Macro Tsimmis

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Posts Tagged ‘SZK’

2Q09 Intelledgement Macro Strategy Investment Portfolio Report

Posted by intelledgement on Tue, 14 Jul 09

Summary of Intelledgement’s Model Macro Strategy Investment Portfolio performance as of 30 June 2009:

Position   Bought   Shares Paid Cost Now Value Change     YTD         ROI       CAGR  
FXI 03-Jan-07 243 37.15 9,035.45 38.37 9,759.47 33.89% 31.89% 8.01% 3.13%
GLD 03-Jan-07 142 63.21 8,983.82 91.18 12,947.56 1.00% 5.39% 44.12% 15.73%
IFN 03-Jan-07 196 45.90 9,004.40 31.11 8,965.04 44.9%3 38.90% -0.44% -0.17%
SLV 03-Jan-07 700 12.86 9,012.80 13.38 9,366.00 4.61% 19.46% 3.92% 1.55%
DBA 13-Mar-08 235 42.50 9,995.50 25.45 5,980.75 3.92% -2.79% -40.17% -32.68%
TBT 21-Jan-09 233 42.84 9,989.72 50.92 11,864.36 16.68% 34.96% 18.77% 48.08%
DOG 21-May-09 146 68.23 9,969.58 66.50 9,709.00 n/a -2.99% -2.61% -21.48%
PSQ 21-May-09 163 61.29 9,998.27 56.35 9,185.05 n/a -22.84% -8.13% -53.91%
SH 21-May-09 146 68.44 10,000.24 65.71 9,593.66 n/a -8.76% -4.07% -31.55%
cash 14,010.22 29,745.37
Overall 31-Dec-06 100,000.00 117,116.26 3.30% 10.79% 17.12% 6.53%
Macro HF 31-Dec-06 100,000.00 113,249.73 5.09% 5.57% 13.25% 5.11%
S&P 500 31-Dec-06 1,418.30 919.32 15.22% 1.78% -35.18% -15.94%

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.

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1Q09 Intelledgement Macro Strategy Investment Portfolio Report

Posted by intelledgement on Mon, 13 Apr 09

Summary of Intelledgement’s Model Macro Strategy Investment Portfolio performance as of 31 Mar 2009:

Position   Bought   Shares Paid Cost Now Value Change YTD     ROI     CAGR
FXI 03-Jan-07 243 37.15 9,035.45 28.53 7,289.13 -1.83% -1.83% -19.33% -9.09%
GLD 03-Jan-07 142 63.21 8,983.82 90.28 12,819.76 4.35% 4.35% 42.70% 17.09%
IFN 03-Jan-07 196 45.90 9,004.40 16.93 6,185.76 -4.16% -4.16% -31.30% -15.35%
SLV 03-Jan-07 700 12.86 9,012.80 12.79 8,953.00 14.20% 14.20% -0.66% -0.30%
DBA 13-Mar-08 235 42.50 9,995.50 24.49 5,755.15 -6.46% -6.46% -42.42% -40.93%
SCC 16-Sep-08 112 86.23 9,665.76 85.80 13,437.11 0.86% 0.86% 39.02% 84.76%
SZK 16-Sep-08 145 68.25 9,904.25 87.20 15,417.18 14.17% 14.17% 55.66% 128.11%
TBT 21-Jan-09 233 42.84 9,989.72 43.64 10,168.12 n/a 15.66 1.79% 9.82%
cash 24,408.30 33,282.42
Overall 31-Dec-06 100,000.00 113,307.62 7.20% 7.20% 13.31% 5.73%
Macro HF 31-Dec-06 100,000.00 107,769.25 0.46% 0.46% 7.77% 3.38%
S&P 500 31-Dec-06 1,418.30 797.87 -11.67% -11.67% -43.74% -22.58%

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 (blank 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 historically provides a CAGR of around 10.5% (although only +6.37% since 1988). 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 1% rate of interest on the listed cash balance.

Transactions: Three purchases and three sales—two of which canceled each other out:

Performance Review: An excellent quarter for us, as we were up 7%, beat the macro hedgies—who were flat—handily, and buried the S&P 500—who lost 12%.

Tactically, it was a quarter of gyrations. In mid-February, as the initial “obtimism” that the new administration would solve all our problems dissipated, we manuevered the portfolio sharply to the short side, with a peak of six out of our 11 total equities—SCC, SZK, SDS, TBT, PSQ, and DOG—positioned to rise as the market headed south. But barely a month later, the risk of another sharp bear-market rally—like the one that raged last Nov-Dec—waxed notably, and we cashed in half of the inverse ETF positions, booking a healthy short-term profit.

Overall, we are now 57 points ahead of the market: +13% for us and -44% for the S&P 500 in the 27 months since the inception of the model at the end of 2006. We are also beating the GAI Global Macro Hedge Fund Index over the same time span, +13% to +8%.

Analysis: As we discussed last quarter, the watchword continues to be volatility.

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 nine months 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. Consider: under normal circumstances—let’s say, from March 1950 through June 2007—the average daily change in the value of the S&P 500 index is 0.57% (up or down)…but since then, here are the number of days in each quarter categorized by the daily move up or down rounded to the nearest percentage, and the overall average:

Year 0% Days 1% Days 2% Days 3% Days 4% Days 5% Days 6% Days 7-9% Days 10%+ Days Average Daily Change
3Q07 27 23 10 3 0 0 0 0 0 0.83%
4Q07 23 27 8 6 0 0 0 0 0 0.97%
1Q08 10 33 13 4 2 0 0 0 0 1.27%
2Q08 33 18 10 2 1 0 0 0 0 0.75%
3Q08 17 21 15 4 3 3 0 1 0 1.53%
4Q08 4 19 6 9 9 5 5 5 2 3.27%
1Q09 11 17 14 9 4 4 1 1 0 2.00%

Thankfully, 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. But the point is, when we are experiencing single days when the market moves as much as it normally moves in an entire year, one’s perspective as to what constitutes a “long term investment” is subject to being telescoped.

There’s trouble, right here in River City. In living beyond our means, we’ve been digging our own grave for years, and the new U.S. administration’s main plan to fix the problem seems to be borrowing (more) money to afford everyone the latest and greatest new shovels. As we have said before, we got into this mess by overspending, borrowing beyond our means, and speculating on bubble-valued assets. Any “solution” that involves lowering interest rates, increasing our debt levels, and easing credit/issuing more money is, essentially, attempting to put out a fire by dousing it with gasoline. The government does not have the resources to “rescue” all the zombie banks whose obligations exceed their assets, not to mention all the homeowners whose mortgage obligations now exceed the value of their properties, not to mention all the industrial companies whose profligate and short-sighted management have left them vulnerable to the economic tsunami we are experiencing…etcetera, etcetera. Yet it appears this is to be our plan of action…along with providing universal health care, switching to more expensive energy, building highspeed rail systems…etcetera, etcetera…all with (more) borrowed funds.

And we don’t believe the economy has bottomed out. The negative feedback loop of less demand-more unemployment-less demand is still intact. 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.

So we believe things are headed south. And yet, in March we sold half our short ETFs (that go up when the market declines). Why? Because this market is so volatile, that we felt it was risky to stay short in the face of “obtimism” that the new administration would somehow work a miracle. We held our short positions last November in the teeth of a post-election rally…and saw the value of the portfolio decline 29% in six weeks. Once burned, twice cautious. But, unfortunately, we do expect to be going short again, this quarter or next.

Conclusion: Things will almost certainly get worse; the real question is, how much worse? As of 1 April, we retained three inverse ETFs in the portfolio…covering the consumer goods (SZK) and services (SCC) sectors as well as long-term Treasury bonds (TBT), which we expect 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. If the rally that ensued in March persists, we may further lighten up on the shorts and temporarily go long energy or Brazil.

But batten down the hatches. Upgrade your vegetable patch, make sure your emergency supplies of batteries, dried food, and water are current, check the ammo for your shotgun, and touch base with the neighbors to encourage them to be prepared, too. The odds still favor things not getting that bad…but those odds are not as good as they were three months ago.

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BUY TO COVER Best Buy (BBY), Mastercard (MA), & Wal-Mart (WMT)

Posted by intelledgement on Thu, 02 Apr 09

We detailed the reasons why we think it is prudent to cover our retailing sector short positions earlier today in our IMSIP post recommending selling inverse consumer goods and services ETFsbby. Accordingly, in the ISOP, we are buying to cover our short positions in retailing giant Wal-Mart (WMT), specialty retailer Best Buy (BBY), and consumer credit card vendor Mastercard (MA). While we do not believe that the bailout has enabled the USA economy to recover—or, more specifically, that the consumer will resume spending as in the past—the market apparently disagrees with us…or at least believes that we have pulled back from the brink of disaster. Perhaps we have; in any event, the perception that we have—in view of the violent volatility we are experiencing—increases the risk of an upside panic. So we are stepping aside here with the expectation that we can reenter these short positions at substantially higher prices down the road a bit.

Previous retailing short-related posts:

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SELL UltraShort Consumer Goods ETF (SCC) & UltraShort Consumer Services ETF (SZK)

Posted by intelledgement on Thu, 02 Apr 09

We still believe the macros point down from here. However, the current rally is very strong and there are a number of factors supporting it:

  • Several financial services companies reported last month that they are now profitable
  • Timothy Geithner’s bank rescue plan has been better received than most anyone expected (although it doesn’t look so hot to us)
  • Today’s announcement of mark-to-market reform will help the companies who hold toxic assets to at least appear to be in better shape
  • The Obama administration is having a good patch here, exceeding expectations at the G20 meeting
  • Emerging markets have been in rally mode, more or less, since 20 Nov and the most recent Chinese Purchase Management Index numbers have been positive
  • There are still substantial short positions out there, and if the market heads north from here, short covering may well fuel the rally

Looking specifically at consumer spending, we still see strategic issues with housing prices falling and unemployment rising. However, for now, the horizon is brightening: consumer spending has ticked up, and the positive effects of lower energy costs, the forthcoming tax cut, and lower mortgage interest rates could keep the party going in the short run. Plus there is talk of a government mandate to force lower credit card interest rates. Such a move would be tricky, as it could hurt the weakened financial sector, but if it happens, it is likely to stoke consumption spending. Even the prospect of such an eventuality could propel consumer goods and services providers share prices higher here.

In the end, we expect all this brightness is likely to turn out to be a false dawn. However, we are in a period of profoundly extreme volatility, and following the same logic we used last month in dumping our index shorts, we are stepping aside here. If the market melts down and we have to reacquire these ETFs at a higher price, well that is a risk we are willing to take to lock in the profits we have on these positions, and avert the risk—more likely, in our opinion—of a sharply higher move. We expect to buy these ETFs again and are betting it is more likely we’ll get a chance to do so at a lower price than today’s, and not have to settle for a higher one.

Previous retailing short-related posts:

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4Q08 Intelledgement Macro Strategy Investment Portfolio Report

Posted by intelledgement on Wed, 14 Jan 09

Summary of Intelledgement’s Model Macro Strategy Investment Portfolio performance as of 31 Dec 2008:

Position   Bought   Shares Paid Cost Now Value   Change       ROI     CAGR
FXI 03-Jan-07 243 37.15 9,035.45 29.09 7,425.21 -14.48% -17.82% -9.38%
GLD 03-Jan-07 142 63.21 8,983.82 86.52 12,285.84 1.70% 36.76% 17.01%
IFN 03-Jan-07 196 45.90 9,004.40 18.30 6,454.28 -19.68% -28.32% -15.38%
SLV 03-Jan-07 700 12.86 9,012.80 11.20 7,840.00 -5.49% -13.01% -6.76%
DBA 13-Mar-08 235 42.50 9,995.50 26.18 6,152.30 -13.34% -38.45% -45.39%
SCC 16-Sep-08 112 86.23 9,665.76 84.78 13,322.87 17.64% 37.84% 202.14%
SZK 16-Sep-08 145 68.25 9,904.25 74.01 13,504.05 29.04% 36.35% 191.03%
SDS 19-Nov-08 88 112.98 9,950.24 70.94 7,253.88 n/a -27.10% -93.60%
cash 24,447.78 31,458.21
Overall 03-Jan-07 100,000.00 105,696.64 -4.81% 5.70% 2.81%
Macro HF 03-Jan-07 100,000.00 107,271.13 -0.91% 7.27% 3.57%
S&P 500 03-Jan-07 1,418.30 903.25 -22.56% -36.31% -20.18%

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 = Change since last report (blank for positions new since last report)
ROI (Return on Investment) = on a percentage basis, the performance of this security to date
CAGR (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 2007 inclusively) provides a CAGR of around 15.3%. 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 1% rate of interest on the listed cash balance.

Transactions: Another relatively active quarter with five transactions—three sells and one buy—plus the usual bevy of year-end dividends and capital gain distributions:

  • 7 Oct – IFN dividend of $6.45/shr
  • 11 Nov – Sold 489 PHO for $13.02/shr (ROI of -28.8% and CAGR of -16.7%)
  • 19 Nov – Bought 88 SDS for $112.98/shr
  • 16 Dec – Sold 92 SRS for $61.74/shr (ROI of -35.27% and CAGR of -27.78%)
  • 16 Dec – Sold 97 SKF for $104.70/shr (ROI of 1.5% and CAGR of 4.9%)
  • 22 Dec – FXI dividend of $0. 20802/shr
  • 23 Dec – SCC dividend of $0.008631/shr and capital gains distribution of $33.91358/shr
  • 23 Dec – SZK dividend of $0.006616/shr and capital gains distribution of $18.85726/shr
  • 23 Dec – SDS dividend of $0.028553/shr and capital gains distribution of $11.46188/shr

Performance Review: A mediocre quarter for us, as we beat the market by a country mile, but still both lost to the macro hedgies and lost money overall. For the market, at -22.6% it was not just the worst quarter since the inception of the IMSIP two years ago, but the worst quarter since the fourth quarter of 1987—which included Black Monday—when it finished  -23.3%. The S&P also recorded its worst six month period, -29.4%, since 1974 when it logged -32.4% in the second and third quarters. As for the hedge fund pros, overall 2008 was the first ever negative annual return for the industry since Greenwich Alternative Investments (GAI) began keeping track in 1988. Hedge funds overall clocked in at -15.95% for the year; macro hedge funds, however—our heros!—were the fourth-best performing class out of 18 tracked by GAI at -4.8% for 2008. Not so bad in a year when the market produced a -38.5% ROI.

Tactically, our sale of the water infrastructure ETF PHO in early November was probably a bit premature, as it could run up here on stimulus package-related “obtimism” (that is, Obama administration-related optimism that things will turn around—or, at least, a lot of money will get spent on infrastructure—under new leadership after the inauguration on 20 January). It ended the year at $14.39, so at a minimum, a little patience would have netted us a better sale price. We also should have waited on our SDS purchase in mid-November, for the same reason. Obtimism could drive the price down in the short-to-medium term; certainly the price at the end of the year, $70.94, would have been a much better entry point than the dividend-adjusted $98.10 we paid. Pursuant to our recent analysis of the performance of leveraged short ETFs, we will be looking to replace this fund with the 1x SH fund when the opportunity presents itself.

Obtimism considerations lead us to dump our reverse ETFs for the financial (SKF) and real estate (SRS) sectors in mid-December. So far, so good on this front, as both were lower at the end of the year. Sad to say, we anticipate buying back in post-20 January—once obtimism about how quickly the new administration can effect economic recovery abates—as we still expect things get worse before they get better. (As of now, there are now 1x inverse financial or real estate sector ETFs available.)

Overall for the two years we’ve been tracking the IMSIP, we are now narrowly trailing the GAI Macro Hedge Fund Index, +6% for us to +7% for them. The market overall is a very distant third at -36%.

Analysis: Too bad we don’t recommend individual stocks for most clients because if we did, a neck brace manufacturer would look good just about now. While 4Q08 at -22.6%s was not the worst ever for the S&P 500, it may well have been the most volatile quarter ever. Normally, the daily ebb and flow of prices amounts to less than ±1% for the S&P 500 index. If you round off the nearest whole number, the average daily change in the S&P 500 in all of 2006 was 0%…in 2007 it was 1%…and last year it was 2%. Here is a comparison of the fourth quarter for all three years:

Year 0% Days 1% Days 2% Days 3% Days 4% Days 5% Days 6% Days 7-9% Days 10%+ Days
4Q06 48 15 0 0 0 0 0 0 0
4Q07 23 27 8 6 0 0 0 0 0
4Q08 6 16 6 9 9 5 6 4 2

Six days in 4Q08—10% of the trading sessions—on which the market was up or down between 7% and 12%! About six year’s worth of value change in six days! Folks, this is a cry for help. The market is telling us that no one knows from day-to-day what the right value for stocks is. And the reason this uncertainty exists, in our opinion, is that almost all the “rescue” plans promulgated so far by the Paulson administration (W having apparently taken early retirement here) seem to be aimed at papering over our problems, rather than dealing with them forthrightly and genuinely moving forward.

As we have said before, we got into this mess by overspending, borrowing beyond our means, and speculating on bubble-valued assets. Any “solution” that involves lowering interest rates, increasing our debt levels, and easing credit/issuing more money is, essentially, attempting to put out a fire by dousing it with gasoline. The government does not have the resources to “rescue” all the zombie banks whose obligations exceed their assets, not to mention all the homeowners whose mortgage obligations now exceed the value of their properties, not to mention all the industrial companies whose profligate and short-sighted management have left them vulnerable to the economic tsunami we are experiencing…etcetera, etcetera. Aside from laudibly refusing to rescind the mark-to-market rule, the only honest move the administration made in this sorry mess was allowing Lehman Brothers to go bankrupt…and typically, that is now seen as a misstep.

The one facet of our desultory march into hades has surprised us is the strength of the dollar. We expected that the gobs of money the Fed has injected into the system in an effort to stimulate lending would be immediately inflationary; we failed to adequately reckon with two contrary effects. The first of these is the deflationary effects of demand destruction. When everyone has degraded retirement savings, a home that is worth 30% less, and—if still employed—job security issues, no one is out there buying new cars or even new clothes…or, at least, not with the same old reckless abandon. When demand fades, supply waxes…and prices fall. The second effect that surprised us was the flight-to-safety effect that—ironically—has money piling into treasuries. So desperately were money managers seeking a safe haven for funds that last month we had the spectacle of the USA borrowing money at 0% interest! Folks, when the safest place on the planet to put money is in bonds issued by a virtually insolvent government, we are in deep doo-doo.

Of course, Paulson is history and Obama is imminent. No matter what, 20 January will be a day of optimism and celebration for the USA. Perhaps the new man’s vaunted pragmatism will light the way towards smarter and less short-range responses. We hope so with our hearts, but our heads are saying, “don’t invest on it.”

Conclusion: Let’s hope for the best. The incumbant crew was most definitely leading us deeper into the morass; the new crew recognizes we are in a big hole…perhaps they will be smart and brave enough to stop digging. We subscribe to the injunction to make love, not war, but we still believe in being prepared for both. Accordingly, we retain three inverse ETFs in the portfolio…covering the consumer goods (SZK) and services (SCC) sectors as well as the S&P 500 overall (SDS). 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.

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Ultra inverse ETFs fall short of expectations

Posted by intelledgement on Mon, 05 Jan 09

Aide: We’ve analyzed their attack, Sir, and there is a danger. Should I have your ship standing by?
Grand Moff Tarkin: Evacuate? In our moment of triumph? I think you overestimate their chances.

Intelledgement’s strategy is macro-based, which means we analyze broad trends and make investments designed to align with them. Thus if we expect energy and China and Brazil to do better than average in the long run, we will seek to go long (buy) securities that are likely to reflect those successes. Conversely, if expect an economic reversal that will hurt real estate values and depress consumption, we will seek to go short (sell) securities that are likely to decline in price.

Generally, we do not recommend owning (or shorting) individual stocks for most of our clients, because it is easier to be right with a more broadly targeted mutual fund or exchange-traded fund (ETF)—which invest in numerous stocks—than trying to divine the fate of a single company (which could run into accounting problems and tank even if the industry they are in does well overall, for example). And very few of our clients are comfortable with margin accounts and short selling, which is inherently more risky than buying stock (as we have explained elsewhere). Therefore, the tactic we employ to invest money on the short side when the macros so dictate is buying so-called “inverse” ETFs, such as our current position in the the ProShares UItraShort S&P 500 ETF, which is designed to “correspond to twice (200%) the inverse (opposite) of the daily performance of the S&P500® Index,” using short sales, options, derivatives, and other relatively arcane maneuvers. This enables us to take a virtual short position without employing margin or undertaking the theoretically unlimited risk associated with an actual short position.

Now, while ETFs have been around for 20 years, it wasn’t until 1998 when State Street introduced “Sector SPDRs” that it became possible to employ a robust macro strategy using exchange-traded funds. And even then, it was not possible to bet against sectors or national indexes or commodities other than by selling the requisite ETF short. Until 2006, that is, when Proshares introduced their line of inverse ETFs, that go up when the targeted index goes down, and vice versa. So inverse ETFs, including “ultra” inverse funds—which aspire to double (or triple) inverse performance—don’t have a long performance track record.

Ultrashort ETFs—along with their ultralong cousins—have commonly been regarded as the Deathstars of exchange-traded fund investing. Afterall, it stands to reason, if you are absolutely convinced that the price of oil is going down, why be content with an mere inverse fund oil fund when you can buy an ultrashort fund that tracks 2x the inverse of any change in the price of oil?

One concern that commentators have pointed out is that the design of the funds—to reflect the inverse of fund performance on a daily basis—gives them an inherently bearish bias in a volatile environment, because mathematically, an x% move down always trumps an x% move up. That is, if you start at 100 and have a 10% up day followed by a 10% down day, you end up at 99; and by the same token if again starting at 100 you have a 10% down day followed by a 10% up day, again you end up at 99. A slow and steady move in either direction minimizes this effect, but it is likely to be augmented when volatility is high, as demonstrated by Eric Oberg in his thestreet.com article last month.

Of course, we don’t have a lot of performance data to analyze—as the inverse ETFs are so new—but let’s take a gander at the data we do have:

Security Symbol Inception Cost Value ROI Index Index ROI Rating
Cons Svs Ultrashort SCC 02-Feb-07 46.47 84.78 82% DJUSCY -39% +3
S&P500 Short SH 21-Jun-06 55.81 72.02 29% GSPC -28% +1
DOW30 Short DOG 21-Jun-06 57.69 68.55 19% DJI -21% -2
QQQ Short PSQ 21-Jun-06 60.43 73.03 21% IXIC -26% -5
Cons Goods Ultrashort SZK 02-Feb-07 52.92 74.01 40% DJUSNC -24% -8
Oil & Gas Short DDG 22-Jul-08 57.72 68.16 18% DJUSEN -35% -17
S&P500 Ultrashort SDS 13-Jul-06 57.28 70.94 24% GSPC -27% -31
DOW30 Ultrashort DXD 13-Jul-06 51.33 53.56 4% DJI -19% -34
QQQ Ultrashort QID 13-Jul-06 60.79 57.35 -6% IXIC -23% -52
Financials Short SEF 22-Jul-08 68.32 76.03 11% DJUSFN -66% -54
Financials Ultrashort SKF 01-Feb-07 66.74 103.01 54% DJUSFN -55% -57
Oil & Gas Ultrashort DUG 22-Jul-08 26.45 25.04 -5% DJUSEN -35% -75
R/E Ultrashort SRS 01-Feb-07 62.07 50.71 -18% DWRSF -60% -138

Security = the name of the exchange-traded fund (ETF)
Symbol = the symbol of the ETF
Inception = date the ETF started trading
Cost = closing price of the ETF on the first day it traded
Value = closing price of the ETF on 31 December 2008
ROI (Return on Investment) = on a percentage basis, the performance of this ETF from inception to 31 Dec 08
Index = the market index the ETF is tracking (inversely)
Index ROI = on a percentage basis, the performance of this index from inception of the associated ETF to 31 Dec 08
Rating = how well the ETF has performed relative to expectations (see notes below)

Notes: our rating is derived by comparing the ROI of the inverse ETF with the ROI of the index it is tracking and calculating how the ETF has performed relative to expectations. For example, if the underlying index declined 10% since the inception of the fund, we would expect an inverse fund to be +10%, and an ultra inverse fund—which, you will recall, strives to log 2x or 3x the inverse performance of the underlying index—to be either +20% or +30%. So, if the index has declined by 10% and an inverse ETF is up 10%, that yields a rating of 0 (zero), as it matches our expectations. For example, as of 31 December 2008, the Proshares S&P 500 Short fund (SH) was up 29% since inception while the S&P 500 index itself (GSPC) was down 28%…so that ETF has a rating of +1. In contrast, Proshares Real Estate Ultrashort fund (SRS) is down 18% since inception while the index it tracks is down 60%…we would expect SRS to be +120% and thus it has a rating of -138.

In general, the news is bad for the “ultrashort” 2x funds. Every single one of the eight ultrashort funds we analyzed are tracking an index that was down through 31 Dec 08…and therefore we would expect them all to be up twice as much as their respective index was down. This was true of only one: the Consumer Services Ultrashort ETF (SCC), which was up 82% while the Dow Jones US Consumer Services Index (DJUSCY) was down 39%. Four of the remaining seven ETFs were up, but only one of them was close to expectations: the Consumer Goods Ultrashort ETF (SZK), was up 40% while the underlying index was down 24%. The Financials Ultrashort ETF (SKF) was up 54%, but that was less than half what it should have done relative to its index, which was down 55%. And the S&P 500 Ultrashort ETF (SDS) was up 24%, less than half what it should have done relative to the GSPC, down 27%. The DOW 30 Ultrashort was up 4%…way lower than it should have been with the DJI down 19%.

From there, it gets really bad. The other three ultrashort funds were all down, even though with their respective index down, they should have been up sharply. We would have expected the QQQQ Ultrashort ETF (QID) to be up 46%…but it was down 6%. We would have expected the Oil & Gas Ultrashort ETF (DUG) to be up 70%…but it was down 5%. And the SRS was discussed above (should have been +120%, was -18%).

And it gets still worse! In every case where there are both an inverse ETF (targeting mirror image performance of the underlying index) and an ultra inverse ETF (targeting 2x inverse performance), the performance of the inverse ETF is relatively better than that of the ultra inverse ETF:

Index Short Fund Ultrashort Fund
S&P 500 +1 -31
DOW 30 -2 -19
QQQQ -5 -52
Oil & Gas -17 -75
Financials -54 -57

In absolute terms, the SKF ultrashort financials ETF still outperformed SEF, the inverse ETF (as you would expect when they both underperformed their expectations by about the same degree). But in the other four instances, the four inverse funds not only did relatively better, but beat their ultrashort cousins in absolute ROI. The DUG and QID ultrashort ETFs actually lost money, even though their respective indices each was in the red.

While this does not prove Oberg is correct in his analysis that volatility is doing in the ultrashort ETFs, it does constitute prima-facie evidence that his conclusion—the ultrashort ETFs are underperforming—is on target.

And accordingly, it is time to consider evacuating the Deathstar.

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SELL SHORT Best Buy (BBY), Mastercard (MA), & Wal-Mart (WMT)

Posted by intelledgement on Fri, 19 Sep 08

We detailed the reasons why we think it is prudent to short retailers earlier today in our IMSIP post recommending purchasing inverse consumer goods and services ETFs. Accordingly, in the ISOP, we are selling short retailer giant Wal-Mart (WMT), specialty retailer Best Buy (BBY), and consumer credit card vendor Mastercard (MA). Given the weakness in consumer spending that we anticipate over the next 12-to-18 months, we anticipate that all these companies are likely to experienced both sales and profits that are below both prior performance and expectations. And, of course, that this will adversely affect the price of their stock.

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