Macro Tsimmis

intelligently hedged investment

3Q07 Intelledgement Macro Strategy Investment Portfolio Report

Posted by intelledgement on Thu, 11 Oct 07

Summary of Intelledgement’s Model Macro Strategy Investment Portfolio performance as of 28 Sep 2007:

Position Purchased Shares Paid Cost Now Value Change ROI CAGR
EWM 03-Jan-07 988 9.10 8998.80 11.89 11,747.32 0.76% 30.54% 43.80%
EWZ 03-Jan-07 192 46.85 9,003.20 73.55 14,121.60 19.75% 56.85% 84.68%
FXI 03-Jan-07 81 111.45 9,035.45 180.00 14,580.00 39.70% 61.36% 91.96%
GLD 03-Jan-07 142 63.21 8,983.82 73.51 10,438.42 14.38% 16.19% 22.69%
IFN 03-Jan-07 196 45.90 9,004.40 54.30 10,642.80 24.40% 18.20% 25.59%
IXC 03-Jan-07 81 111.47 9,037.07 138.04 11,181.24 6.73% 23.73% 33.66%
PHO 03-Jan-07 489 18.41 9,010.49 21.35 10,473.40 2.11% 16.24% 22.76%
SLV 03-Jan-07 70 128.64 9,012.80 136.55 9558.50 10.57% 6.05% 8.34%
USO 03-Jan-07 174 51.60 8,986.40 62.55 10,883.70 18.02% 21.11% 29.83%
SKF 26-Jul-07 107 84.14 9,010.90 78.93 8,445.50 n/a -6.28% -30.92%
SRS 31-Aug-07 92 97.84 9009.28 89.11 8,198.12 n/a -9.00% -70.79%
cash       907.31   2,004.94      
Overall 03-Jan-07     100,000.00   122,390.27 9.70% 22.39%   31.70%
Macro HF 03-Jan-07     100,000.00   108,737.29 3.41% 8.74% 12.09%
S&P 500 03-Jan-07     1,418.30   1,526.75 1.56% 7.65% 10.56%

Position = security the portfolio owns
Bought = date position acquired
Purchase Price = price per share
Shares = number of shares the portfolio owns
Cost = what portfolio paid (including commission)
Value = what it is worth as of the date of the statement (# shrs multiplied by price per share plus value of dividends)
Change = Change since last report (blank for positions new since last report)
Return on Investment = on a percentage basis, the performance of this security to date
Compounded Annual Growth Rate = annualized ROI for this position (to help compare apples to apples)

Notes: The benchmark for this account is the Greenwich Alternative Investments Global Macro Hedge Fund Index, which historically (1988 to 2006 inclusively) provides a CAGR of around 15.5%. For comparison’s sake, we also show the S&P 500 index, which historically provides a CAGR of around 10.5%. Note that dividends are added back into the value of the pertinent security and not included in the “cash” total (this gives a more complete picture of the ROI for dividend-paying securities). Also, the “Cost” figures include a standard $8 commission and there is a 2% rate of interest on the listed cash balance.

Transactions: We booked a dividend of $0.0132/share for PHO on 21 Sep. We also had our first transactions of 2007 since staking out our initial positions in January:

  • 26 Jul – Sold 562 EWH for $16.82/shr (ROI of 4.9% and CAGR of 9%)
  • 26 Jul – Bought 107 SKF for $84.14/shr
  • 15 Aug – Sold 383 EWA for $25.21/shr (ROI of 7.1% and CAGR of 12%)
  • 31 Aug – Bought 92 SRS for $97.84/shr

Performance Review: Another excellent quarter. Despite the subprime woes, despite the downturn in the housing market, despite the slow-motion collapse of the dollar, the US economy is somehow still generating jobs and more importantly, the US consumer is still spending as if there were no tomorrow. Energy prices are back up again, but part of that is a function of the weakening greenback and notwithstanding, the emerging markets continued to charge ahead: China (FXI +40%), India (IFN +24%), and Brazil (+20%) lead the way for our portfolio. Our commodity plays all beat the market as well: oil (USO +18%), gold (GLD +14%), silver (SLV +11% and now in the black for the year), and water (+2%…ok, this one just matched the market for the quarter). Our integrated energy sector investment lagged, but did manage to beat the market (IXC +7%). The only dark spots, appropriately enough, were our new short positions: our financials sector short fund (SKF -6%) and our housing sector short fund (SRS -9%). So far, this market downturn insurance protection is proving expensive: had we just stood pat with Australia (EWA) and Hong Kong (EWH) instead of trading them in for the short funds, we would have been considerably better off (up 15% for the quarter, up 29% for the year, and zooming along at a CAGR of 41%).

Still-in-all, bottom line, the strategy worked well this past quarter. While the Macro Hedge Fund Index (+3% compared to +4%) and the S&P 500 (+2% compared to +6%) both slowed down this quarter from their 2Q07 pace, we actually improved (+10% compared to +9%). Year-to-date, we are +22% as compared to +9% for the Macro Hedge Fund benchmark and +8% for the S&P 500.

Analysis: The signal event of the quarter was the decision by the Fed to lower interest rates by a half point to 4.75% back on 18 Sep. The reduction reversed a three-year old policy of unflinching support for fighting inflation and buttressing the dollar and by raising short-term rates, which had seen them rise from 1% in mid-2004 all the way up to 5.25%. The Fed made their move amid growing concerns about the decline in the US housing market—which encompassed declines in sales of new and existing homes, declines in the rate of increase in the value of homes overall and outright declines in value in some markets, and declines in construction and other ancillary markets such as home improvement—and the concomitant rise in mortgage defaults, which set off a chain reaction tumble in subprime lending-related equity valuations. This latter development engendered a lot of smoke, as the creation and distribution of mortgage-backed securities involves arcane high-level financial wizardry which is little understood outside of the practitioners…and how well even they understand the attendant risks is an open question. Suffice it to say that when a subprime borrower faces the end of their introductory “teaser” low rate, if the cost of refinancing has gone up due to tighter credit and the value of the property has declined due to a weak housing market, it may not be economic either to continue to pay the mortgage at the higher rate or even to sell the house…so the borrower defaults. When you are a financial institution holding mortgage-backed securities and a higher-than-anticipated number of the underlying mortgages go into default status, this is a bad thing. We had a situation where it was unclear how much bad paper the Morgan Stanleys and Barclays of the world were holding, and worse still, it was hard to price new mortgage-backed securities due to the intrinsic uncertainty as to their value. The Fed’s move to lower interest rates is designed tactically to lower the cost of credit for the financial institutions and strategically, to decrease the pressure on individual borrowers and head off some of the looming defaults.

Alas, what is good for US consumers and borrowers with respect to interest rates is bad for the US dollar. This is true both tactically—in that there is less incentive for foreign investors to buy US treasuries when they have a lower rate of interest and this translates into a dollar that, relative to non-US currencies, has less value—and strategically—in that everyone knows that US consumer borrowing/spending is an unsustainable pyramid scheme and while there is money to be made there for the nonce, the closer we get to the end of the ride, the less anyone is willing to pay for a seat on the merry-go-round. To the extent that lowering interest rates exacerbates the consumer debt situation, it is making the strategic situation worse, not better.

For now, however, treating the symptoms feels good! The markets, which had been off 10% prior to the Fed move, have subsequently recovered to new highs. (Hence the pain associated with our short positions.) And the Fed is not fighting this retreating action alone…there is still the Imperial Guard in reserve—China’s trillions of dollars which they should prefer to convert into real property before the charade ends—when things get even more wobbly, as they will, look for the Celestial Kingdom to prop up the status quo by deploying those dollars. Better to own some discounted GE shares and depressed Miami real estate than worthless dollars. These holding actions, executed skillfully and blessed with some good luck, can potentially delay the inevitable for years.

Conclusion: The Fed’s dramatic move to lower interest rates is a tactical boon for the markets but strategically makes things worse. The end is nearer…but still not nigh. There are still strong defensive cards to play and we still are confident the center is very likely to hold through next year’s Olympics/elections; from this perspective, it gets murky after that. In the meantime, contrary to current market psychology, we believe the margin of error continues to shrink, and the danger that an unanticipated random event could trigger an avalanche here beyond the ability of the bankers to control, while still relatively small, is increasing. Accordingly for now we are maintaining our short position “insurance”.

We will continue to monitor this situation closely; if the cost of portfolio insurance gets much more expensive—and we come to agree with the market that the immediate risk has receded—we will cut our losses there. Conversely, if we perceive increased risk, then we would likely cash in additional emerging market ETFs and buy more insurance in the form increased GLD or SLV positions or possibly an index short ETF.

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