I apologize for not posting my thoughts on Fed's latest move earlier, but I wanted to finish reading Greenspan's new book to understand a bit better the mind of one of the history's greatest central bankers. I started reading it on Monday night and after the first 50 pages I realized that Greenspan is even better than many people give him credit for. I have personally criticized him numerous times for his aggressive monetary policy moves, and still think that he might have been a bit too accommodative but I understand his rationale a lot better now.

Greenspan was able to correctly calculate that his otherwise overly aggressive support for the economy would be offset by the deflationary pressures from various events throughout his reign at the Fed (example millions of new entrants entering the workforce across the globe after the fall of the Soviet Block, unprecedented productivity increases driven by IT revolution of the 90s etc). However, one of the most chilling revelations of this book is that he now too believes that most of these deflationary pressures are now thing of the past and that the new Fed faces challenges that he never had to face- most of the same deflationary events have turned the other way now- productivity is slowing, salaries are rising dramatically across the globe, "weak dollar" is leading to higher imported inflation etc.

He stated (before the cut Tuesday by the way) that US will be facing higher interest rates and inflation in the years to come. I happen to agree with him a 100%, and think that the decision by the "Bernanke Fed" will lead to the most unwanted outcome- significantly higher inflation in the years to come without really supporting economic growth. I have outlined my logic in the previous posts.

Now instead of trying to further rationalize yesterday's move by the Fed, I will now simply try to point which sectors I think will benefit from the cut and how to best take advantage of the situation.

Here are the actions I took yesterday immediately following the move:

Sold my "insurance" ultra short picks- TWM, SDS, QID for a small loss (they were all in green on Monday so the overall loss was miniscule); Sold PEG (utility play) and NDAQ (Nasdaq) with double digit gains. Both of my sub prime "non junk" ( sorry Andrew- great post on your part but I certainly think rational people would agree that IMH, NFI and LUM are riskier than IMB and CFC which their moves to cancel the dividend only confirm :)) picks did very well with a double digit gains over the last few days, and I expect to sell them in the next few days as the "Fed fever" wears off. I would have probably sold early this morning but was away from the computer at the time ( I need to become a full time investment manager I guess :))

Now here is the punch line- we have been dealt a deck of cards by the Fed - not exactly what we wanted but that does not mean that the world is over. I still think that US will end up in recession in the next 12-18 months but this outcome has been delayed by a few more quarters. So here is the composition of my new portfolio and quick rationale for them:

The markets that will benefit the most from the cut are emerging markets for several reasons- they are a lot more dependent on commodities that will run up with spike in inflation and will also benefit from the reverse flight away from quality that lower rates entail. So I picked the country that could be considered a definition of the commodity market- Russia and picked the sector with one of the highest Betas- telecom. Two largest players are Vimpelcom and MTS- they control majority of the cell phone market and have been great money makers for me in the past. Neither one of them is particularly cheap at this time but I am hoping to score some gains as Russian Rouble rallies against the dollar in the next 3 months. So here we come- VIP and MBT both at 9.5%.

Next pick- technology play- NVDA- looks a little overextended here but it is hard to win this contest competing against high Beta portfolio loaded with technology plays that are predominately momentum driven. Today momentum favors Large Cap Growth stocks and thus if it lasts until December -those pure bet portfolios could win by simply being at the right place at the right time...NVDA in with a 9.5% position.

My next pick here is NXG- contrarian beaten up commodity play- I've made a lot of money on this stock before and think that the "permit decline" sell-off has been overdone. I might even double down if situation unfolds the right way.

My strategy with DFC and FMT will be purely data driven and those two are subject to sell at anytime. I am expecting more gains from these picks but will monitory situation closely to make sure I get out before it's too late.

CHNG and FSIN are both Chinese value plays and do not seems to be correlated to anything or any particular even so I will keep them on tight leash with limits in place to reduce positions with double digit gains.

DHIL- looking to sell above $84 for a nice gain.

P.S. I promised not to question Fed but here it comes-still can't believe that did they get comfortable with a fact that inflation is still so disturbingly high:
•Food prices have been rising at an annual rate of 5.6% vs. 2.1% increase for all of 2006
•Overall inflation is rising at an annual rate of 3.7% , up from a 2.5% increase for all of 2006
•Energy prices are up at 12.7 % annual rate this year, even with the declines in the past three months and that's before prices hit $80+ per barrel recently
•Medical costs are up 4.5 percent over the past year
•Core inflation rising at an annual rate of 2.3 percent through August, down from an increase of 2.6 percent for all of 2006 but still way above the 1-2% comfort corridor

Now done, more thoughts on this later
Trade safe and cheers,
Vad

Comments: View Comments |  Wednesday September 19, 2007  |  Stocks: CFC, CHNG, DFC, DHIL, FMT, FSIN, IMG, IMH, LUM, NDAQ, NFI, NVDA, NXG, PEG, QID, SDS, TWM,

"Recession is when your neighbor loses his job. Depression is when you lose yours."
Ronald Reagan

I think that tomorrow's meeting could determine which one of the above we might end up facing here in the United States in the next 12-18 months...It might sound a bit dramatic and many people out there will probably question my judgment for making statements like this but, oh well, I am not running up for reelection which is why I can state what I think and not what other people want to hear. Here is my rationale:

Fed's job to me is composed by two objectives:
1. Primary objective- achieving price stability
2. Secondary objective-helping economy to achieve its full growth potential

Now let's assume we are stepping into Ben's shoes for a few minutes- we are faced with many choices and none of them are perfect:

"Choice 1"- By cutting rates dramatically in the next few months, the secondary objective ("growth") could be fulfilled (at least in the short term). But in this case inflation problem is going to be become a real issue. Commodities will receive additional support from the expectation of rejuvenated growth; speculators are going to bet on further rate cuts which in turn might push existing bubbles (ex. commercial real estate prices) even higher; dollar should lose even more ground which would in turn again increase import prices. Combined all of these and many other issues and we could see significant inflation pressures in the short term, which would eventually again lead to another series of rate hikes, followed by what could become a prolonged period of real stagflation or depression (high inflation-low growth)

"Choice 2"- Fed could cut rates by 25BP max, with a statement that tells everyone that are no more cuts in the "wizards" sleeve for a while, or may be no cuts at all for now. That move would likely lead markets to drop significantly with commodities, financials and emerging markets falling harder than others. Many more bankruptcies in the financial sector would be likely, commodities should slump and thus recession would come faster than in other scenarios but it would also likely not to be as lengthy, because all the current excesses would be shaken off very rapidly. To sum it up - this scenario is likely to achieves the primary objective- inflation will be destroyed but will also reduce short term growth and likely to lead to higher unemployment faster than other scenarios.

"Choice 3" or "2A"- Fed cuts rates by 25BP on Tuesday with some additional "styling" on top of it- may be something like additional cuts in the discount rate or statements in support of increasing caps of Fanny and Freddie. Market should sell off again but not as heavily as in "Choice 2". But inflation expectation should not spike as high as in "Choice 1" and who knows may be even the indication that Fed is taking at least some proactive action will improve liquidity to more acceptable levels, which should support US economy for a few more quarters. However, given all the accumulated excesses in the world's markets- real estate bubbles throughout the world, Chinese high fever/unsustainable growth, yet unexposed bad loan problems etc that are just starting to blow all around the world will still force the economy into recession. Whether this recession will be as lengthy as in "Choice 1" is unclear at this point.

"Choice 4" - Fed believes that the economy can weather all the storms and that strength of the IT and Industrial sectors of the economy and strong exports growth combined with always "trigger happy" free spending consumers will carry the US economy out of any slowdown in growth. In this case no cuts are necessary- while this scenario could be possible I would assign a very low probability of this actually happening- no more than 20% or so...

I am great believer in "invisible hand of the market" that is why I would make a "Choice 2". It is very likely that recession will be here one way or another in the next 12-18 months- the question is-which route will the Fed take? Just think of US economy as a patient with cancerous tumor ("inflation") in one lung that has been treated with chemotherapy ("rate hikes"). Patient's wife ("general public") tells the doctor ("Fed") that based on what her friends and neighbors ("politicians") are telling her- it's not a big deal and this time it will be different. Doctor ("Fed") tells her that the he is not sure that the decease has been completely cured and thus he recommends continuing the treatment ("Holding rates steady") because he needs to monitor the patient a little longer before making judgements whether cancer is gone. Now wife can listen to friends and neighbors (who's expertise in medicine is just great as in monetary policy matters) and risk being back in the hospital within the next few years with a tumor in the second lung, or she could leave doctor alone and let him do his job.

Now if you were faced with this situation would you consciously make a choice of ignoring the doctor's advice and having the cancer come back with potentially lethal consequences or would you ignore the politicians and make your own decision?

P.S. If I had a hundred PhD staffers armed with most recent data points, we could probably quantify a little better what the implications of most likely scenarios could be. But just on the surface while Scenario 3 is probably most likely to occur due to political and market pressures, I would personally go with Scenario 2.

P.S.S. Anyway, enough talk for now- here what I did on Friday to prepare for Tuesday- I took some profits off the table from the expected pre Fed- sub prime rally and bought two sub prime relative underperformers- FMT and DFC both are now at roughly 10% of my portfolio. To hedge the downside I have also entered into positions that I rarely take- ultra short ones- those should offset possible downside volatility -QID, TWM and SNM. I hope principles will win over style on Tuesday but you can never be sure... Better safe than sorry.

Trade safe and cheers,
Vad

Comments: View Comments |  Monday September 17, 2007

"In matters of style swim with the current, in matters of principle-stand like a rock"
Thomas Jefferson

I think the next few weeks will determine the direction of where the world largest economy will be heading for the next few years. If you read most of the mainstream press it sounds like this direction is clear- series of rate cuts, followed by shallow recession and bright future. Not so fast...It's definitely easy to be a politician and make it look like all of the world's economic problems could be magically wiped off the face of the Earth by a swift downward hand movement by a wizard called Ben Bernanke...

The truth, as usual, is that popular opinions always swing too far. Rate cuts are rarely followed by a period of short term market out performance and thus problems will not just simply go away. What's more in most recent rate cut cycles the decisions when to start cutting were relatively simple (9.11, debt crisis etc) and most of the time were on target. The more difficult decision is when to stop cutting rates and that's were we might've had less success with the outcome- at least some of the current problems are due to what many believe was one of the few mistakes Alan Greenspan has made- cutting rates too low.

This time Ben's decision is neither easy nor warranted by a consistent pool of homogenous data. There wasn't a major stock market crash(10% is decline is merely a correction), corporate earnings are still climbing (albeit very slowly). What's more oil has just hit a new all time high today, copper is pushing multi months highs, wheat is at all time high as well. Inflation overall is still stubbornly high and is above or in the higher range of the desired 1-2% corridor; dollar is pushing all time lows against the euro, Chinese bubble is only getting fluffier every day, rents are still climbing, consumers are still spending... So in short the data for a significant series of rate cuts is not there ( I do anticipate that recession is likely to occur in the next 12-18 months one way or another)

The question now is whether all of the above is just a lagging indicator of the irrational behavior from the excesses of the last five years. Liquidity struggles of the last six weeks have not yet been resolved completely even though normality is slowly coming back into the financial system. So the real issue is whether Ben is going to bow under pressure and will swim with the current of the "cutting mood" or will he acknowledge that maintaining price stability is the most important role that Fed plays and that buckling under popular pressure is the easiest way for introducing unnecessary volatility and excesses into the otherwise well functioning Economic machine. Inflation beast has not been defeated yet and until it happens everything else (growth or unemployment) is less relevant

Playing with size of Cap of Freddie's and Fannie's mortgage portfolios, accepting new forms of collateral for the Repo agreements as well as introducing new regulation into the lending world are purely matters of style and thus in this case my advice for Ben would be to swim with the current. Let politicians have their time in the light- it's not worth fighting over.

However maintaining price stability IS the matter of PRINCIPLE and standing like a rock is the only appropriate stance that Ben Bernanke should take.

Now going back to business- as I said before my expectation that Fed while could cut rates (25BP) next week but I would expect that the screamers could be disappointed that the cuts don't go far enough and the overall market will sell off. Thus while I still have some Rate cut exposure (subprime) I am repositioning it into slightly lower volatility picks- I sold NFI (double digit gain) and IMB (small gain) today and replaced them with CFC and FMT.

Both of my new picks have deviated from the overall Subprime group in the last few days and now it is time to regress back to the mean again.

P.S. Oil is getting frothier by the day and I think absent major supply shocks in the form of the hurricane or a terrorist act we are up for a significant correction in the next few months...

Trade safe and cheers,
Vad

Comments: View Comments |  Wednesday September 12, 2007

"Nobody rises to low expectations"

One of the key principles that I found to work for me in investing is to be flexible at all times. I make statements or investments that I believe to be correct at the time but once situation changes I have to act quickly and thus I frequently modify my recent opinions/trades as new information becomes available.

For example I believe that current market expectations for a significant (50BP) cut next week are greatly exaggerated. The are several reasons to think so- but the main one is that I believe that as a good and competent economist Bernanke is primarily focused on keeping inflation low and thus until data shows that inflation fight is over he won't make his move.

It is way too early to state that fight is over- prices of various commodities are still hitting new all time highs, unemployment is at multi year lows, food inflation has not yet slowed significantly. Yes housing prices are down slightly but has it become any cheaper to rent an apartment, which is I think by the way a more reliable indicator for shelter related portion of inflation? I don't see that yet in the data quite yet.

Certainly we would expect there is always some lag between monetary action and economic performance. So I guess if one believes that all signs are pointing to zero economic growth in the 1st quarter 2008 (I think it is possible that happens) may be Fed should act during the next meeting? May be they will- but I expect the cut (if there is one) will be minimal -25BPs with a statement that while economy has slowed considerably it is still expanding. I also think that Fed under Bernanke will be more patient than it was under Greenspan and thus over time market expectations of swift cuts will decline which will probably result in lower overall willingness to risk taking by more speculative market players.

What does it all mean? Here is what I am doing- first of all I am avoiding jumping too heavily on the materials/oil and gas bandwagon. As they say "Every bull market has a copper roof". Copper is ripe for a significant correction as new capacity comes on board. I also think that $75 per barrel of oil price is not sustainable long term, but I alos don't believe that market is pricing it that way in O&G stocks anyway; prices probably reflect something closer to $50-60 right now. Absent some significant supply shock I think that price is $10-15 too high. That means that while there are some opportunities out there in the O&G sector- I would expect the sector overall to move inline with the rest of the market or even underperform slightly...

I think the two sectors that will outperform in the next 12 months are IT and Healthcare. Not all healthcare or IT is the same though. I am not so keen on jumping onto Apple or RIMM bandwagon like many other contesters in SLO challenge. Both are great companies that will be successful long term but way too expensive at this point. I think AAPL made a huge mistake of releasing the iPhone exclusively with AT&T and will pay for that in the short term. Edge network is so lame that it is not even funny... iPod touch is going to be hot, I know I will buy one, but it won't make up for slowing growth of regular iPods- it is harder to grow of higher base but at this price market expect the growth to continue... GRMN on the other hand is a great company that will benefit from the overall GPS craze this Christmas and thus I think it will outperform both AAPL and RIMM in the next 12 months.

Anyway here we go my favorite topic again-"Subprime lenders" - this sector is going to be the main beneficiary of what I expect the Fed related expectations are today. I do think that a few more companies could go bankrupt- one of my current holdings- NFI could very well be one of them, but I don't that will happen before the end of September. If Fed does make a move- I expect more volatile sub prime lenders (NFI, FMT, DFC, IMH) to make double digit moves up, if Fed does not move- there isn't much downside for the overall sector due to what I expect would be consolidation expectations.

However one should be careful when buying those- my advice is to only buy the relative weakness in this sector for now- for example, the reason I bought NFI and IMB last week was that both stocks declined in high double digits while the rest of the sector stayed in single digits? Is the Subprime problem company specific? I don't think so and thus such a large price discrepancy in a short period of time is not warranted regardless of company specific announcements unless they are Bankruptcy related. I doubled down early Friday when both IMB and NFI gapped down- the result is that both positions are in black again.

Will I wait for the Fed to act? I am not sure at this point, however, I think there will be at least one suprime rally prior to the announcement- if it satisfies my double digit requirement for taking so much risk I will sell without looking back.

To sum it up- "Vad's short term recipe" to play the Fed- "Buy most beaten subprime lenders on a day of heavy weakness/double digit declines. Don't be afraid to double down once or twice but also be careful -don't overload the portfolio because ALL of them, except may be the bigger ones like CFC, TMA or IMB, are subject to going BK at any time. I don't think that will happen in September but better safe than sorry.

Trade safe and cheers,
Vad

Comments: View Comments |  Sunday September 9, 2007

"All happy families are alike, all the unhappy families are unhappy in their own way"

You might recognize this famous first sentence from a novel by Leo Tolstoy and ask how is it related to the SLO challenge blog? The answer is simple- I honestly believe that to be a successful investor you have to be more than just a PhD or a freshly minted MBA with a great looking resume. Being a truly great stock picker requires as much commitment as a successful marriage, it required recognition that no strategy is perfect at all times, it also requires ability to acknowledge and correct mistakes. Being intelligent is equally important to understanding that you will never be perfect. You know it is easy to claim that one is a great investor based on one particular lucky pick over an X period of time. We all know 75% of so called "great" fund managers can't even beat passive investment over longer period of time. I wonder if this is simply because most of them are claiming to be "different" and "special" while in reality most of them are missing at least one of the key ingredients for success.

I have a background that should theoretically one day make me a great portfolio manager- heavy math/economics background, double finance/accounting majors, all three CFA exams passed within 18 months, job related to valuation and risk tolerance that allows me to sleep well with my entire portfolio in few penny stocks.But I am still learning to become more consistent and tend to make common mistakes such as trading too frequently, taking profits too early and sticking with losers for too long. However as results from the last 5 years in Marketocracy and in this SLO contest show I am on the right track.

Last week I have made some moves that might have puzzled anyone who followed my portfolio. Even though at the beginning of the week I stated my intent to stick with safer bets for the remainder of the contest, after seeing both NFI and IMB sold off for three days in row I could not resist jumping back in the sub prime game. The good thing so far I've been correct again- even though DOW has sold off 250 points my portfolio has actually went up again, with most sub prime players going down NFI has bucked the trend and went up 8%...

Hopefully my current first position in SLO ranking will hold up all the way to December. I am willing to bet that a Top 5 finish will require no more than a 20% return as I am currently in the mild Bear camp. The goal for next week is to take some profits on both IMB and NFI assuming my scenario of Fed/Rate cut related event occurs.

Anyway thanks for reading and trade safe,
Vad

P.S. I will post my take on how one can benefit from Fed related frenzy in the next 24 hours

Comments: View Comments |  Saturday September 8, 2007

I can't resist the opportunity to take another position in beaten up lenders. Today's reaction of IMB in particular seems very peculiar to say the least. Home sales fell to lowest level in 6 years in July- what a surprise??? You know what, here is another projection- August sales will be even lower!!!

Selling VPHM for a 10% profit and LRCX for a 1% profit and reinvesting all proceeds into IMB...Will look to sell on next FED related action...

P.S. Sold WFR as well for a small loss- reinvesting all cash evenly into IMB and NFI for a roughly 15% position each.

Comments: View Comments |  Wednesday September 5, 2007

It is pretty amazing to be able to actually observe the laws of economics in real time. I think if I had an opportunity to dedicate enough time to economic research, I would set up my shop in Harare, hire a bunch of college GAs to collect data from all possible local sources and than would write a book on how to destroy the economy most efficiently.

I think Mr.Chavez should send some of his best officials over there to study the effects of the absurd economic policies in motion.
NY Times Article

P.S. I have used the opportunity to capture Bush-Bernanke bailout frenzy on Friday to reposition my portfolio and made it look a bit closer to what was originally intended.

I still think that overweighting at least one position to capture more Alpha in a relatively market neutral portfolio is a very sensible strategy. It worked for me well so far with NFI, LEND and DFR. So I doubled my stake in CHNG last week as a I think that private placement sell-off was overdone.

Cheers and trade safe,
Vad

Comments: View Comments |  Tuesday September 4, 2007