Sunday, December 21, 2008

Bookkeeping: Weekly Changes to Fund Positions Year 2, Week 20

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Year 2, Week 20 Major Position Changes

Fund positions of 1.0% or greater can be found each week in the right margin of the blog, under the label cloud and recent comments areas; I highlight weekly the larger position changes.

Being a long only fund, via Marketocracy rules, the only hedges to the downside I have are cash or buying short ETFs. I cannot short individual equities.

To see historic weekly fund changes click here OR the label at the bottom of this entry entitled 'fund positions'.

Cash (2 positions [SHV/BIL] + cash): 52.0% (vs 35.5% last week)
31 long bias: 37.0% (vs 58.1% last week)
7 short bias: 11.0% (vs 6.4% last week)

40 positions (vs 41 last week)
Additions: Lennar (LEN)

Removals: Apple (AAPL), Research in Motion (RIMM)

Top 10 positions = 23.5% of fund (vs 32.0% last week)
26 of the 40 positions are at least 1% of the fund's overall holdings (65%)

Major changes and weekly thoughts
The past week the market has sort of stalled into a very narrow range; we are in a gray area both in market direction and hopes for the financial/economic condition. As one of the great philosophers of our time (no, not Socrates... no, not Aristotle... I'm talking Yogi here)

When you come to a fork in the road, take it.

This is essentially where we are on both the market and economic fronts. Which is very different than most times - generally you model a path, and make allowances for divergences either side of a relatively well known road; 20 degrees to the left, 30 degree to the right. As opposed to our current situations which are 180 degree bipolar outcomes. Obama saves us; or Obama doesn't save us. 4.5% mortgages save us; or 4.5% mortgages don't save us. Ben Bernanke has it all figured out; or Ben Bernanke is desperate. Deflation; Inflation. Stocks are cheap; stocks are expensive. It truly is quite amazing the divergence in opinion of the intermediate future. And as I have written - no one can say for sure where we end up, because the nature of the financial experiment we are embarking on is without precedent and historical models are mostly moot. I say many times we are like Japan, but even then - history only rhymes; obviously we have 2 very different situations in some manners (there - a high savings rate, here a non existent one; to name one). I can at least see the bull case if not agree with it. The issue with the bull case is really we are just kicking the can down the road - which unfortunately is the most "positive" outcome if B-52 Ben Bernanke is successful. We will solve a national problem of debt, by encouraging the same thing that got us here in the first place - layering on of debt. This is the battle plan, and while I think a scared consumer threatened with losing their job and with little savings will not embark on a quest for oodles more debt to reinvigorate the economy - I always allow for the chance I could be wrong (never happens, but I allow for it) ;)

A quick (edit: not so quick) layman's economic discourse before we go to our normal discussion. I'll spare you the economic formulas but if you are interested, click here. Right now we have a problem of money flow - both the amount of "money" in the system, and the velocity of said money. In the simplest terms, just think of velocity as the amount of times money changes over. The higher the better. About 4-5 months ago both these areas (amount and velocity) were lacking. Capital was being destroyed in an over levered system; much of it unregulated in a "shadow banking system". For every 1 "actual dollar" in the system, 10-20-30x was "lent". Much of it was based on the housing bubble. So as the 1 actual dollar is destroyed, the capacity to lend 10-20-30x of that dollar is also destroyed - and your velocity of money crumbles. As we've outlined the past few months, our money supply is now going off the charts - the Federal Reserve has made it clear they will create money at any cost. They are going to do everything and anything in their power to liquidate the system, assuming I suppose that a currency crisis is a better outcome (or predicting no currency crisis will happen) than a financial crisis. It is very sad how we lurch from emergency to emergency in this country - but it is what it is.

When I say the Fed will do anything; I mean anything - the latest shake your head in surreal disgust moment - from FT.com "Hedge Funds Gain Access to $200 Billion in Fed Aid" - it appears anyone can now access our money. Anyone. The Federal Reserve balance sheet which used to consist of staid Treasury Bills was at $800Billionish last year, it is now approaching $2.3 Trillion and much of that is now the junk, I'm sorry - "the undervalued assets that once the market returns to normalcy will return to their rightful value- which will be MUCH higher" - that banks want to get rid of. So the Federal Reserve, and by implication, the taxpayer is now holders of said auto loan, student loan, mortgage, consumer loan securitizations. It is now to the point the Federal Reserve will take it said "undervalued assets" off the books of hedge funds so our shadow banking system can re-emerge (the one that got us here in the first place) They are desperate and they will do anything. I said in my 2009 Outlier Prediction that $2.3 T is just getting started, we could be headed for $5 Trillion. In the meantime they shall slay all the poor suckers in America (such as retirees) who'd like a decent CD rate. They want you to spend and take risk, not save @ 1-2% interest. (saving is for loser countries) The 65+ crowd? Get your money out of banks and back in this here stock market; the water's fine!

So let's frame this since we are becoming immune to the large numbers thrown out there - a few billion here, a few billion there and it all gets lost in the mess. U.S household wealth fell 11% year over year as of Sep 30, 2008 (and it's lower from there as stock markets and home values have continued to fall dramatically) - it was down to $56.5 Trillion.

So, about a year ago we were at $64 Trillion in net worth, the Federal Reserve balance sheet was full of the safest US government Treasury bills - about $800B worth, and there were no backstops (backstops ultimately mean "we" are on the hook if the underlying asset goes bad)

Fast forward a year, we have $56 Trillion in net worth, the Federal Reserve balance sheet has tripled ($2.3 Trillion), much of which of the new stuff is now much more risky loans of all types to heavily indebted US consumers along with stuff we can only imagine that the Goldman Sachs, Morgan Stanleys, Citigroups, AIG's et all "lent to us", and we have in excess of $8 Trillion backstopped. And we have just now begun the buying of "new stuff" that the Federal Reserve is promising will be coming in 2009.

So a year ago, about 1.5% of household net worth was on the Federal Reserve balance sheet and 0% was backstopped. Now, just 12 months later 4.1% (and growing - and of a much riskier variety) of our household net worth is on the Federal Reserve Balance sheet, and 14%ish is now "backstopped". So effectively 20% of our household net worth is on the shoulders of the Federal Reserve; either through loan or backstop. And it will only grow from here, as promised at the latest Federal Reserve meeting. And Wall Street is happy about this. Just "have faith" - the government is here to save us.

So that's half the picture; the other is the even more tricky question of velocity. We are handing the banks (and other parts of the financial system) dollars by the wheelbarrow, but if they do not get circulated within the economy there are useless to everyone but banks. Who can park them in ... well let's say US Treasuries yielding 2% and we all sit here and say "this sucks, we are Japan". So we have one half the equation being force fed by the Fed/Treasury - the money supply will be ballooning - no matter the potential cost to the currency, and the other half of the equation is based on the belief that at some point so much money will be provided to said financial institutions that even the most risk averse will lend a portion. And we can begin anew. I won't even touch the long term questions this brings since we only deal with one crisis at a time. So that's what we are facing in a very simplistic fashion - either you believe that the Federal Reserve will not (no longer an issue) or can not (due to the potential of the US dollar plummeting) print enough money to offset the capital destruction going in the system - this is our deflationary spiral; or you believe at some point before this all blows up, the banks will begin to lend again - and as important, the consumers WANT the money (all about confidence and job creation/retention) and a flood of newly formed capital will awash the countryside, potentially creating heavy inflation.

Don't look to me for an answer; just understand we are all lab rats in the biggest financial experiment in history. In the biggest economy, with the largest amount of money created; with the potential for the biggest blow up ever. Frankly it's kind of scary to me, but CNBC assures me - it will work. So as I wrote above - we have bipolar outcomes. 180 degree differences in opinions. It did not work in Japan, but we're not Japan. Just keep repeating that to yourself when you worry about the implications - we're #1! USA! USA! USA! That solves everything I have found.

On to the stock market - I can make the same bipolar bull or bear cases in the near term. Back to our weekly list of conditions to turn us from a trader mindset to an investor mindset
  1. reduction in volatility
  2. separation of "benign" sectors from "poor" sectors
  3. separation of "solid" companies from not so solid within a sector
  4. the end of "student body left" (sell everything!) and "student body right" (buy everything!) trading
  5. the ability to invest in 98% of stocks with more than a 2-48 hour time frame
  6. the emergence of any sort of sustained leadership
  7. stocks that go up on bad news (bad news priced in) .... or at least stocks that respond to good news!
  8. individual company metrics mean more than government announcements
  9. a 20 second comment on CNBC doesn't move the stock market 5%
#7 has been our calling card the past 3 weeks; but now #1 is also working more in our favor. While it is all relative (the type of volatility we have had of late would of been considered bone chilling in 2006, but relative to the past 4-5 months it's almost "quiet") We still lack any sort of leadership as hedge funds jump from 1 sector to another to ride for a few days/weeks based on "theme" and "thesis", and government announcements mean more than anything else. Occasionally we can invest for more than 48 hours, but there still remains the problem in that many "themes" that if you jump in on day 4 of the move - you missed most of the move. In a return of the bull, rallies will last for months and months and day 4 will be inning 1, not inning 8 of a move. So it remains a trading market.

In my "core" and "edge" strategy, I don't look for time frames when I take partial positions off the table; I am looking for % gains. If I can book a 20-30% gain, I like to take 20%, 30% maybe more off the table and try to rebuy lower. And keep rinse, lather, repeating. Those 20-30% gains used to take months, or at best 3-4 weeks to play out. Now, they take 1-2 days. So when our targets get hit, no matter the time frame, we are booking those profits. We've repeated some trades 3x in the past three weeks as the individual stock continues its ping pong, round trip moves. Great for very short term traders - terrible for investors.

As for our positions we have moved to a much higher cash position since many of our stocks have "run" but not pulled back materially yet. But in a bigger picture, we've now effectively rallied a bit over 20% from the worst lows the week before Thanksgiving. We caught much of that move with only some of our capital exposed which is the best of both worlds - gain without major risk. As I was saying through October and November, what we were going through "then" was abnormal - a continued straight line down. The S&P 500 was at historic divergence from the 200 day moving average - which means the rubber band was pulled as far away from a trend line (37%) as it had ever been. We were due for a snap back and we now have had (some of?) it. If you look back at charts of 2001-2002 you see a more normal bear market pattern - similar to what we experienced in the 1st half of 2008 and now... large swings down, followed by multi week rallies (or in some case multi month) before resuming a trend down. From these eyes, that's where we are now - and it's very normal. We've been like a magnet to S&P 900 of late, and stuck between S&P 850 and 920 for two weeks straight.

We were able to catch much of this move since we reduced our short exposure (which had been running in the 25-35% range in Oct/Nov) and many of our long names have jumped tremendously. So the danger now is complacency - as you've experienced, when the mood turns back sour - it happens very quick and you don't have time to escape. I am not saying it is imminent as we've been calling for a Santa Claus rally and "year end mark up" by hedge funds to goose their performance for quite a few weeks now. Unfortunately, in the past 5-7 days I am starting to read about Santa Claus rallies EVERYWHERE, and on Wall Street rarely does what everyone assume to happen actually happen. So my thesis from early in the month makes me me nervous from "everyone is expecting it" in the past week; so perhaps we either end the rally "now", we rally way past Christmas (straight to inaguaration?), or we do nothing but stagnate. It just seems too convenient for what is now EVERYONE looking for a Santa Claus rally, to actually have one.

But really we don't need to guess. Our cash is up from 35 to 52% this week as we took a lot of profits; and our short exposure is back to "not really bearish but closer to a normal hedge" level of 11%. We've been moving sideways now for the better part of a month, and the longer we go sideways (building a base) the larger the move eventually will be. The question is direction. Right now we still sit below the 50 day moving average and the longer you sit below key moving averages the more propensity for the move to be down. However, we are not far from breaking back above the moving average (now in the 920s) as we are near S&P 890. That's only 3% away which is 1 hour of work (3 PM to 4 PM) in this market... so if we indeed break north of that resistance, we have capital to deploy back to the long side and drink egg nog (Kool Aid variety). But if we cannot break above this resistance level, we don't want to be overly deployed. Adding to the trickery is a holiday week dominated by smaller players so as I said, reading anything into this next week and a half is not to be done. Volume has been light, which makes an argument for bears (the rally is on light volume!) and bulls (the pullbacks are on light volume!) - which brings us full circle. It's 180 degrees out there.

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