equities bucket (+28bps) and the NCAV bucket (+1bp) also helped performance during the month. Against these profitable Long positions, the Hedges/Put options (-75bps) and the China-Related thesis (-<1bp) were negative contributors. The newly-started Currency bucket also posted a small loss during the month (-7bps)
Portfolio
43.0% - Long Treasury Bonds (20.5% TLT and 22.5% in the Aug-29 Bond)
14.7% - Long Bond Funds (6.8% HSTRX, and 7.9% VBIIX)
6.8% - Value Idea Equities (4.5% THRX, and 2.4% DRWI)
4.4% - NCAV Equities
3.1% - Other Equities (1.6% NWS, 1.6% CMTL, and 0.0% SOAP)
-0.0% (delta-adjusted) - China-Related Thesis (<1bp premium in FCX put)
-3.9% (delta-adjusted) - Hedges/Put Options (6bps premium in S&P 2010 puts, 68bps premium in S&P 2011 puts and 5bps premium in a GS put)
5.5% (leverage-adjusted) – Currencies (EUO, Ultrashort Euro, 2.76%)
24.4% - Cash
Saturday, October 30
Thursday, October 28
Portfolio Update
Not much has changed with the portfolio over the last few months, so this represents the first update in a while following a couple of trades in the last day or so.
In the NCAV bucket, while there has been no further news on the QXM situation since the last update, the last little bump in the stock put it up over 65%+ since inception. As such, in accordance with the NCAV bucket's selling rules I have cut half the position. The same is true of CNTF, which was up around 75% since inception.
Finally, in a follow-up to the recent post on currencies, a new theme or bucket was started (which I’m titling “Currencies”, catchy isn’t it!) with the addition of EUO (A 2x Short Euro vs. USD position). The recent hints of more Greek accounting issues and the Euro meeting continued resistance once more at $1.40/Euro was the tipping point for me to put on the trade, which is initially sized at c3% NAV (though remember, it’s a double leverage position so it will have the impact of a 6% position size).
The next week promises to be a bonanza of macro-related news; with Q2 GDP out on Friday, US mid-term elections next week and then (not to be left out) the FED telling us how much money they intend to throw at the problems (and how frequently) through QE2. It will be interesting to see how markets respond to all this news, and whether the response in the coming weeks matches the initial response.
In the NCAV bucket, while there has been no further news on the QXM situation since the last update, the last little bump in the stock put it up over 65%+ since inception. As such, in accordance with the NCAV bucket's selling rules I have cut half the position. The same is true of CNTF, which was up around 75% since inception.
Finally, in a follow-up to the recent post on currencies, a new theme or bucket was started (which I’m titling “Currencies”, catchy isn’t it!) with the addition of EUO (A 2x Short Euro vs. USD position). The recent hints of more Greek accounting issues and the Euro meeting continued resistance once more at $1.40/Euro was the tipping point for me to put on the trade, which is initially sized at c3% NAV (though remember, it’s a double leverage position so it will have the impact of a 6% position size).
The next week promises to be a bonanza of macro-related news; with Q2 GDP out on Friday, US mid-term elections next week and then (not to be left out) the FED telling us how much money they intend to throw at the problems (and how frequently) through QE2. It will be interesting to see how markets respond to all this news, and whether the response in the coming weeks matches the initial response.
Wednesday, October 20
Some Initial Thoughts on Currencies
While not much has happened in recent months to warrant changes to the portfolio, the single most interesting thing has been the march of the Yen. As this graph shows, the yen has continued to strengthen (a drop in the graph = yen strength, and dollar weakness) fairly steadily throughout the period and this has also been broadly true since mid-2007.
As you can see the big spike in mid-September was when the Bank of Japan announced it would intervene to slow the yen’s rise (during September it bought sold 2.12trn yen and bought $25.4bn). The alert amongst you will have noticed that September’s intervention wasn’t sterilized (i.e. the Japanese just printed the money and then bought dollars with it) as Japan again tries to create inflation.
With the yen having started rising again, we have unsurprisingly seen the Bank of Japan moving to employ new ways of trying to prevent the yen’s rise, including asset purchases of corporate bonds, real estate trusts and even stock funds!
But, why’s this interesting?
Well, because Japan’s government bonds have (again) become a popular theme on the short side with Kyle Bass, amongst others, eloquently stating the case (here on CNBC). A corollary to this is the generally held view that the yen should be far weaker, with various Japanese politicians (not to mention various financial folk) others suggesting a 120 Yen/Dollar rate as being ‘fair’. Over time, I have great faith that both those who are short the yen and JGBs will be proven correct. I can’t help but wonder, however, if in order to see the yen move to the 120-140 range that people predict, we won’t have to see it reach the other extreme (i.e. the Yen at 50-60) first!
Perhaps, the move that’s currently underway is the start of a spring uncoiling, after all Japan’s consistent trade surpluses (and the foreign reserves that they’ve build up) mean that the Japanese (like everyone else) are short the yen. If people start to unwind those positions and the stronger Yen causes Japanese exporters to struggle (and potentially need to take on more debt…thus increasing the demand for yen) then things could get really interesting. The irony is, of course, that if the Japanese government is successful with the asset purchases and even manages to create inflation, the victory will be pyrrhic (as the higher inflation will necessitate higher nominal interest rates on JGBs, hastening the default that the JGB shorts see coming).
So that’s my ponderings on the yen, interesting but given the scope of the move the risk-reward probabilities suggest that there’s nothing to do here, However, as mentioned back in the mid-year review, one of the things I have my eyes on is a short position in the Euro (vs. the Dollar)…something that’s not a popular sentiment these days.
The dollar has been unquestionably weak against the Euro over recent months (see this chart). It’s also expected to remain weak for the foreseeable future, with Europe countries having seemingly resolved their sovereign debt problems and the Fed poised to undertake another Quantitative Easing program (QE2). However, with a 10% move over the last month and sentiment so anti-dollar, is all the news priced in?
Certainly, it seems pretty certain that QE is coming after the Fed’s Nov 2-3 meeting with people now mainly arguing over the size (will it be $1trn at once in a shock and awe move, or $100bn a month for 6-12months?) and the instruments that will be purchased (predominantly Treasuries, but potentially also some munis). For those who’re wondering why the QE is seen as such a sure thing; through Bernanke’s statements (and those of his cohorts, like Charles Evans), it’s become clear that there seems to be consensus for it. The only thing that the Fed fears more than inflation is deflation; and if a picture’s worth a 1,000 words, then the Fed’s fears can be summed up in this one chart (source: SF Fed):
As for Europe, are the sovereign problems are resolved (with Portugal, Ireland, Italy Greece and Spain now model sovereigns with no real probability of default) or has the ECB’s program to back-stop the debt provided suitable liquidity to push the questions of solvency further down the road. I would suggest that a real solution to the problem of excess debt is unlikely to be found in taking on more debt, and programs that facilitate this rather than looking for a better long-term solution are likely to eventually fail. While the ECB’s moves have succeeded in pushing the spectre of European sovereign failures from the front pages, they haven’t addressed the underlying problem (too much debt!). Furthermore, I would expect that any recurrence of the fears that we saw earlier in the year will be reflected in the Euro’s performance.
Longer-term, as readers know, I believe that the problem of excess credit/debt will be solved either by paying back the debt or by defaulting on it (and the creditor having to write-off that debt). When you payback debt (and don’t replace it with new debt) or write it off then dollars are removed from the system…and the dollar, like all things that become scarcer, will go up! While the scale of the Fed’s QE is expected to be large ($1trn), it pales in comparison when we consider that about 50% of the world’s debt issued is denominated in dollars. As such, there’s likely to be a meaningful opportunity to go Long the Dollar (vs. the Euro) in the near future.
As you can see the big spike in mid-September was when the Bank of Japan announced it would intervene to slow the yen’s rise (during September it bought sold 2.12trn yen and bought $25.4bn). The alert amongst you will have noticed that September’s intervention wasn’t sterilized (i.e. the Japanese just printed the money and then bought dollars with it) as Japan again tries to create inflation.
With the yen having started rising again, we have unsurprisingly seen the Bank of Japan moving to employ new ways of trying to prevent the yen’s rise, including asset purchases of corporate bonds, real estate trusts and even stock funds!
But, why’s this interesting?
Well, because Japan’s government bonds have (again) become a popular theme on the short side with Kyle Bass, amongst others, eloquently stating the case (here on CNBC). A corollary to this is the generally held view that the yen should be far weaker, with various Japanese politicians (not to mention various financial folk) others suggesting a 120 Yen/Dollar rate as being ‘fair’. Over time, I have great faith that both those who are short the yen and JGBs will be proven correct. I can’t help but wonder, however, if in order to see the yen move to the 120-140 range that people predict, we won’t have to see it reach the other extreme (i.e. the Yen at 50-60) first!
Perhaps, the move that’s currently underway is the start of a spring uncoiling, after all Japan’s consistent trade surpluses (and the foreign reserves that they’ve build up) mean that the Japanese (like everyone else) are short the yen. If people start to unwind those positions and the stronger Yen causes Japanese exporters to struggle (and potentially need to take on more debt…thus increasing the demand for yen) then things could get really interesting. The irony is, of course, that if the Japanese government is successful with the asset purchases and even manages to create inflation, the victory will be pyrrhic (as the higher inflation will necessitate higher nominal interest rates on JGBs, hastening the default that the JGB shorts see coming).
So that’s my ponderings on the yen, interesting but given the scope of the move the risk-reward probabilities suggest that there’s nothing to do here, However, as mentioned back in the mid-year review, one of the things I have my eyes on is a short position in the Euro (vs. the Dollar)…something that’s not a popular sentiment these days.
The dollar has been unquestionably weak against the Euro over recent months (see this chart). It’s also expected to remain weak for the foreseeable future, with Europe countries having seemingly resolved their sovereign debt problems and the Fed poised to undertake another Quantitative Easing program (QE2). However, with a 10% move over the last month and sentiment so anti-dollar, is all the news priced in?
Certainly, it seems pretty certain that QE is coming after the Fed’s Nov 2-3 meeting with people now mainly arguing over the size (will it be $1trn at once in a shock and awe move, or $100bn a month for 6-12months?) and the instruments that will be purchased (predominantly Treasuries, but potentially also some munis). For those who’re wondering why the QE is seen as such a sure thing; through Bernanke’s statements (and those of his cohorts, like Charles Evans), it’s become clear that there seems to be consensus for it. The only thing that the Fed fears more than inflation is deflation; and if a picture’s worth a 1,000 words, then the Fed’s fears can be summed up in this one chart (source: SF Fed):
As for Europe, are the sovereign problems are resolved (with Portugal, Ireland, Italy Greece and Spain now model sovereigns with no real probability of default) or has the ECB’s program to back-stop the debt provided suitable liquidity to push the questions of solvency further down the road. I would suggest that a real solution to the problem of excess debt is unlikely to be found in taking on more debt, and programs that facilitate this rather than looking for a better long-term solution are likely to eventually fail. While the ECB’s moves have succeeded in pushing the spectre of European sovereign failures from the front pages, they haven’t addressed the underlying problem (too much debt!). Furthermore, I would expect that any recurrence of the fears that we saw earlier in the year will be reflected in the Euro’s performance.
Longer-term, as readers know, I believe that the problem of excess credit/debt will be solved either by paying back the debt or by defaulting on it (and the creditor having to write-off that debt). When you payback debt (and don’t replace it with new debt) or write it off then dollars are removed from the system…and the dollar, like all things that become scarcer, will go up! While the scale of the Fed’s QE is expected to be large ($1trn), it pales in comparison when we consider that about 50% of the world’s debt issued is denominated in dollars. As such, there’s likely to be a meaningful opportunity to go Long the Dollar (vs. the Euro) in the near future.
Thursday, October 7
Things from my Google Reader...
You may have noticed posting has been rather light recently, and there are of course some fine excuses for this. In part it’s because Our Man has been scouring the market for a job, and hence spending a chunk of his time preparing for and being in interviews. However, it’s also large because there’s not much to do at the moment – I’m relatively comfortable with the portfolio and while there’s a little bit to do on some of the other themes that are on deck, you know what they are (Energy Storage and Water). Finally, I’ve also been doing a little bit of pondering on currencies, which I’ve mentioned before but is a new area for me. In some ways, they (or rather the ETFs related to them, since I can’t actually hold foreign currencies) seem like the best way to play some of the animal spirits and trends that I’m seeing in the market so expect some preliminary thoughts on that.
However, here are some of the things that I’ve been reading recently and have found thought provoking. Like the “Chartology” series, expect to see “Things from my Google Reader” series to appear irregularly but hopefully serve as something interesting (if nothing else they’ll at least be a good way for me to find links back to these articles in the future).
(Spoiler Alert: I’ve put the finance ones at the top and non-finance ones at the bottom)
- A Gold Valuation Model: Talk about gold is everywhere at the moment, with lots of people saying it’s going up but…how should you value gold? It has no earnings, and its value comes from people’s belief in its value (kind of like those much derided fiat currencies…). Here’s a model worth thinking about from Eddy Elfenbein, at Crossing Wall Street.
- The politics of Chinese Adjustment: As you know, I’m not a China bull (see here and here), in part because of the economic imbalances that I see in their economy. In this post on his blog Peking University Professor Michael Pettis looks through the sequence of steps on rebalancing those imbalances.
- Beware of Greeks Bearing Gifts: In case you thought that Greek crisis thing was all over, here’s a really good (and easy to read and understand) article on it by Michael Lewis, at Vanity Fair. It’s right on the Money(ball)!
- Fractals and the Art of Roughness: Our Man often makes references to trading time being slow or fast, to fingers of instability and glimmers of hope, etc when talking about the portfolio and markets. All are related to do with the fractals and roughness, and if you’ve ever wanted to know what the hell that means…here’s a video of a talk by the father of fractal geometry, Benoit Mandelbrot (at TED 2010) that introduces the subject gently. (For those who're tired of the finance-related links, here's JJ Abrams talking about Lost and other mysteries at TED 2007).
- Scared of Mathematics (and other educational things): Learn everything you fail to remember from school at the Khan Academy. Apparently even Bill Gates likes this former hedge fund guy’s easy to understand bite-size videos on a variety of subjects. (Fortune)
- Nolan and Ichiro: Is Nolan Ryan the Greatest Pitcher Ever? Here’s a finely constructed argument saying that though Nolan is great, he’s not the greatest (ditto for Ichiro). (Joe Posnanski).
- The Fan Experience at Sports Events: Never Look Down: Mark Cuban’s thoughts on what it should be like to go to a game. As a football (aka soccer) loving Brit, it doesn’t quite resonate with me (soccer doesn’t have the non-playing time during the game that US sports have, and by the virtue of being relatively rare goals feel special vs. baskets/runs) but I can certainly see why it makes sense.
However, here are some of the things that I’ve been reading recently and have found thought provoking. Like the “Chartology” series, expect to see “Things from my Google Reader” series to appear irregularly but hopefully serve as something interesting (if nothing else they’ll at least be a good way for me to find links back to these articles in the future).
(Spoiler Alert: I’ve put the finance ones at the top and non-finance ones at the bottom)
- A Gold Valuation Model: Talk about gold is everywhere at the moment, with lots of people saying it’s going up but…how should you value gold? It has no earnings, and its value comes from people’s belief in its value (kind of like those much derided fiat currencies…). Here’s a model worth thinking about from Eddy Elfenbein, at Crossing Wall Street.
- The politics of Chinese Adjustment: As you know, I’m not a China bull (see here and here), in part because of the economic imbalances that I see in their economy. In this post on his blog Peking University Professor Michael Pettis looks through the sequence of steps on rebalancing those imbalances.
- Beware of Greeks Bearing Gifts: In case you thought that Greek crisis thing was all over, here’s a really good (and easy to read and understand) article on it by Michael Lewis, at Vanity Fair. It’s right on the Money(ball)!
- Fractals and the Art of Roughness: Our Man often makes references to trading time being slow or fast, to fingers of instability and glimmers of hope, etc when talking about the portfolio and markets. All are related to do with the fractals and roughness, and if you’ve ever wanted to know what the hell that means…here’s a video of a talk by the father of fractal geometry, Benoit Mandelbrot (at TED 2010) that introduces the subject gently. (For those who're tired of the finance-related links, here's JJ Abrams talking about Lost and other mysteries at TED 2007).
- Scared of Mathematics (and other educational things): Learn everything you fail to remember from school at the Khan Academy. Apparently even Bill Gates likes this former hedge fund guy’s easy to understand bite-size videos on a variety of subjects. (Fortune)
- Nolan and Ichiro: Is Nolan Ryan the Greatest Pitcher Ever? Here’s a finely constructed argument saying that though Nolan is great, he’s not the greatest (ditto for Ichiro). (Joe Posnanski).
- The Fan Experience at Sports Events: Never Look Down: Mark Cuban’s thoughts on what it should be like to go to a game. As a football (aka soccer) loving Brit, it doesn’t quite resonate with me (soccer doesn’t have the non-playing time during the game that US sports have, and by the virtue of being relatively rare goals feel special vs. baskets/runs) but I can certainly see why it makes sense.
Saturday, October 2
September Review
Performance Review
September proved the strongest month for equities in some time as a result of both economic data steadying and market participants becoming more confident that the FED will launch a second quantitative easing program (QE2) in early November. Despite this move towards a risk-on sentiment in September the portfolio was able to eke out a small gain of 0.72% (putting the YTD at 8.7%), though this pales in comparison to the strong performance of most markets.
Unsurprisingly, the Treasury Bonds bucket was a large negative contributor (-87bps) as it suffered heavily in the first half of the month from both the reduction in risk aversion and fears about QE2’s impact on long-term government finances. The Bond Funds (+7bps) also suffered during the first half of the month, but were able to benefit more from the recovery in the 2nd half of the month.
In contrast the fund’s equity positions benefited from the rise in the markets, with Other Equities (+44bps) and NCAV Equities (+33bps) both contributing well. However, the main driver of performance in September was the Value Equities bucket (+209bps), which was driven by the position in THRX (+174bps) following some Phase II trial results (if circumstances allow, the position in THRX will be trimmed a little). Against these profitable Long positions, the Hedges/Put options and the China-Related thesis were negative contributors (130bps).
Portfolio
44.0% - Long Treasury Bonds (21.2% TLT and 22.8% in the Aug-29 Bond)
14.4% - Long Bond Funds (6.6% HSTRX, and 7.8% VBIIX)
6.4% - Value Idea Equities (4.3% THRX, and 2.0% DRWI)
5.0% - NCAV Equities
2.8% - Other Equities (1.4% NWS, 1.0% CMTL, and 0.0% SOAP)
-0.0% (delta-adjusted) - China-Related Thesis (1bp premium in FCX put, <1bps premium in EWA put)
-7.0% (delta-adjusted) - Hedges/Put Options (27bps premium in S&P 2010 puts, 101bps premium in S&P 2011 puts and 24bps premium in a GS put)
25.9% - Cash
September proved the strongest month for equities in some time as a result of both economic data steadying and market participants becoming more confident that the FED will launch a second quantitative easing program (QE2) in early November. Despite this move towards a risk-on sentiment in September the portfolio was able to eke out a small gain of 0.72% (putting the YTD at 8.7%), though this pales in comparison to the strong performance of most markets.
Unsurprisingly, the Treasury Bonds bucket was a large negative contributor (-87bps) as it suffered heavily in the first half of the month from both the reduction in risk aversion and fears about QE2’s impact on long-term government finances. The Bond Funds (+7bps) also suffered during the first half of the month, but were able to benefit more from the recovery in the 2nd half of the month.
In contrast the fund’s equity positions benefited from the rise in the markets, with Other Equities (+44bps) and NCAV Equities (+33bps) both contributing well. However, the main driver of performance in September was the Value Equities bucket (+209bps), which was driven by the position in THRX (+174bps) following some Phase II trial results (if circumstances allow, the position in THRX will be trimmed a little). Against these profitable Long positions, the Hedges/Put options and the China-Related thesis were negative contributors (130bps).
Portfolio
44.0% - Long Treasury Bonds (21.2% TLT and 22.8% in the Aug-29 Bond)
14.4% - Long Bond Funds (6.6% HSTRX, and 7.8% VBIIX)
6.4% - Value Idea Equities (4.3% THRX, and 2.0% DRWI)
5.0% - NCAV Equities
2.8% - Other Equities (1.4% NWS, 1.0% CMTL, and 0.0% SOAP)
-0.0% (delta-adjusted) - China-Related Thesis (1bp premium in FCX put, <1bps premium in EWA put)
-7.0% (delta-adjusted) - Hedges/Put Options (27bps premium in S&P 2010 puts, 101bps premium in S&P 2011 puts and 24bps premium in a GS put)
25.9% - Cash