Summary of Intelledgement’s Model Macro Strategy Investment Portfolio performance as of 30 June 2009:
Position = security the portfolio owns
Bought = date position acquired
Shares = number of shares the portfolio owns
Paid = price per share when purchased
Cost = total paid (price per share multiplied by # shrs plus commission)
Now = price per share as of date of report
Value = what it is worth as of the date of report (price per share multiplied by # shrs plus value of dividends)
Change = on a percentage basis, change since last report (not applicable for positions new since last report)
YTD = on a percentage basis, change since the previous year-end price
ROI (Return on Investment) = on a percentage basis, the performance of this security since purchase
CAGR (Compounded Annual Growth Rate) = annualized ROI for this position since purchase (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 2008 inclusively) provides a CAGR of around 14.3%. For comparison’s sake, we also show the S&P 500 index, which since January 1950 has produced a CAGR of around 8.0% (although only +6.4% since 1988). Note that for our portfolio’s positions, 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 1% rate of interest on the listed cash balance.
Transactions: The busiest quarter in the two-and-a-half year history of the portfolio, with five purchases and four sales:
Performance Review: An adequate quarter for us in absolute terms, as we were up 3%, although in relative terms we were outshone by the macro hedgies—who were up 5%—and were lapped four times by the S&P 500—who recorded a spectacular +15% quarter, easily their best since the inception of the IMSIP two-and-a-half years ago.
Tactically, it’s hard to tell if we are coming or going. We started the quarter with two long positions (China and India), three inflation-hedge commodity positions (gold, silver, and agriculture), and three short positions (consumer goods, consumer services, and treasuries), down from six short positions earlier in 1Q09. With the market rally gathering stream, we sold off the two consumer short funds at the start of the quarter, and then in May, briefly got longer with a Brazil and energy ETF. But the market rally fizzled and as our strategic bias remains negative, we jettisoned those positions after just a week, and then took positions in index short funds for the DOW, S&P 500, and NASDAQ. So at the end of the quarter, the overall lineup includes the same two long positions (China and India), the same three inflation-hedge commodity positions (gold, silver, and agriculture), and now four short positions (treasuries plus the three index shorts).
Overall, we are now 52 points ahead of the market: +17% for us and -35% for the S&P 500 in the two-and-a-half years since the inception of the model at the end of 2006. And we are still ahead of the GAI Global Macro Hedge Fund Index, +17% to +13% (as we have been every quarter since inception except 4Q08).
Analysis: Our strategy is to look for long term investment opportunities congruent with macro trends, such as the rise of the Chinese, Indian, and Brazilian economies while tactically hedging against risks such as the collapse of fiat money in general and the dollar in particular with commodity plays. However, the systemic risk we have experienced over the last year has engendered extraordinary volatility—both down and up—as the market has struggled to process and integrate extreme eventualities into valuations. The intrusion of politics into economic decision-making has exacerbated this volatility. As a result, it is difficult to implement any static long-term strategy without risking significant short-term capital losses.
The good news is we have now had two consecutive quarters of relatively calmer trading. In 1Q09 we backed off of the surreal level of volatility experienced in 4Q08…which is to say, instead of nearly 6x normal volatility, we “only” had 3.5x normal—2.00% average daily change, down from 3.27%. And the sequential decline in the direction of normalcy (0.58%) continued in 2Q09, when the average daily change in the S&P 500 was “only” 2.2x normal (1.27%).Should this calming trend continue, the obvious implication would be that in the collective wisdom of the market, there is less uncertainty as to the valuation of equities. Such a development would be bullish, as the uncertainty is much more defined by the spectre of systemic risk than it is by the fear that we are grossly undervaluing GOOG or GE or C here. In other words, if the market is materially misvalued, it is much more likely that it is overvalued here than undervalued. Thus as the likelihood that the market is misvalued declines, the risk of a near-term market collapse is perceived to decline along with it. This is not quite the same thing as saying that the actual risk of a sudden sharp drop has declined—given all the shoes of Damocles hanging up there that could drop at any moment—but if investors and traders believe the risk has declined, they are more likely to bid prices north until such time that someone in plain view gets beaned with a dropping shoe.
As we have said before, we got into this mess by overspending, borrowing beyond our means, and speculating on bubble-valued assets. And we still don’t believe the economy has bottomed out. The negative feedback loop of less demand-more unemployment-less demand is still chugging along. There are many more residential foreclosures looming, which will continue to devalue housing prices, which also inhibits demand (as consumers are less wealthy). And more credit card defaults, which dry up credit, which also inhibits demand. We’ve barely begun to scratch the surface of commercial real estate foreclosures, and the concomitant bad loans, and the ramifications for the lenders.
We believe that the policies the Bush administration implemented—and the Obama administration has continued—of attempting to paper over the cracks in the system with bailouts of bad banks, bad real estate loans, bad credit default swaps, and bad industrial companies are neither the morally correct thing to do nor in our own long-term self interest. To the extent these actions succeed in postponing our day of reckoning—manifestly, they have done so for at least a year now—they ultimately succeed primarily in digging us into a deeper hole. No matter how brilliantly one conducts a retreat down a blind alley, in the end, there’s nowhere to go—and by then, the long-lasting damage to our financial institutions and to our confidence in our own ability to manage our affairs will be greater, and our resources and capacity to retrace our steps and chart a new path will be much reduced.
And speaking of reduced resources, the Obama administration seems hellbent on making things worse, with plans to fritter away our scant remaining funds on a myriad of grandiose mandates such as providing subsidized health care and promoting production of uneconomic energy. They can’t even come up with a stimulus package without vectoring the majority of the funds to exisiting Federal, state, and local government programs rather than allocating them to new job-creating infrastructure work, as they originally promised.
Of course, it is in the interests of both government policy makers and financial institutions to make a silk purse out of a sow’s ear with respect to these dubious policies. If folks stop believing that government policies have a reasonable chance of succeeding here, all sorts of unpredictable behavior could ensue. Therefore, we are likely to continue to hear the message that things are getting better, no matter what the reality.
Consequently, we continue to forecast heavy weather ahead, with a risk of unaccountable bouts of sunshine. Those are more likely than not eyes in the storm; conducting picnics during them is not advised.
Conclusion: Things will almost certainly get worse…but when, and how much worse? As of 1 July, we have four inverse ETFs in the portfolio…three short index funds covering the DJIA (DOG), S&P 500 (SH), and NASDAQ (PSQ) respectively—these go up if the market goes down and vice versa—as well as the short long-term Treasury bonds ETF (TBT), as we expect 20+ year treasure bonds to decline in value as interest rates inevitably rise in order to entice buyers of the copious outpourings of US debt. We still expect the cumulative effect of the liquidity injections and increased need for borrowing by the USA to eventually degrade the dollar’s value, and consequently remain long our commodity plays (GLD, SLV, and DBA). And finally as a hedge against a quicker-than-anticipated recovery, we still retain our China and India emerging market funds (FXI and IFN)—as we expect those economies to lead the recovery. Indeed, if we perceive increased risk of a sharp rally similar to the ones that started in November 2008 and March 2009, we may again lighten up on the shorts and temporarily go long energy or Brazil as we did in 2Q09.