To Our Friends and Investors,
This is an update from Saddle Point Capital Partners, LP.
We acted on our comment mentioned at the end of the May update (see “SPCP I
Update 5-12-2009”), and invested 40% of the fund’s assets in a combination of
mostly Canadian and some Australian dollars. We also added a little bit to our
GLD and GDX positions. Shorted equity modestly -- little worried about the
market going higher. Covered a good portion of our equity shorts on June 1st.
Everybody wants to know about the stock market because it’s seen as the
barometer of how things are. At the moment the bulls clearly have the upper
hand. As we wrote last month, “currently the markets and growth trade is
enjoying a nice cyclical bull market within a larger secular bear trend”, and overall
nothing has changed that view, except that the market rally seems to be
extending itself. As the Saddle Point “way” is one of skepticism, we would state
that all is not as well as it appears for the bulls; however, we have enough
respect for them that we have fairly modest equity short holdings, compared to
our holdings of gold (20+ %) and Canadian / Australian dollars.
Notwithstanding that the market may ride the liquidity train to new highs, in
general, we believe that the market is seriously overoptimistic about things; that
“green shoots” are more a phenomenon of spin and hype than real resurgence;
that the consumer is irreparably damaged; and, that the market is very vulnerable
to numerous unintended consequences of the very policies that have floated this
latest mini bubble. For example, we’ve seen that Treasury bond yields have
started to rise sharply and that the dollar is declining sharply at the same time -
this is not a good combination if you think in terms of getting people to buy our
Treasury Debt. We believe that these are powerful trends (rising rates and
depreciating dollar) and that they will stress the system in unforeseen ways.
To keep the recent equity market activity in perspective, see the two charts
below. The top chart depicts inflation-adjusted earnings for the S&P 500; the
bottom chart represents the P/E multiple that is applied to the earnings to arrive
at the S&P 500 value. These two charts illustrate how market optimism has
driven up equity market valuations in the face of falling earnings. In the event
that “green shoots” do not manifest in a sharp rebound in economic activity and
earnings, one can only conclude the market is very vulnerable. Technically there are a couple of major red flags: volatility is still extremely high
by historic standards and characteristic of an early phase bear market rally. The
volatility comes from the fact that the primary trend is really down, but the public
doesn’t believe it and, as a result, when the market starts to rally it brings out
residual bullish behavior (ie. appetite for risk) and the market regains that “old
time” feel in spurts. Unfortunately, it is swimming an upstream battle against an
overleveraged global capital structure and equity prices are not likely to win. If
one studies the sentiment of past market bottoms, there is very low volatility and
nothing of this residual bullishness left when the real bottom comes along
because at the real bottom, everybody has been demoralized and nobody is
interested in stocks (opposite of a mania). Ironically, it is that very lack of interest
that creates the values from which a bull market can take root.
Another red flag for the market is the fact that volume has been much lighter on
the rally than it was during the decline. So, while the market feels and acts great,
and we are sad to be missing out, we are still pretty bearish and expect that the
market will make new lows, and would not be shocked to see this happen by the
end of the year. We believe that the next couple of weeks will be important as
the market is very volatile and stuck in a trading range (8200-8500 on the Dow
Jones) where a break either way would probably cause a pretty good move in the
market. Keep in mind that a breakout either way (to the upside or downside)
without follow-through (a.k.a. a “false” break) would also be a significant data
point.
In addition, there are some very interesting divergences in the markets, which
may be indicative of some future trends/themes. A good information source of
ours, floated the idea that there is an ongoing early-stage bifurcation occurring
between asset classes, with those that are oversupplied and typically
overleveraged (like commercial real estate) plunging (we recently took a short
position in IYR a real estate ETF), and those that are not leveraged and not
oversupplied, like oil and wheat...oh, and gold...going up. This concept is
supported by the charts of major global markets, and it could be explained by the
fact that even though there is not enough money yet created relative to what was
destroyed to cause leveraged assets to rise, people are still willing to make
advance bets against the future point at which enough, and then naturally... too
much, money would be created. So, people flee the dollar for inflation hedges as
they watch the USA shift hard left with an associated monetary/fiscal package
sure to damn the native currency...In the meantime, cash starved over-levered
real estate and corporate and personal assets will continue to deflate for the
foreseeable future. And of course, rising interest rates won’t help either. Many
talk of deflation, but most talk about the coming inflation and that is more or less
a foregone conclusion. It is as if deflation doesn’t have a chance, and in the
“black swan” school, this is interesting in and of itself.
As of this writing, we are looking to add to our dollar short exposure, either
through continued purchasing of select foreign currencies, and/or gold related
assets. In addition, we remain watchful of the bond market and continue to see
the short side in Treasury bonds as one of great opportunity. We will watch the
market the next few weeks to see if we will be standing pat or shorting more, or
possibly covering to minimize potential future losses, and we will be watching the bifurcation theme to identify outperforming sectors such as commodities and selected currencies.
Wednesday, January 6, 2010
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