1.0 poseidon perspective january 2010

8/9/2019 1.0 Poseidon Perspective January 2010

1/17

THE

POSEIDON

PERSPECTIVE

soundnavigationthroughperilouscrosscurrents

30January2010

DearInvestor,

Year2009leavingthelingeringthoughts

thatmuchmoreneedstobedoneto

resolvetheUSeconomicmorass. Asthe

greatrally

in

financial

asset

prices

begins

totaperoff,wenotethatthebalanceof

economicpowerisnowshiftingfromthe

WesttotheEast. However,theemerging

economiesarenotofsufficientsizeor

strengthtopullthesaggingWestfroma

continuingslump. Whiletheremaybea

partialeconomicdecouplingofAsia

fromtheEuroAmericanaxis,therewillbe

noEasterncoattailsfortheWesttoride

upon. ThefuriousgrowthinChina

continuesto

benefit

its

Asian

satellites

and

largecommodityproducingcountries.

DecliningconsumptioninAmericameans

thatglobalreadjustmentwillcontinue.

Meanwhile,securitiesmarketsworldwide

haveshownayearofoutstanding

appreciation. Privateequitywasthesole

loserin2009.

TABLE

A

A

WORLD

OF

ASSET

RETURNS

Index 2009 3Years 5Years 7Years 10Years 12Years 15Years

DJComposite 15.6% (4.70)% 0.99% 5.98% 1.05% 2.64% 7.10%

S&P500 23.5% (7.70)% (1.65)% 3.44% (2.72)% 1.17% 6.09%

USBonds 7.03% 6.41% 5.21% 4.99% 6.54% NA NA

DowREIT 20.9% (16.8)% (4.51)% 3.49% 4.58% NA NA

CRBIndex 23.5% (2.66)% 0.00% 2.74% 3.33% 1.79% 1.21%

MSCIEAFE 27.2% (8.27)% 0.77% NA 2.32% NA NA

MSCI EM 72.0% 2.27% 12.7% NA 5.75% NA NA

GlobalBonds 5.97% 7.06% 5.14% 5.60% 6.47% 6.08% 6.85%

PrivateEquity (7.60)% 1.80% 7.99% NA 7.60% NA NA

Gold 24.0% 19.8% 20.1% 17.8% 14.3% 11.7% 7.26%

Note:SourceforUSBondandGlobalBondreturnsisBarclaysCapitalComposites(formerlyLehmannBros.Aggregate).

PrivateEquityisfromStateStreetAdvisorsIndexwhichincorporates1,650partnerships,valuedat$1.5trillion. Private

EquityreturnsaremeasuredasannualIRRthruSept30foreachperiod;othermultiyearfiguresarecompoundannualrates

ofreturn.

Wehavenotedvariousreturnsofmany

assetclassesoverthepastfifteenyearsin

TableA. Thispresentsanamazingmosaic.

Year2009,alone,wasatimeoffinancial


2/17

THEPOSEIDONPERSPECTIVE 30January2010

crisis,economicrecession,marketcollapse,

andsuddensurgeinassetprices. Our

choiceofindexesisanattempttodisplay

anarrayofinvestmentoptions. Atthe

sametimewehaveattemptedtoreveal

somehistoricperspective.

Wereviewafewoftheassetclassesin

moredetail. Oneareaofinterestisshown

inChart1. Beginningin2004realestate

investmenttrustsasindicatedbytheDow

REITperformedmuchmorelikeanequity

investmentthananinflationindexedbond

orlongterminvestmentinbricksand

mortar. Since2007thisrelationship

appearstohaveaclosecorrelationofrisk.

Thismaycontinuebutcreditdeleveraging

willbringacleansingofbalancesheetsin

commercialrealestateand,thus,weedout

marginalplayersandproperties.

Eventuallyinflationwillreturntosupport

realestatepricingandreturns.

CHART1 FOLLOWINGTHEDOWS

Source:PSI;StockCharts

Page 2

Chart

2

shows

the

VIX,

Wall

Streets

fear

gauge,withanunderlayoftheS&P500.

Webelievethattheneedforequity

portfolioinsurancewillcontinuetoexhibit

periodsofrisingconcernthroughout2010.

TheVIXhasbeenathistoricallyhighlevels

since2007;thiscontinuingvolatility

appears

to

feed

on

itself.

As

the

S&P

500

hassurgedfromitslowinMarch2009

manyinstitutionalinvestorsareverywary

ofthecontinuedappreciationwithout

someperiodofseriouscorrection. After

providinghorrendousreturnsoveraten

yearperiodwhichincludedtwobubbles,


3/17


thoseinvestorswhopurchasedduringthe

lowsof200809maylooktotakesome

profitsattaxfavorable,longtermgains.

Sudden,explosivegainsofftheMarch2009

low,continuingvolatility,andeconomic

uncertaintyshouldencourageinvestorsto

lowertheirallocationtoequities. One

conclusionwedrawfromtheabove

returnsistheoldadagethatyoumake

yourmoneyinthebuying. Thus,ifoneis

committedtoabuyandholdstrategyfor

equities,thetimingofpurchase(s)isof

greatimportance. Thevolatilityof

markets,asseeninTableA,duringthe

past10yearshassupportedtheneedfor

prudenttimingandselectioninall

investmentarenas. Webelievethatthe

securitiesmarketsin2010andgoing

forwardwillbedominatedonaglobal

basisbysupply/demanddisconnects,

continuingcreditconcerns,andpolitical

responsestoperceivedcrisis. A

fundamentaldriverofvolatilityand

returnswillbegovernmentfiscalpolicies,

internationalcurrencyadjustments,and

centralbankmonetarysurprises.

CHART2 CONTINUINGJITTERS


Page 3

Theemergingmarketsreturn,MSCIEM,

in2009wasquitephenomenal. Weview

thisasasharpreturntohighrisktrading

andthestrengthofChinascontinuing

growthstory. Asiaingeneralhassuffered

muchlessthanthedevelopedeconomies

duringthehousingandcreditcrisis.

China,inparticular,actedquicklyand


4/17


aggressivelytosupportcontinued

economicgrowththrumajorfiscal

stimulusandtightcurrencyandcapital

controls. AsseeninChart3monetaryand

fiscalpolicyhaveprovidedthestimulus

forresurgenceintheChineseequity

marketasrepresentedbytheShanghai

StockExchange(SSEC). Chinesedemand

hasalsosupportedthecommoditymarkets

foroveradecade;thequestionishow

muchlongerwillthiscontinue. Chinamay

beinthemidstofahugehousing,equity,

andcreditbubblebutrightnowmuchof

therisktakingworldwideisridingonthe

upwardpathofthedragon.

CHART3 THEEASTERNBAROMETER


IntheUSweview2010asaperiodof

continuedeconomicadjustmentandan

endtoaggressiverisktaking. Wenote

four

dynamics

which

will

put

severe

pressureonbothstockandbond

valuations. Theyare1)continuedhigh

unemployment;2)continuing

deteriorationinthehousingmarketwith

increasingforeclosuresandreduced

valuations;3)aseveredislocationin

commercialrealestate;and4)worldevents

includingsovereigndefault,political

upheaval,andeconomicconflict. This

does

not

portend

global

collapse;

this

will

beastrategicretreattothosecurrencies

andsecuritieswhichprovidethespecterof

lowerriskandrealreturns.

Page 4

Amajorconcernofmanymarket

participantsgoingforwardistheendof


5/17


theFedsquantitativeeasing. The

engineofrecoveryintheUShasbeen

creditgrowthandevenwiththehuge

increaseinbankreservestheeconomic

recoveryintheUShasbeenfeeble. There

isunderlyingfearthatwhenquantitative

easingiswithdrawntheremaybea

suddencollapseindemandforamultitude

ofsecurities;thus,generatingaglobal

retrenchmentofrisktaking.

SOUNDINGS

InApril2009RussellNapier,authorof

AnatomyoftheBear:LessonsfromWall

StreetsFour

Great

Bottoms,

gave

a

presentationattheCFAInstituteAnnual

Conference. Thiswassubsequently

publishedintheInstitutesConference

ProceedingsQuarterlyunderthetitle,

IdentifyingMarketInflectionPoints. We

wouldliketorelatesomeofthemore

pertinentpointswhichNapieraddresses

withregardtocurrentequitymarkets. His

historical

perspective

is

important

because

currentfinancialanalysisrarelygoes

beyondtherecentquarteroryearover

yearcomparables. Napiersexamination

ofthestunningmarketbottomsinAugust

1921,July1932,June1949,andAugust

1982arethebasisforhisbooksincehe

believesthatatthebottomthemarket

provestobemostinteresting. Thebottom

areaalsoprovidesthemostattractive

potentialfor

investment

returns.

Napier

valuedeachmarketbottomaccordingtoits

cyclicallyadjustedpricetoearnings

(CAPE)ratioandTobinsqratio. CAPEis

ameasureofthepriceofequitiesrelative

to10yearsofrollingaverageearningsand

Tobinsqratiomeasuresthepriceof

equitiesincomparisontothereplacement

valuetotheassets.Justificationforthese

valuationmethodologiesisbasedupon

ValuingWallStreetbySmithersand

Wright(2000). Inauniqueapproachtohis

researchNapierreadeverycopyofthe

WallStreetJournalfortwomonthsbefore

andtwomonthsaftereachbottom,which

comesto16monthsofbearmarket

bottomsandabout70,000articlesinthe

WallStreetJournal.

Napierstatesthatifthereisonestrategic

conclusionfrom

his

book

it

is

that

all

bear

marketsaredrivenbydisturbancestothe

generalpricelevel,whetheritisinflation

ordeflation. Healsonotesthatvaluation

peaksresultfromthesameillusionthat

thereisaneweconomywhichembodies

lowinflationandhighgrowth. While

thepricedisturbancewhichinstigatesa

bearmarketisusuallyinflation,they

usually

end

with

deflation

or

deflationary

riskascentralbanksfinallyoverreactto

inflation. Webelievethatitisvery

importanttonotethecripplingeffectthat

deflationcanhaveonequities. The

expectationoffallingpricescanquickly

destroythereturnonassetswhich

themselvesarefallinginvalue. Thus,a

companyscashflowbeginstorecedeat

thesametimethatitsfixedcosts,especially

debtburden,

remains

the

same,

equity

valuesareextinguishedunderthe

discountingoffuturereturns. Importantly,

Napiersummarizeshisfindingsthatthe

bottominadeflationaryinducedbear

marketrevealsthefollowing:

Page 5

Inventoryinthesystemislow;


6/17


Commoditypricesstarttostabilize; Demandgoesupatlowerprices,

particularlyforluxurygoodsorgoods

instructuraldemand;

Certaintyongeneralpricelevelsandvaluationsincreases;and

CorporatebondsrallyGiventhesehistoricalfactorswecan

surmisethatthemarketlowinMarch2009

wasabottom. Commodityprices

bottomedwithequitiesandbothhavenow

recovered. Priceslevelsasmeasuredby

TIPS/Treasuriesdifferentialarerising.

TwoyearsagoTIPSwereforecasting

deflationand

now

indicate

amove

to

inflationexpectations. Finally,corporate

bondswhichareaverygoodindicatorofa

marketbottom,haverallied.

However,theNapieralertsustosome

evidencethatthemostrecentmarket

bottom,March2009,maynotbethefinal

bottom. Henotesshortpositionindicators

and

trading

volume.

He

believes

that

the

mostimportantfactorswhichdenotethata

finalbottomhasnotbeenmadeareoverall

volumestatisticsandturnoverratios. His

readingonthesetechnicalmeasures

indicatesthatwehavenotarrivedatan

equitymarketbottom. Baseduponhis

studiesandperceptionsofcurrent

conditions,Napierconcludes:

Toreachtherecordlowsof1921,1932,1949,

and

1982,

US

equities

will

have

to

fallby50percentfromtheircurrent

levels.

Deflationproducesrecordlowequityvaluations,butprolongeddeflationin

todayseconomyremainsunlikely.

Asignificantshorttermrallyintheequitiesmarketislikely. Investors

shouldwatchcorporatebonds,

commodities(particularlycopper),and

TIPSasindicatorsofequitymarket

changes.

Thefinalstageoftheequitybearmarketwillbedrivenbyabearmarket

inTreasuries.

Wetaketheseconclusionsunderserious

considerationaswelookforwardtoequity

marketperformanceduring2010and

beyond. WhenNapierspresentationwas

deliveredthe

S&P

500

was

priced

at

857.

Thusa50%declinewouldleavetheS&Pat

alevelaround430. Weconsideradropto

thislevelaverylowprobabilityevent.

Yet,aseverecorrectiontothe700800level

ismuchmorerealistic. Weconcurwiththe

premisethatprolongeddeflationis

unlikelybutweseecontinuingdeflation

untilbankreserveswiththeFedare

unwound

in

a

new

gyration

of

credit.

We

haveseenamarketrallyofgreatstrength;

wemustnowwatchforthecorrection.

Finally,wearewatchingTreasury

securitiescloselyaswealsobelieve,as

Napier,thatabearmarketinTreasuries

mayigniteagrandselloffinequities.

Page 6

Givenpastoccurrencesandhistorical

postulatesmarkettimingisalwaysa

criticalissue.

As

we

have

seen

with

the

housingcrisiseconomicavalanchesmay

takelongerthanexpectedtoruntheirfull

course. Chart4exhibitstwentyyearsof

theDowJonesIndustrialAveragewhich

encapsulatestwobubbles,deflation,

reflation,andeventualrecovery. Chart4


7/17


Page 7

includestwoofthebearmarketlows,1921 and1932,whichNapierhasstudied.

CHART4 TWODECADESOFRECOVERY

Source:StockCharts

AsNapiernotedcopperisawellknown

proxyforeconomicdevelopment. Until

2004whentheworldrecognizedthestrong

developmentinBRICemergingmarkets


8/17


copperwasdormant. Thiscommoditylike

manyothersiscurrentlydrivenbyChinese

demand. Akeyquestionishowmuch

longerthisdemandwillpushthepricing

ofbasemetals.

CHART

5

DR

COPPER,

THE

INDUSTRIAL

INDICATOR


Page 8

However,therecentriseoftheYen

demandsthatwerevisittheJapanese

experienceoverthepasttwentyyears. In

Chart6theNikkeiIndexofJapanese

equitiesisshownwithacurrency

underlay. Whilecorrelationisnot

causationthesuddenriseintheYenasthe

marketcollapsedin19901995isnotable.

This

experience

is

not

lost

on

the

mandarinsinChinawhoarevery

concernedabouttheimpactofcurrency

appreciationontheirexportledeconomy.

ThereisastrongcurrentwithinChinathat

believesthecrashofJapanesestocksand

thelostdecadecoincidedwithan

untimelyandunfortunateescalationin

valueoftheJapanesecurrency. Weawait

themassivedevaluationoftheYenin

orderforJapantobecomemuchmore

competitiveinaneconomicrecoveryunder

AsianandChinesedominance. Great

importmustbegiventotherecent

downgradeofJapanesesovereigndebtto

AA

by

Standard

&

Poors.

The

worlds

secondlargesteconomyandlargest

nationaldebtloadaspercentofGDPwill

haveseriousreverberations. Webelieve

thatJapanmayprovidecluestothefinal

resolutionoftheUScreditcrisis. Asthe

currencyandbondmarketsadjusttothese


9/17


dynamicswebelieve2010willbea

tumultuoustimeforAsiancurrencyand

equitymarkets.

CHART6 TWODECADESWITHOUTRECOVERY

Source:StockCharts

WEATHERWATCH

Page 9

OnJanuary3,2010ChairmanBernanke

utilizedhisstatus,reputation,and

academicbrilliancetocrushanysuspicions

thatthemonetarypolicyoftheFederal

Reservewastoblameforthehousing

bubbleandsubsequentcreditcrisiswhich

hastriggeredglobalrepercussions. His

speech,MonetaryPolicyandtheHousing

Bubble

(www.federalreserve.gov/newsevents/spee

ch/bernanke)wasamasterfuldiscourseon

thepowerofpositivethinkingand

statisticalpersuasion. Hereadilyadmits

thattherewasalapseinregulationand

oversight. However,hepersistsin

counteringthose

who

claim

that

excessivelyeasymonetarypolicybythe

FederalReserveinthefirsthalfofthe

decadehelpedcauseabubbleinhouse

pricesintheUnitedStates. Bernanke

mentionstherecessionof2001whichhe

admitswascausedbythemarketcollapse

ofthedotcomboomwithoutany

referencetomonetarypolicyormargin

requirements

which

is

also

a

Fed

bailiwick.

Hereviewsthereasonsforaggressive

monetarypolicyoflowratesfrom2001

until2004andtheraisingofrateswith

clearlysignaledforwardguidance. The

justificationswhichinclude

unemploymentfearsanddeflation


10/17


expectationsareclearlyoutlined. To

evaluatethedecisionmakingprocessin

tighteningoreasingofratesBernanke

launchesintoanextensivediscussionand

detailedcritiqueoftheTaylorRule.

Thus,thepolicydecisionofacommitteeof

thoughtful,brillianteconomistsisdistilled

intoasimplebutalwayschanging

algorithm. Regardingoneofthetencharts

providedintheAttachments,the

Chairmanconcedesthatthevalidityof

thatconclusiondependsonwhether

specificassumptionsandmeasurements

usedtoconstructtheTaylorrulespolicy

prescriptionare

appropriate.

This

need

forproperassumptionsisthenextendedto

CPIdataandinflation,currentvaluesand

forecastingvalues,temporaryexpectations

andlastingexpectations. Ofcourse,he

mentionsthelag. Then,hemovesonto

morequantitativeimplications. Wenote

thatBernankemustreverttoresearchdone

bystaffattheSt.LouisFedbecausethe

Philadelphia

Feds

Greenbook,

the

economicforecastsusedbytheFOMC,is

releasedtothepublicwithafiveyearlag.

Thisreversiontoalternativedatacomes

fromthesamemanwhocommittedto

makingtheFedmoretransparent.

Havingrefutedonecloselywatchedpolicy

mandate,Bernankemovestootherreasons

fortherunupinhousingprices. The

foregoneconclusion

is

that

the

magnitude

ofpriceincreasescouldnothavebeen

causedwhollyorsolelybymonetary

policy. Atthispointhebringsintheheavy

artilleryofeconometricmodeling. TheFed

staffusedvectorautoregressionmodels

whichincorporatesevenvariables. As

definedbyWikipediathistypeofmodelis

usedtocapturetheevolutionand

interdependenciesbetweenmultipletimes

series,generalizingtheunivariateAR

[autoregression]models. Allthevariables

inaVARaretreatedsymmetricallyby

includingforeachvariableanequation

explainingitsevolutionbaseduponits

ownlagsandthelagsofalltheother

variablesinthemodel. Theinherent

ironyisthatValueatRisk(VAR)models

whicharebaseduponARmodelswerethe

riskmanagementtoolsatmanylarge

bankswhichprovedtobeofsmallvalue

whenthe

credit

markets

destroyed

Bear

StearnsandLehmanBrothers.

Page 10

Wewillnotattempttodisputethefindings

ofthehighlyrespectedFedstaffotherthan

tonotea)increasingthenumberof

variablesinaregressionincreasesthe

overallabilityoftheregressiontoexplain

therelationshipbutmayweakenthe

significance

some

variables;

b)

there

are

dataminingissueswiththisquantitative

proof;c)therehavebeenserious

refutationstoVARanalysis. Wereferto

BankofEnglandPaper18VectorAnalysis

andtheGreatModerationbyBenatiand

Surico

(www.bankofengland.co.uk/publications/e

xternalmpcpapers/extmpcpaper0018.pdf)

whichexaminestheanalysisoftheUS

GreatModeration

based

on

VAR

methods. Atonepointtheyconclude:

Thesefigurescastseriousdoubtsonthe

presumptionthatchangesinthesystematic

componentofmonetarypolicyshould

manifestthemselvesmostlyaschangesin

theVARcoefficients.Onthebasisofthis
http://www.bankofengland.co.uk/publications/externalmpcpapers/extmpcpaper0018.pdfhttp://www.bankofengland.co.uk/publications/externalmpcpapers/extmpcpaper0018.pdfhttp://www.bankofengland.co.uk/publications/externalmpcpapers/extmpcpaper0018.pdfhttp://www.bankofengland.co.uk/publications/externalmpcpapers/extmpcpaper0018.pdf


11/17


Page 11

presumption,resultsfromearlier

contributionshavebeeninterpreted

accordingtothenotionthatstrong

evidenceofbreaksintheVARinnovation

variances,coupledwithweakorno

evidenceofbreaksintheVARcoefficients,

isevidenceagainstpolicyandinfavourof

luck.

ChairmanBernankethenrattlesalong

abouttheeffectofinnovationsinhousing

financeincludingalternativemortgage

productsandsecuritization. Inthiscasehe

agreesthattheseproductsarelikelyakey

explanationof

the

housing

bubble.

ChairmanBernankeexamines

internationalhousingbubbleswith

complexstatisticalmeasurestoexplain

awayanyrelationbetweenFedmonetary

policyandtheUSbubble. Atthispointhis

argumentsbegintoreekofdesperation,for

nowhepullsouthisfamoussavingsglut

hypothesis.Weareamongthegroupwho

dispute

this

explanation

for

massive

US

deficitsasaresultofChinesesavings.

However,thatisnotthepoint. Ofthe

nationscitedbytheChairman,mostifnot

all,didnothavethecomplexand

sophisticatedfinancialsproductsand

secondarymarketswhichtheUSbanks

andshadowbankssoadroitlyexploited.

Theglobalhousingbubblewastheresult

ofexcessivecreditexpansion. Itwasthe

directresult

of

lax

central

banking

not

only

intheUSbutacrosstheglobe. Yet,

ChairmanBernankeandtheFedstaff

modelersarethesamepeoplewho,

whileshowinggreatdexterityat

developingvectorautoregression

analysis,couldnotseethehousingbubble

asitrapidlyinflatedfrom2003thru2006.

Wearenowexpectedtobelievethattheir

statisticalgymnasticscansubstantiatethat

theextendedperiodofeasymonetary

policywasinnowayresponsiblefora

disastrousbubbleanditstragic

unwinding.

Wecannotaccepthisexplanation. We

believethatthetremendousleverage

createdbybanks,bothonandofftheir

balancesheets,

was

akey

factor

in

development,securitization,and

disseminationofalternativemortgage

products. Thegreatleveragewasaresult

notonlylaxregulationbutalsoextremely

accommodativemonetarypolicy. Our

contentionisthatChairmanBernanke

cloakedinhisarrogantbrilliancehas

learnednothingfromthecripplingcrisis

and

continuing

recession.

His

reappointmentheraldsareturntobusiness

asusualforthemoneycenterand

multinationalbankswhich,inturn,will

resultincontinuingmarketvolatility,

currencygyrations,andunconventional

governmentinterventioninmarkets.

WepresentinChart8anupdatedversion

ofacommonShillerchartofhousing

prices,the

top

and

the

demise.

Whatever

theexplanationsforthissurrealisticasset

bubble,itsunwindingwillhavealongand

deleteriousimpactontheUSeconomy.


12/17


CHART8 HOUSINGPRICEPEAK

Source:www.ritholtz.com/blog

Finally,wewouldliketonotetwomajor

realestatedislocationsduringthepast

year. ThefirstwasthebankruptcyinApril

2009ofGeneralGrowthProperties,aretail

malldeveloperandownerwithdebtof

$27.3billionmuchofittakenonto

accommodate

the

$11.3

billion

acquisition

ofRouseCompanyin2004. Thisleverage

wasprovidedduringatimeofvery

accommodatingmonetarypolicy

promulgatedbytheFed.

Page 12

Secondly,inJanuary2010TishmanSpeyer

renegedonscheduleddebtpaymentsand

thus,cededcontrolofthePeterCooper

VillageandStuyvesantTownproperties

whichincludeover11,000apartmentunits

inManhattan. Theresultwasacomplete

loss

of

equity

investment

and,

most

probably,allmezzanineinvestment. This

mortgagedefaultisonepartofTishmans

complexseniordebtof$4.45billionand

mezzaninefinancingof$1.45billion. The

problemwashugeleverageundertakenon

theoriginaltransactionpriceof$5.4billion
http://www.ritholtz.com/blog/wp-content/uploads/2009/06/case-shiller-updated.pnghttp://www.ritholtz.com/blog/wp-content/uploads/2009/06/case-shiller-updated.pnghttp://www.ritholtz.com/blog/wp-content/uploads/2009/06/case-shiller-updated.pnghttp://www.ritholtz.com/blog/wp-content/uploads/2009/06/case-shiller-updated.pnghttp://www.ritholtz.com/blog/wp-content/uploads/2009/06/case-shiller-updated.pnghttp://www.ritholtz.com/blog/wp-content/uploads/2009/06/case-shiller-updated.pnghttp://www.ritholtz.com/blog/wp-content/uploads/2009/06/case-shiller-updated.pnghttp://www.ritholtz.com/blog/wp-content/uploads/2009/06/case-shiller-updated.pnghttp://www.ritholtz.com/blog/wp-content/uploads/2009/06/case-shiller-updated.pnghttp://www.ritholtz.com/blog/wp-content/uploads/2009/06/case-shiller-updated.pnghttp://www.ritholtz.com/blog/wp-content/uploads/2009/06/case-shiller-updated.pnghttp://www.ritholtz.com/blog/wp-content/uploads/2009/06/case-shiller-updated.pnghttp://www.ritholtz.com/blog/wp-content/uploads/2009/06/case-shiller-updated.pnghttp://www.ritholtz.com/blog/wp-content/uploads/2009/06/case-shiller-updated.pnghttp://www.ritholtz.com/blog/wp-content/uploads/2009/06/case-shiller-updated.png


13/17


whichinNovember2006wasthebiggest

residentialdealinNewYorkhistory. The

largestholdersoftheseniortranche

mortgagebackedsecuritiesfundingthe

dealareFannieMaeandFreddieMac.

Tishmaninvestedonly$56millionofit

ownmoneytopurchasetheproperties

Onceagainwebelievethatmonetary

policyiscreatingunintended

consequences. TheFedsFOMChasheld

thetargetfundsrateclosetozeroforan

extendedperiod. Onedaythiswill

change. Chart7showsthecurrentyield

for10

year

and

2year

Treasuries.

These

arereflectiveofFedpolicybutfiscalpolicy

maybringtheirpricingpowertoahalt.

Thefiscaldeficitin2009requiredover$1.5

trillionofnewdebt;foreignpurchases

subsumedabout$300billion,Chinaalone

taking$100billionofthisamount. TheFed

wasthebuyeroftherestbothdirectlyand

indirectlyastheypurchasedboth

TreasuriesandAgencymortgage(ie

FannieandFreddie)debt,mostly30year.

Thesellersofthatdebt,suchasPimco,

thenusedtheproceedstopurchase

Treasuries. Giventhisscenariowefindit

hardtoconceiveofanyFedexitduring

2010. Whocouldabsorbtheimmense

quantityofdebttobeissuedbytheUS

Treasuryas

the

government

deficits

continuetoclimb?

CHART7 WHENTHETIDETURNS


Page 13


14/17


Meanwhile,theUSeconomyissufferinga

deceptiveboutofdeflationwhichtheFed

continuestobattlewithitsunprecedented

quantitativeeasing(i.e.moneycreation).

AsNapierpointedoutabove,webelieve

thismoneycreationwill,inthenextfew

years,spiralrapidlyintomassiveprice

inflation. Thiswillcauseaninterestrate

escalationwhichtheFedwillnotbeableto

managewithoutevenmoredrasticand

wildlyunconventionalpractices.

PROVISIONING

Goingforwardassetallocationdemands

carefultiming,

sector

analysis,

and

security

selectiononaglobalbasis. Whilewefind

USequitymarketstobeovervaluedbyas

muchas20%,thisequitypricepremium

mayincreaseasearningsarereported

duringthefirsthalfof2010. However,

opportunitieswilleventuallyarisewith

marketcorrections. Wearepreparedto

capitalizeonourcurrentlylargeallocation

to

cash.

The

equity

sectors

which

we

deem

attractive,afteranyforthcoming

correction,includetelecommunications,

healthcareespeciallypharma,energy,and

rawmaterials. Thesesectorsarenot

restrictedtoUSequitymarketsbutmaybe

appliedtonumerousglobalopportunities

inbothdevelopedandemergingmarkets.

Infact,webelievethatupto50%ofany

equityallocationshouldbeinmarkets

outsidetheUS. Wepreferthe

uncompromisedfinancialstrengthoflarge

multinationalsinanygivensector. Our

missionduringthetribulationsof2010will

betoundertakeequityinvestmentsona

costaveragingbasis. AswenotedinTable

Athepastdecadeofpoorequityreturns

shouldprovideanopeningforfuture

equityreturnswheninvestmentis

undertakenatpropervaluations. Patience

iskey!

Overtheyearsanalystshavebeen

hopelesslyoveroptimisticinearnings

estimatesfortheS&P500andweexpect

2010tobenodifferent. Thus,wehighly

recommendbuyingonlyonweakness. We

expectintermediatetermdeflation,

strengtheningoftheUS$,andsome

unwindinginthecarrytradeastheriskof

being

short

the

US$

grows

substantially.

PartoftheUS$strengthwillnotbeUS

economicstrengthbutthefactthatsome

tradersharborfearthattheeuromay

collapseastheGIIPS(Greece,Ireland,

Italy,Portugal,andSpain)debtloads

becomeuntenable.

Page 14


15/17


CHART9 RESURRECTIONOFTHERELIC


Asusualweendwiththecaseforgold. As

seenaboveinTableAtheinvestment

returnsfor

gold

have

been

stellar

over

the

past10years. Weexpectthistocontinue.

Additionally,aftersomecorrectiontothe

equitymarketsthemetalminingstocks

shoulddisplayanexuberantriseasa

leveragedplayonthepreciousmetals.

Withinthissectorwewouldrecommend

theGoldMinersIndex(GDX)andthe

morespeculativejuniors(GDXJ). For

direct

holding

of

gold

there

are

Gold

SharesTrust(GLD),iSharesSilverTrust

(SLV)andCentralFundofCanada(CEF),

theCanadiantrustwhichholdsbothgold

andsilverbullion,andSwissgold

holdings,SGOL. Individualnamesinclude

NewmontMining(NEM),AgnicoEagle

(AEM),YamanaGold(AUY),andBHP

Billiton(BHP). Thesestocks,attimes,

trackthe

equity

market

more

closely

than

goldbullion;seeChart9whereweuse

NewmontMiningasanexample. We

woulddeferpurchaseoftheirsharesuntil

laterin2010. However,oncethereisa

seriouscorrectionthesenamesholdthe

potentialforgreatreturns.

Page 15

Chart10displaysthepricesoftheGold

Miners

Index

(GDX)

and

a

major

mining

company,thegreatoreandcoalproducer

BHPBillitonoverthepast5years. Once

againnotetherelativityofgoldproducers

togeneralminingstocks. Webelievethis

spreadwillwidensubstantiallyasequity


16/17


marketscorrectandpreciousmetalsbegin

ariseinpricesduring2010Q3.

Thepastdecadehasbeenaperiodof

marketturmoil. Noonecanpredictthe

future;yet,asweviewthepastwemust

prepareourportfoliosforcontinuing

changeandrisingvolatility. Forthis

reasonourprimaryallocationsremainin

cash,gold,shortdurationTreasuries,and

midshortdurationbonds. Thegalestorm

increditmarketsmayhavepassedbutthe

windsofchangecontinuetoblow.

CHART10 ALLTHATGLITTERS


Whilereviewingthepastyearandruminatingoneventsbeforeandaftertherecentmarket

upheavalwehavebeenchallengedathowsomeanalystsinterpretandcommunicate

historicalevents. ThesethoughtsimmediatelybringtomindthebrillianceofHarvard

philosopherGeorgeSantayanawhosLawofRepetitiveConsequencesisfrequentlynoted

as

Those

who

cannot

learn

from

history

are

doomed

to

repeat

it.

Yet,

how

do

we

truly

learnfromthepast. Ourcognitivefacultiesareeasilyovercomebyemotionandinformation

overload.

Page 16

WereturnedtothatgreatmasterofphilosophicalmeanderingG.W.F.Hegel. Asweread

thruthelectureswhichbecamethebasisforhisThePhilosophyofHistorywequickly

rememberhowharditwastoreadthisGermanpedantic. Hegeldemandsreverencetothe


17/17


overridingimportanceofthedialecticprocess,thesis,antithesis,synthesis. Progressisthe

successivemovementswhichareresolutionsfrompreviouscontradictions. Reflectivehistory

isnotconfinedtothelimitsofthetimesbutretainsaspiritwhichtranscendsthepresent. The

historianinfusestheworkwithhisownspirit;heisthecreatorofannalswhichbringthepast

tolife. Thenwemoveonthrupragmatichistoryandcriticalhistoryand,finally,

philosophicalhistory. Onandonwiththegreatroleofreasonandthentheallconsuming

Geistwhichamongitsmanytranslations,spiritisthemostpopular.

Suddenly,itwasclear. ThiswassimilartoreadingaBernankespeech. Bernankesgeistis

thegrandmodelingofeconometrics. VARisoneofthequantitativespiritswithitsmany

variables,coefficients,evolvingrelations,andcontinuingfeedbackloops. Theroleof

complexityandlogicistoparalyzethementalprocesseswiththeexclusionofintuitive

knowledge. Theevolutionandinterpretationofpasteventsisonlytheresultofassumptions

andalgorithms. Rationalquantificationbecomesthemeanstointerpretthepastandcontrol

thepresent.

Rightorwrongisnotforustodecideatthistime. Whatwemustmaintainthroughoutthis

periodofnoveleconomicpolicyandfinancialupheavalisahealthydoseofskepticism.

Sincereregards,

BrianE.Shean,CFAPRINCIPAL

POSEIDONSTRATEGICINVESTMENTS

_________________________________________________________________________________

Page 17

Theviewsexpressedinthiscommentaryarethoseoftheauthoratthetimeofcomposition. Theassumptions,analysis,and

conclusionsaresubjecttochangeinconjunctionwithchangesinthesecuritiesmarketsordiscoveryofadditionalor

conflictinginformation. Allinformationconveyedhereinhasbeendeduced,compiledorquantifiedfromsourcesthoughtto

beconsistentlyreliable. Thisinformationalreportisproducedforgeneralcirculationandisnottobeconstruedasa

solicitationtobuyorsellsecurities,financialinstruments,orinvestmentproducts. Priortoenteringanytransactionsfor

investmentproductspleaseconsultacompetentfinancialadviserandundertakeproperduediligence. AMDG

1.0 poseidon perspective january 2010

Documents