“If a man takes no thought about what is distant, he will find sorrow near at hand.”
There are a lot of things about this business that are challenging, but what we refer to internally as Duration Mismatch is at the top of the list. With an increasingly interconnected global marketplace changing the facts on our screens every day, the perpetual collision of investment durations creates both noise and opportunity.
Are you really an investor “for the long run”, or does that narrative only apply to your money manager who has learned that the art of managing money is having money to manage? Are you a short term “trader”, or are you a risk manager? Are you allowed to change as the facts change or does your investment mandate draw a box around your head? Do you own your duration?
By learning the hard way (losing money), I have come to the conclusion that it’s best to be duration agnostic. You show me a market that crashes to the upside for a +52% move since March 9th, 2009, and I’ll show you a market that I would have liked to have bought and held for that duration. You show me a market that crashed -57% like it did from October 10th, 2007 to the downside, and I’ll show the efficacy of daily risk management. Everything has a time and a price.
In the US market this morning I am presented with the following durations to consider:
- Immediate term TRADE = bullish (month end)
- Intermediate term TREND = bullish (provided that the Buck continues to Burn)
- Long term TAIL = bearish
The beauty of Wall Street is that, not only do people fancy themselves as some of the most intelligent people on earth, they actually are. That beauty provides tremendous opportunities. Being too intelligent quite often results in having duration mismatch.
Whether it was all of the “smart people” being short the US Housing stocks in Q2 of 2004 or their being short the US stock market in Q2 of 2009, it’s all one and the same. It’s called being too early. Timing in this business is everything. Show me a fund manager that has crushed it every year for the last 9 years, and I will show you Bernie Madoff.
Back to durations here in the US stock market, here are my immediate term TRADE levels of risk management this morning:
- SP500 support = 1017, resistance = 1041
- Nasdaq support = 2006, resistance = 2058
- Dow support = 9452, resistance = 9703
In the immediate term, I remain long the Nasdaq and short the Dow. In the intermediate term, that setup of long liquidity (Nasdaq) and short leverage (Dow) continues to prove to be a winning strategy (Nasdaq is +28.6% YTD and the Dow is +8.8%). In the long term, as cost of capital rises and access to it continues to tighten, I want to maintain this investment “style” – again, long liquidity, short leverage.
In the long term “we are all dead” – we don’t need Keynes to reveal that, but for whatever reason when considering investment durations, his whisper is always reminding us of investor mortality. Successful investment durations and styles are not perpetual. Our risk management role, in the long term, is to constantly evaluate the immediate term relevance of these strategies and their effectiveness.
In today’s long term, these are the two most important global macro factors: The US Dollar’s price and Chinese demand.
In today’s immediate term, the US Dollar Index remains broken and so is China’s Shanghai Index. Yes, one of those things is not like the other. China breaking down through both the immediate term TRADE line (3166) and the intermediate term TREND line (2962) is as new as last Wednesday (on 8/26, China closed above the TREND line). That’s why we sold out of it.
Context is always critical. We have been bullish on China since December of 2008, and Andrew Barber called for a -17% correction when we published our long term “China Black Book.” But after last night’s -6.7% smack down in the local Shanghai Composite exchange, there are no “buts”… we’ve already played the risk management hand that is in front of us, and if we hadn’t, we would be doing so, and promptly, this morning.
Early last week, we booked another gain in the China closed end fund (CAF) and replaced that stylistic Chinese exposure via the lower volatility, lower beta H-shares (EWH) in Hong Kong. While we are still bullish on China for the “long run.” That doesn’t mean we have to own it at every time and price.
Whether you are long China here or short US Energy stocks on the heels of a big merger Monday (Baker Hughes $5.5B for BJ Services), everything has a time and a price. Every investment’s success is largely determined by timing. Every day our goal remains managing how “smart” we think we are alongside our greatest risk, Duration Mismatch.
Best of luck out there this week,
XLV– SPDR Healthcare — We’re finally getting the correction we’ve been calling for in Healthcare. It’s a good one to buy into. Our Healthcare sector head Tom Tobin remains bullish on fading the “public plan” at a price.
EWH – iShares Hong Kong — The current lower volatility in the Hang Seng (versus the Shanghai composite) creates a more tolerable trading range in the intermediate term and a greater degree of tactical confidence.
EWZ – iShares Brazil — President Lula da Silva is the most economically effective of the populist Latin American leaders; on his watch policy makers have kept inflation at bay with a high rate policy and serviced debt –leading to an investment grade credit rating. Brazil has managed its interest rate to promote stimulus. Brazil is a major producer of commodities. We believe the country’s profile matches up well with our reflation call.
QQQQ – PowerShares NASDAQ 100 — We bought Qs on 8/10 and 8/17 to be long the US market. The index includes companies with better balance sheets that don’t need as much financial leverage.
CYB – WisdomTree Dreyfus Chinese Yuan — The Yuan is a managed floating currency that trades inside a 0.5% band around the official PBOC mark versus a FX basket. Not quite pegged, not truly floating; the speculative interest in the Yuan/USD forward market has increased dramatically in recent years. We trade the ETN CYB to take exposure to this managed currency in a managed economy hoping to manage our risk as the stimulus led recovery in China dominates global trade.
TIP– iShares TIPS — The iShares etf, TIP, which is 90% invested in the inflation protected sector of the US Treasury Market currently offers a compelling yield. We believe that future inflation expectations are currently mispriced and that TIPS are a efficient way to own yield on an inflation protected basis, especially in the context of our re-flation thesis.
GLD – SPDR Gold - Buying back the GLD that we sold higher earlier in June on 6/30. In an equity market that is losing its bullish momentum, we expect the masses to rotate back to Gold. We also think the glittery metal will benefit in the intermediate term as inflation concerns accelerate into Q4.
LQD – iShares Corporate Bonds – Corporate bonds have had a huge move off their 2008 lows and we expect with the eventual rising of interest rates that bonds will give some of that move back. Shorting ahead of Q4 cost of capital heightening as access to capital tightens.
DIA – Diamonds Trust- We shorted the financial geared Dow on 7/10, 8/3, and 8/21.
EWJ – iShares Japan –While a sweeping victory for the Democratic Party of Japan has ended over 50 years of rule by the LDP bringing some hope to voters; the new leadership appears, if anything, to have a less developed recovery plan than their predecessors. We view Japan as something of a Ponzi Economy -with a population maintaining very high savings rate whose nest eggs allow the government to borrow at ultra low interest levels in order to execute stimulus programs designed to encourage people to save less. This cycle of internal public debt accumulation (now hovering at close to 200% of GDP) is anchored to a vicious demographic curve that leaves the Japanese economy in the long-term position of a man treading water with a bowling ball in his hands.
SHY – iShares 1-3 Year Treasury Bonds – 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. Yields are going to continue to make higher-highs and higher lows until consensus gets realistic.