“What lies behind us, and what lies before us are small matters compared to what lies within us.”
-Ralph Waldo Emerson
After the US market broke down through both the 2002 and 2008 lows into Friday’s close, Yale’s senior standout goalie, Alec Richards, stopped 28 of Cornell’s 30 shots in New Haven, earning nationally ranked Yale their first ECAC conference title since 1998.
As I said in my Friday morning missive, I am going to spend less time going off on the losers who have wrecked the credibility of this US Financial system, and start focusing on the winners. There are plenty of them out there – you just have to look at where the puck is going, rather than where it has been. At this stage of the game, listening to the manic media talk about penny stocks like AIG and Citigroup is a waste of time.
For the month of February, I was pleasantly surprised to register a positive return in the Research Edge Asset Allocation Portfolio. Albeit barely, the model portfolio (which only contains liquid ETFs – no stocks), returned a positive absolute return of +0.12%. On a relative basis, this compares favorably with the SP500’s return, which was down -11% for the month. For 2009 to-date, our Asset Allocation Portfolio is down -1.62% versus the SP500 at down -18.6%.
As I said in last Monday’s note, my goal for 2009 is to put up another positive year of absolute returns. What lies behind us in terms of our positive returns in 2008 are just that, behind us. What lies before us are today’s market prices – no matter where you go in this morning’s Northeastern snow storm, there those prices are. It’s what lies within our proactive risk management process that ultimately matters most.
Over a decade ago, I wrote my senior thesis here in New Haven about the efficacy of duration in Warren Buffett’s investment style. I was working on that thesis in the mid 90s, and that’s when Berkshire’s long term track record looked best. Looking at Berkshire’s price at Friday’s close, since 1998 Buffett has had real relative performance issues. Fully loaded with his foray into using derivatives and the like, some in the investment community might even go as far as to say that Mr. Buffett has had what we call “style drift”… 
The risk manager in me sees Buffett’s current performance issues quite clearly. His portfolio has what we call sector style concentration risk. Berkshire’s marked to market exposure is way over-indexed to the US Financials, and with the XLF (S&P Financials ETF) down -40% for 2009 to date, there is basically nowhere for Buffett to hide from this dominating performance factor in his portfolio.
I have been short the US Financials (stocks and ETFs) for over a year now. As importantly, I haven’t bought the XLF on the long side since we started the firm. Simply not being that guy who is always trying to call the bottom in Financials has probably been one of the largest drivers of both my recent February and 2009 YTD performance. There was no genius in this decision, but there was sobriety. While I covered both the short position we had in Citigroup (in our client virtual stock portfolio) and the XLF on Friday, that doesn’t mean that I won’t re-short these tickers on strength.
People think about short selling in a lot of different ways – I think about it in terms of risk management. Some people say that I “trade too much” – I say that I manage risk too much. But in this market environment, can one manage risk “too much”?
Managing risk requires one to, as my mentor and former Coach, Tim Taylor, used to say, “keep moving your feet.” If that is expressed via a higher paced trading game, then so be it… Right here and now, that’s my proactive investment process, and I am sticking to it.
There are no tax efficiencies associated with holding onto gains on the short side “for the long run.” Other than telling your favorite Swissy friend at his fund of fund how many shorts you have kept on your books forever, I don’t get why you’d “short and hold.” If Citigroup goes from $10 to $1, why wouldn’t you try to make $15?
There are a lot of questions to be asked on this topic, and in the coming weeks I will spend more time reviewing winning strategies in terms of both risk management and short selling. For now, the best advice I can give myself, given that I am behind schedule to this snow storm, is to wind up this note…
Into this morning’s opening weakness that we proactively prepared for (our immediate term downside target on the SP500 on Friday was 730 and we closed at 734), at a bare minimum I think you should be covering shorts. No, that doesn’t mean that a new bull market cometh. Quite to the contrary, it’s a realization that bounces in bear markets are actually higher than in bull ones… so manage the implied risk associated with being short securities when we get oversold.
At some point this week, I think that the SP500 can rally back up to 766 (+4% from Friday’s new YTD low) and nothing will have changed in this US market other than price. Trade and tread carefully… what lies behind us is yesterday’s news. I have a 76% position in Cash. I am long both China and gold again. I am short India, Hong Kong, Korea, US Treasuries, and oil. I am looking forward to finding winners in March.
Best of luck out there today,

CAF - Morgan Stanley China fund – The Shanghai Stock Exchange is up +14.38% for 2009 to-date. We’re long China as a growth story, especially relative to other large economies. We believe the country’s domestic appetite for raw materials will continue throughout 2009 as the country re-flates. From the initial stimulus package to cutting taxes, the Chinese have shown leadership and a proactive response to the credit crisis.

GLD - SPDR Gold- We bought gold last Thursday with the S&P500 in the red and gold down. We believe gold will re-find its bullish trend.

TIP - iShares TIPS- The U.S. government will have to continue to sell Treasuries at record levels to fund domestic stimulus programs. The Chinese will continue to be the largest buyer of U.S. Treasuries, albeit at a price.  The implication being that terms will have to be more compelling for foreign funders of U.S. debt, which is why long term rates are trending upwards. This is negative for both Treasuries and corporate bonds.

DVY - Dow Jones Select Dividend -We like DVY's high dividend yield of 5.85%.

VYM - Vanguard High Dividend Yield -VYM yields a healthy 4.31%, and tracks the FTSE/High Dividend Yield Index which is a benchmark of stocks issued by US companies that pay dividends that are higher than average.

SHY –iShares 1-3 Year Treasury Bonds- On Thursday of last week we witnessed 2-Year Treasuries climb 10 bps to 1.09%. Anywhere north of +0.97% moves the bonds that trade on those yields into a negative intermediate “Trend.” If you pull up a three year chart of 2-Year Treasuries you’ll see the massive macro Trend of interest rates starting to move in the opposite direction. We call this chart the “Queen Mary” and its new-found positive slope means that America’s cost of capital will start to go up, implying that access to capital will tighten. Yield is inversely correlated to bond price, so the rising yield is bearish for Treasuries.

USO -Oil Fund- After a nice squeeze back up to resistance last Thursday we shorted oil into the close. The supply / demand picture remains very bleak, particularly in the U.S. where recent DOE reports indicate the oil inventory is well above its 5-year average.

EWY -iShares South Korea- We bought EWY on 2/23 on an up day. Despite efforts by the Bank of Korea to weaken the Won to spur exports, we see no catalyst in sight to drive external demand to the levels necessary  to stimulate recovery. January export data was down -32.79%, the lowest Y/Y level recorded.

IFN -The India Fund- We have had a consistently negative bias on Indian equities since we launched the firm early last year. We believe the growth story of "Chindia" is dead. We contest that the Indian population, grappling with rampant poverty, a class divide, and poor health and education services, will not be able to sustain internal consumption levels sufficient to meet the growth levels targeted by the Singh administration. Other negative trends we've followed include: the reversal of foreign investment, the decrease in equity issuance, and a massive national deficit. Industrial production fell 2% in December Y/Y and exports decreased 22% in January Y/Y.

EWH -iShares Hong Kong- Hong Kong is not China. The ETF is broken on both a trade and trend perspective.

UUP - U.S. Dollar Index - We believe that the US Dollar is the leading indicator for the US stock market. In the immediate term, what is bad for the US Dollar should be good for the stock market. The Euro is down versus the USD at $1.2586. The USD is down versus the Yen at 97.0950 and up versus the Pound at $1.4179 as of 6am today