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August 2008

Correlations Gone Topsy Turvy

The market stabilized a bit in July (down .84%), as commodity prices dropped in response to a further slowing of global economies. For the year as a whole the S&P 500 is down 13.01 %. Please see our results on performance page. It was a frustrating month for many hedge funds and advisors who have gotten it right up to this point ( ourselves included ), as correlations between emerging markets and the price of oil have turned positive ( oil goes down and emerging markets go down ) , and the price of US banks versus emerging markets has suddenly become negative. Much of this has to do with the unwinding of trades that are no longer profitable, but surely, normal correlations should return in due course as lower oil prices and a stable financial environment are certainly bullish for developing markets.

Although it is too early to call for an end of the current cyclical bear market, there are signs that we might be close to a reverse in course and the start of a new cyclical bull market.

• Valuations of global equities are modest and there is plenty of cash around.
• Stagflation fears should abate as commodity prices continue to fall and become range bound at lower levels.
• The dollar appears to be stabilizing against most developed countries and that should stem any major outflows.
• Investor and advisory sentiment as well as mutual fund liquidations are at extremes often seen at turning points in the market.

It is important to remember that during the previous twelve cyclical bull markets ( source bca publications ) sixteen percent of the upside move was seen in the first two weeks of the rally. In my view, it’s best to remain fully invested, retain our put protection, and wait for the inevitable reversal of this woeful market.

Joe

July 2008

They may look the same, but they're really quite different

The worst June, since 1930, and the worst month since 2002. Thank goodness it's over. The usual culprits caused a rout in the market as the S&P 500 was down 8.43% for the month, 2.70% for the quarter and leaving the index down 12.15% for the year. Please review results on performance page. The good news is that well diversified portfolios easily outperformed the major index's, and remain well positioned for the eventual and inevitable market turnaround. The catalyst for this could well be the slowing of the commodity boom with prices correcting and then trading in a more orderly range. In fact, we're beginning to see this in the commodity related stocks, often a precursor, but not yet in commodity prices ( excepting basic materials ) themselves.

There has been much written and talked about as to how the current inflationary environment resembles that of the stagflation seventies, and while the headline number does indeed begin to look like the seventies, a closer look at the core number ( ex food and energy ) shows that they are really quite different ( please see the enclosed chart courtesy of bca publications ). Some of the reasons for this: unions are no longer operating from strength, tariffs have been dramatically reduced, the regulatory environment has become a lot less restrictive, and in general, a highly competitive global economy. This is important as wage hikes, tariffs, and regulated prices are not subject to market pressures and thus cause cost push inflation; whereas, food and energy will eventually moderate the headline spiraling inflation number. The double negative ( creating a positive ) that I see: the slumping US economy will slow ( but not put into recession ) the emerging markets where high inflation is indeed on the verge of choking off their economies. Here's hoping for a soft landing.

Joe

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June 2008

The Next Phase

The relief rally continued in May as the S&P 500 advanced 1.3%. Please view our performance. While the credit crisis appears to be largely behind us, the damage done to the financial institutions is sure to have a long term deleterious effect on economies, and investors should get used to lower than normal historical returns in developed markets. Fortunately, as CNBC's crack stock jockey Jim Cramer would say, "there's always a bull market somewhere in the world". With the easy money made, here are the three possible outcomes going into the next phase.

• Commodities continue to trade in a mania frenzy. This would certainly cause markets to stagnate, but gains would continue to come from a narrow group of stocks that stand to profit from surging commodity prices. Although higher commodity prices seem unlikely in the short term, as can be seen from the attached chart ( source, bca publications ), prices have not reached their historical secular peak. This is the market that we've witnessed for the past few months. Not too bad a scenario.
  
  
• The economy begins to show significant strength. Although the odds of this scenario appear to be slight as well, it might be not the best case anyway, as the Fed ( already concerned with inflation ) would be forced to aggressively raise rates.
  
  
• The economy continues to muddle through, and oil and food prices correct from current levels and then remain in a trading range. In my view this is the most likely scenario, and if so, I would look for record levels of cash to be unleashed into equity markets which are still trading at rather modest multiples, and have little competition from fixed income. ( second attachment courtesy bca publications ). More importantly, it could prove to be the catalyst to ignite the fastest growing segment over the past six years: Emerging Markets.

Thanks for your continued confidence.

Joe


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May 2008

Alternating Markets

With the Fed creating new ways to inject liquidity into the system, the S&P 500 rallied sharply, posting a gain of 4.87% for the month of April, the best increase since 2003. Please view our performance. While the market may have seen its lows for the year, it is my belief that the current base building will last a few more months, and that a cautious outlook should be maintained for US domestic markets. The calmer tone, however, may well be enough to launch developing markets back into their secular up trends.

There has been much written about how rising inflation will lead to the end of the emerging market bull market, and while it is true that it will hurt some supply constrained importing countries, the enclosed chart ( courtesy bca research ) portrays quite the opposite picture. It'll be interesting to see if hard assets (commodities and natural resource stocks) that powered the first quarter will now consolidate and let emerging markets provide the octane for the second quarter. This is the reason that I have always argued that the key to long term performance is a well diversified and properly correlated portfolio. Timing is just too darn difficult.

Joe


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April 2008

Flight to Safety

The S&P 500 declined for the fifth consecutive month and had its worst quarterly loss since the third quarter of 2002 as it finished at a negative 9.45%. Please visit performance page to view our results. While the Fed Chairman Bernake is now saying that there might be a slight contraction in the economy, he also believes that we'll see a pickup sometime in the second half. Greenspan looks for housing to bottom well before early 2009. Assuming this to be the case, it is my belief that we will find a bottom, and a gradual recovery in US stocks sometime between now and June.

The enclosed chart (source:BCA Research) represents just how far investors have fled the market to seek a safe haven as the three month T-Bill ( 1.33% ) is currently trading at a nearly fifty percent discount to the Fed funds rate of 2.25%. This flight to safety is unprecedented going back to Franklin National in '74, First Penn in '80, Black Monday in '87, LTCM in '98, and the deflation scare of 2003. In each of these prior events, it wasn't long before the market righted itself and went on to new highs. Can it be too much longer before the contagion that has affected the healthy sectors of the global markets runs its course? I don't think it can. It is said that before a true market bottom can be made, even the strong sectors must capitulate. With commodities selling off sharply a couple of weeks ago, and with emerging markets down a much as forty percent since last November, I do believe that a bottom ( at least in these two sectors ) is at or close at hand.

Joe


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March 2008

Will the current retest of the January lows hold?

The market fell for the fourth consecutive month 3.25% as continued problems in credit, signs that we may be in a recession, and now fears of a seventies form of 'stagflation' all entered into the picture. Our February performance is now posted at: www.oristanocapital.com. Will the current retest of the January lows be enough or will the bear market continue before a new cyclical up leg can get under way? The attached chart (courtesy of bca research) indicates that while bullish investors have capitulated, the investment advisors and professional traders have not yet succumbed to previous levels of bearishness. I think it is prudent to remain hedged at this point.

We well may be in or headed for recession, and the credit crisis still has to work itself through the system, but a seventies style 'stagflation' does not appear to be in the cards. Interest rates and core inflation remain low, (and should remain so with a slowing economy) and global competition is holding wage pressure form getting out of hand as it did in the boom and bust seventies. The Fed's easing and the stimulant package should begin to kick in by the Fall, and if so, it would be reasonable for the market to positively discount an upturn in the March-June time frame.

Joe


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February 2008

1990-91 vs. Today

A late month rally wasn't enough to erase the worst start in twelve years as the S&P slumped 6.0% in January. Please visit investment performance page to see our results. Although many stocks look as though they have capitulated, it is too early in my opinion to call a bottom to this market. Market bottoms usually need to be re-tested, and I think it prudent to believe that this cyclical bear market won't be any different. If indeed a normal recession started in January, it should last for approximately nine months, and that would mean the market ( which normally discounts six months forward ) should start to bottom out sometime in March. I believe that a neutral stance is appropriate at this juncture.

It is an interesting exercise to compare today's market to 1990-91 ( chart courtesy of bca research ) which marked the last time the US found itself in a credit crisis. Back then, the S&P 500 dropped twenty percent over three months, while Emerging markets dropped by over thirty before resuming their uptrend's. The S&P 500 went on to reestablish its powerful secular bull market while the emerging markets continued to rise and fall in cyclical fashion. It is my belief, based on the following, that emerging markets will reemerge as the stronger bourses this time around.

• In early 1990 global growth was rotating to the US from Japan and initiated the US growth boom in the nineties.
• Emerging markets were much more dependent on exports to the US back then with twenty five percent to the US vs. thirteen percent today
• The Chinese economy was irrelevant in the early nineties, but today China imports more from emerging markets than does the US.
• Interest rates are lower in both economies, and while helpful to both from a valuation standpoint, it should be more helpful in jump starting emerging markets.

It is fairly apparent that Emerging markets have structurally decoupled from the developed countries. It is only natural, however, in emotion packed downdrafts that all markets correlate in similar fashion to the down side. When the dust clears and the US stabilizes, it is my belief that Emerging markets will resume their dramatic performance to the upside.

Joe


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January 2008

Recession?

For the first time in ten years, the market failed to rally in the fourth quarter, and the S&P 500 was down 3.34%, with the full year ending up 5.79%. Our performance will be posted in a few days at: www.oristanocapital.com.

With the sub-prime mess and the worst housing slump in over fifteen years causing fears that the economy will slide into recession, the negatives were just too much to outweigh the positives of a tough talking but in the end, friendly Fed.

Although 2007 was a decent year given the dearth of negative news, it was also somewhat frustrating in that our very positive results were adversely affected as discounts on closed-end funds ended at four year lows (source Herzfeld Assoc.). Hopefully this trend will reverse sometime in the New Year and start to work to our advantage once again. As far as the economy, I think it is anyone's guess at this moment if we are headed for a recession, but if we are, the market could well be in for its first significant correction in over five years. To address this potential reality, I have hedged the portfolios through protective puts or through Pro Funds ultra short S&P 500 shares where I didn't have the authorization to buy options. While this strategy is not designed to eliminate all of the pain of a cyclical correction; nevertheless it should do a lot to cushion the downside if it were to occur. On a more optimistic note, and the reason that I believe that any correction will be contained, the enclosed chart (courtesy of BCA research) demonstrates just how reasonably priced world markets are on a P/E multiple basis.

Here's hoping that the economy muddles through, and that our relatively inexpensive insurance expires worthless.

Joe


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