My Portfolio after the Fed's action on March 18, 2009

Most US policy makers had the public caught up in debates of bonuses, inappropriate uses of bailout funds, and who knew what when...

... and then the US Fed dropped its $1.2 T quant bomb announcing it would put the (Mint's) printing presses into overdrive.

Implications:

1. Currency rate forecasting just got more volatile! Weekend's G-20 meeting means Fed action was a semi-coordinated easing of monetary policy globally, though clearly the US has first-mover advantage in a "beggar-thy-neighbour" USD depreciation.  Its baiting other Central Banks to follow its lead -- some will, some wont.  

2. Inflation. The Fed knows it and will watch for it, but managing it is orders of magnitude harder than timing the stock market. Expect the usual inflation hedges (Precious metals (GLD), TIPS) to follow a jagged rise up in this expectation.

3. The Real Economy is worse than we thought: The Fed's action is an oblique way of acknowledging that most of the outlined plans and actions have been doing very little.

My Medium Term Portfolio

Expect a short term bounce. The bear market bounce was already in place; these actions will give it a short term boost. Then for the medium term expect reality to set in and see the return of the bear market.  Big(ger) market movements will be everyday events -- watch your financial assets closely if you want to preserve value.

25%: Long Gold and Silver

I am using DGP, AGQ.  Both make sense given ongoing uncertainty in markets, medium term inflationary expectations. Silver is undervalued relative to gold on a historical basis.

Mining companies also make sense. I have a position in FCX -- introduces company management issues.

15% Inverse Treasury

TBT.  In the short term the Fed will do all it can (and should) to keep interest rates low -- this is the housing market policy! However over time yields on US debt must rise, so the -2X instrument will pay off. Accumulate gradually in the next days to cherry pick low prices -- the payoff is months away.

20%: Inverse US Equities

I use ETF's to get this exposure. BGZ (broad market), FAZ (finacials). They have 3x leverage.

As the bounce fizzles, expect a rapid drop. There should be reasonable time to watch and get out of these positions before the next upswing.

0-20% Long Global equities

Expect China, India, Brazil and others to come out healthier (in relative terms) than the developed world from this recession.  However "decoupling" is a false concept, all will do poorly for some time.  For long term pieces of the portfolio (401K) I am accumulating global equities on dips. It's hard to hold something long in this tempting trader's market, but if anything (beyond GLD) this is what I would hold.

10-30% Commodities

Inflation will drive up this asset class significantly. I'm mostly in Oil (DXO) though starting to explore several other commodities. Stay tuned.

0-20% Short Individual Equities

The overall macroeconomic picture determines most of the choices above. And that is the most important trend right now.  Yet, several smaller trends and bets are worth pursuing as competitive pressures in several industries play out. My short picks:

AMZN, GOOG, EBAY.

New Research Tools for Investing

Recent months have delivered unprecedented returns in the marketplace for those willing to stomach volatility. A number of folks have asked me what it takes to stomach the volatility?

My answer: Frequent games of basketball and a disciplined investment strategy. Market fundamentals are critical and ought to be the central anchor for the portfolio strategy (see http://2008forecast.blogspot.com/2008/12/my-optimal-portfolio-in-todays-market.html for my fundamental views).

The next element of discipline is understanding and watching "animal spirits". However, the game is changing to displaying ever higher proportions herd behavior in near term movements. And interventions by policy makers around the world are further fueling volatility.

So how do you figure out where the herd (and the contrarians) is headed today? Here are the handful of approaches I use:
1. Standard market data on trading volumes
2. 13(f) filings reporting hedge fund positions (http://www.marketfolly.com/2008/08/about-that-time-again-hedge-fund.html does a nice job of updating so you don't have to dig through Edgar)
3. kaching.com is an interesting way to see broad cross-sections of populations and where they are investing. They use "funny" money portfolios so be careful about people's -- "What I say, versus what i do" bias.

I had an interesting conversation with a UChicago professor on a plane a couple weeks ago (name protected till he gives me permission). Amongst several esoteric topics we had one theme on pattern matching and recognition. Success in markets (and many other areas) is simply pattern matching for a larger number of possible states of the world than others are achieving. Buffett has been better at this than most for a long time, but break it down into simpler steps and you can get there too!

My Optimal Portfolio in Today's Market

25% Gold and Precious Metals: This is an offense and defense play. Defense against erosion in the value of the dollar (and other currencies) and for unsettled political scenarios. Offense, since the absence of another reserve currency means we need some store of value -- and will return to the historical standard.

25% Emerging International Markets: The BRIC and other emerging economies will maintain positive growth rates through the global downturn and rapidly pick up growth once the economy turns. The structural advantages (demographic, etc) of those economies make them a good medium term play -- with lots of volatilty in the short term, but a clear light at the end of the tunnel for the medium term.

25% Short Bias on Developed Markets: A secular downtrend is firmly in place for several more quarters, even as we see volatility and false rallies. Individual security, sector, and index level plays (naked shorts, ETF's) will provide alpha.

25% Experiments:
1. Volatility Trading: Expect unprecedented ongoing volatility to continue. Establish a portfolio of stocks (or trade the VIX and equivalents) to monitor and range trade for narrow gain. Remember the secular short bias as you "day-trade" the portfolio
2. Policy created returns: New administration in the US has new priorities and will create new winners and losers based on policy incentives. Expect winners in "Green", Defense, Financial Services.
3. US/Europe small cap stocks: Wait a while on this one, but keep it in mind for a play later in Q1 2009 as the Dow corrects to ~6000 and sets up temporary rallies/recoveries.
4. High Yield Corporate Bonds: Even strong companies are facing a real credit crunch. In the short term there is relatively safe fixed income to be had. Add a bit of diversification to the portfolio. DO NOT expect this to be the historical safe play of bonds. Overall bonds are an asset class to just stay away from at this point.

2008-9 Market Predictions

1. In Search of a Bottom: Global Markets will continue to show dramatic volatility for some months. Collective animal spirits seeking a bottom will see several false bottoms across the next months; followed by upward spikes. 2008 may test 6800 (Dow) but also rise to 9300 before the close of the year. Early 2009 will test ~6000 as a lows; expect to see spikes upto 11000 by 2010.

2. USDollar: The rest of 2008 will show the dollar continuing to strengthen against the Euro, Pound, and several emerging market currencies. Q1 (February) 2009 will mark the peak. The search for an alternate reserve currency remains cloudy at best, yet expect to see the weight of US debt, public finance challenges, and the reality (not the hype) of current political realities.

3. Real Estate: Globally Valuations remain high. Several markets will experience a further 25% correction (with a potential for a further over-shooting of 15%). However, real estate will continue to adjust downward on a more sclerotic pace than the stock market. Expect a significant drop in Q1 and then a downward bias for the rest of of 2009. The linkages of real estate to the economy will be a drag on GDP. The nature of regulation/bailout/policy response will determine the speed with which adjustments are accepted in the market, and thus the speed with which GDP growth can return.

4. Gold: The USDollar continues to benefit from deleveraging and the absence of an alternate reserve currency (no, the yen is not it!). Despite the runup of Gold across the last decade, I believe Gold will continue its climb. Its the store of value of last resort -- once we start re-testing some new lows the faint(er) of heart will head for the exits... and gold. If the Fed/Treasury's bailout plan proceeds spectaculary we will have massive inflation on our hands, and again its time for gold.

More to come..

Financial Market Predictions

I'm going to deviate a bit from the corporate technology theme. The uneasiness on Wall Street (and increasingly Main Street) is generating debate and angst among managers and leaders. Some predictions for 2008 and beyond on how the global economy and markets will evolve.. and implications for consumers and producers.

1. Dow 11000. The DJI will spend a good chunk of time this year in the 11K range. Other indices will show similar impacts including several foreign bourses. Expect 2009 to end with the Dow flirting with 14000 again.

2. US Dollar. The news on the dollar will be better sooner than it will be for the stock markets. The first half of 2008 will show the continuing decline of the USD against the Euro and other currencies that we have seen in the last 18 month. The next Fed rate cut will result in a spiky drop and then the rate of decline will start slows. Expect a bottom against the Euro by summertime and then range bound sideways trading for a bit.

3. BRIC Currencies will continue to show strength against the dollar. This reflects the structural adjustment to the global economy with these economies growing in size, trade, etc. However the secular trend for appreciation of these currencies will be significantly more gradual, and in some cases volatile, across the next 18 months.

..and to come this week -
4. Real Estate : Start with this paper: http://www.economics.harvard.edu/faculty/rogoff/files/Is_The_US_Subprime_Crisis_So_Different.pdf

5. Food Prices

Corporate IT Predictions for 2008+ (aka "Mukul's musings")

It's almost 2008 and nearly time for predictions and forecasts. My traditional end-of-year forecast is going to blog format for the first time and coming earlier than year's past. It's also a fundamentally more uncertain time in the global economy given some key trends --

• inflationary pressures on natural resources (oil, metals, etc)


• labor supply shock (labor from India/China/etc entering the formal workforce, baby-boomer retirement looming, etc), and


• large changes in the average employees risk profile from generational changeover.


• $500 billion of US mortgage debt re-pricing (upwards) and a declining dollar


• US election year

I'm not putting probabilities on the forecasts below, but am happy to have side bets on the over/under :-)

1. The Recession of 2008-09 will bring deeper competitive destruction than (recent) prior recessions. Household assets will drop more steeply and across broader population segments, given changes impacting multiple asset classes.

2. Large global capital movements - particularly cross-border flows from governments and institutions seeing windfall gains from oil, currency reserve surpluses, etc. Sub-prime fallout will continue to reduce LBO's fueled M&A activity.

3. Employee engagement will hit new lows in the US, even as it continues to rise in the BRIC's. The usual trend associated with recessions will be further amplified by the generational chageover currently underway and the stories of continuing euphoric growth in the BRIC's/Europe.

4. Declining central IT budgets with Operations and Maintainence growing in share versus compliance and new projects with a declining share in 2008-2009. Functionality investments will shrink in central IT, and reappear, in part, in shadow IT.

5. Counter-intuitively corporate IT will loose control over adoption and development of new technologies during the recession. The rapid reduction in cost of prototyping and the potential gains from exploiting nearness to customer will lead to experimentation in BU's as revenue and P&L pressures build.

6. Entitlement regarding UserProductivity technology/policy will emerge as the Cultural Battleground in corporations. A new wave of questions is rising: What access to devices, network infrastructure, and other "standard" productivity tools can employees expect from corporations? And what limitations/appropriate usage policies should govern their use?
There is a large mismatch in the perception of risk-adjusted ROI on tools (particularly web2.0) for individuals vs. corporations, with individuals focusing on the value and IT departments on the risks. The policies selected by individual companies will directly impact employee engagement, productivity, and outcomes in the War for Talent.


7. Record year for outsourcing IT, with the pace/size of deals picking up significantly and a continued focus on offshoring. Broad growth will be seen across ITO/BPO vendors with share continuing to shift towards non-US headquartered multinationals.

8. BI/reporting analytics will be the source of much pain and opportunity for improved solutions. Demand for better reporting will continue to grow given the inflexibility of current tools, the proliferations of information and reports. The supply side will improve as vendor competition (through M&A and new startups) will finally deliver next generation capabilities.

9. The power of electronic monitoring tools will begin to haunt corporate IT. The proliferation (and power) of content, network, file monitoring tools will continue given information security needs. Processes to manage the usage of these monitoring tools and data will lag the power of the tools and create the risk of "big-brother-like" abuses.