Strong Treasuries

Largely lost in the drama this week was the rally in long bonds. On Friday, 10 yr Treasury yields hit a new low for the move.

Technically, it appears that a two month head and shoulders pattern has resolved lower.

Bonds could be strong for a number of reasons. One is that bond market investors are not very concerned about a default or about a US credit rating downgrade (otherwise bonds would be selling off). Another is that investors are seeking safety in the midst of domestic and EU fiscal turmoil.

Of course, an alternative view is that domestic bond markets have been so manipulated that no interpretation is possible...

no positions

Trading MSFT

Have been getting long Microsoft (MSFT) for a trade. The stock trades 'dry,' meaning that the stock price remains firm even when the overall tape is weak.

If (when) a debt deal gets cut, then this stock seems a good candidate to lead things in any sort of 'relief rally' that might ensue.

First stop is about fifty cents higher at $28.50. If that is breached, then $30.25ish seems big resistance.

Because it's hard for me to trust 'em these days, odds are good that I'll be gone long before $30.25 comes into view...

position in MSFT

Hedge Fund Interview

Interesting profile in the New Yorker of Ray Dalio, founder and CEO of Bridgewater Associates. Bridgewater is the world's largest hedge fund operator with about $90 billion under management.

Old Age and Sovereign Debt Default

Interesting discussion of the negative relationship between the age of a country's population and propensity for sovereign debt default. What many people don't understand about sovereign debt is that it is usually unsecured, meaning that there is no collateral for lenders to claim if the borrower defaults. This is unlike other debt instruments such as mortgages or corporate bonds which are typically backed by real assets.

As such, lending to countries is pretty much dependent on the creditor's assessment of the borrower's ability, or perhaps more importantly the borrower's willingness, to pay.

It is likely that old age reduces willingness to pay. Paying back debt might cut into entitlements that older segments of the population enjoy, such as State provided health care and retirement benefits. People may be less willing to forego those benefits in lieu of using those economic resources to pay back loans.

If the country is too leveraged, however, then the point may be moot. Socialistic systems require ever more economic resources to keep the wheels on the wagon. Credit will be cut off, either thru default or by bond market shut down.

This is the central message of Reinhart and Rogoff (2009).

Reference

Reinhart, C.M. & Rogoff, K.S. 2009. This time is different: Eight centuries of financial folly. Princeton, NJ: Princeton University Press.

High Hedge Fund Cash Levels

Bloomberg reports that many large hedge funds have low net risk levels and high cash positions. For example, George Soros' Quantum Fund is carrying about 75% cash.

Many large hedgies are 'macro' funds, meaning that they allocate assets and trade on broad macroeconomic theses. Fund managers state that they have lowered risk levels because the macro picture is murky. On the one hand, growing debt problems around the world make for a bearish macro scenario. On the other hand, governments seem poised with vast interventionary resources, which may be bullish.

Keep in mind that the 'clarity' that hedgies currently seek may arrive at pretty much the same time for all. Expect some big moves if/when.

position in SPX

Gold Breaks Out

Pretty much lost in all of the theater this week is that gold marked another all time high this week. Very impressive, as it seemed that the late April high would not be surmounted, and weakness near the end of June suggested that a major break was imminent.

Because gold is essentially a bet on disorder (monetary, fiscal, social, etc.), there could be many interpretations as to 'why' the breakout right here. Most scenarios end with the argument that more money printing is likely.

Late last summer I initiated a position in SLV to exploit a breakout in silver wherein I added more shares as prices went higher. Such pyramid trades are usually not how I roll, but it can be an effective way to play a strong trending move while using higher prices to help manage risk.

In the next week I will be looking for entry points in both GLD and SLV using a pyramid design.

position in GLD

A Bubble in AAA Ratings?

Wow, this observation really struck me. From 1990 to 2009, assets with the highest credit rating increased from 20% of all fixed income to 55%. Sovereign debt comprises more than half of all AAA.

This bids an obvious question. In a world where debt and leverage have been dramatically increasing, how is it that more than half of all fixed income can be stamped as essentially risk free?

Perhaps we have outsourced our brains to the ratings agencies.

Charting S&P Downside Levels

Starting to wonder whether the SPX might not have a date with 1000-1025. Near term support remains 1250ish, which coincides with the uptrend line off the March 2009 lines as well as the 50 day moving average on a weekly basis.

If support at 1250 is broken, then significant support does not come into play until the 1000-1025 area.

Such a level would also correspond to a near perfect 50% fibonacci retracement of the current uptrend.

Do prices have to migrate this way? No way, cookie. Macro winds could blow bullish and the tape could sail higher.

Should things get going to the downside, however, the 1000-1025 level seems a plausible landing zone from a technical standpoint.

position in SPX

Fed Hints of QE3

While speaking to Congress today, Fed chair Ben Bernanke stated that the Fed is prepared to inject additional stimulus should economic conditions warrant. QE3 anyone?

Those words were barely out of his mouth before domestic markets ramped higher by 1% or so.

Exuberance dwindled as the day wore on, however. By the close, major indexes sported a bearish whisker on the candlestick charts. The SPX is once again sitting on its 50 day moving average.

Perhaps it dawned on market participants that further economic weakness will likely be necessary before the Fed can engage in more money printing.

The market continues to act like an addict, perking up at signs of another fix, and fading when prosects of another fix dwindle.

position in SPX

Leverage

Leverage is borrowing funds (i.e., using debt) to magnify potential returns. Of course, risk is also magnified when using leverage.

Nice article that explains the two edged sword of leverage and some ways to leverage in a portfolio.

Italy's Turn

Today it's Italy's turn to take the stage in the EU mess. Chatter has it that Italy's finance minister, who is among the most respected financial minds in Europe, is thinking of stepping down. If he does so, then we may see more fireworks if markets express a vote of 'no confidence.'

position in SPX

Weak Payroll Number

Hard to see much good in today's surprisingly weak payroll number. That may not stop the bulls from drinking it pretty, however.

Bulls will likely suggest that weak job reports like this one 'demand' more stimulus from the government.

Quite convenient thinking--given the recent end of QE2.

position in SPX

ECB Changes the Rules

After Tuesday's downgrade of Portuguese debt by Moody's, the European Central Bank (ECB) today said that it will suspend minimum collateral rules for Portuguese debt in ECB refinancing operations.

A lender's axiom is that borrowers deemed to be greater credit risks must put up more collateral.

As a result of the debt downgrade, ECB rules dictated that Portugal should now be seen as a greater credit risk and must put up more collateral in order to refinance debt. Unfortunately, more collateral is something that Portugal doesn't have.

Facing an inconveient situation, the ECB did the bureaucratic thing. It changed the rules.

Portuguese Debt Downgrade

Well the years start coming and they don't stop coming
Fed to the rules and I hit the ground running
Didn't make sense not to live for fun
Your brain gets smart but your head gets dumb
--Smash Mouth

Yesterday Moody's took Portuguese debt down four notches to junk status. Chatter getting loud on Ireland as well.

Not sure how much longer the EU's pop up blockers can mitigate the debt virus...

Pondering a Failing Rally

After it became apparent that Greece would not immediate come apart, stock markets sprinted higher over the past week to the tune of about 5%.

Commensurately, bonds have sold off, suggesting that much of the recent action has been courtesy of asset allocators rotating out of bonds and into stocks.

Is this move durable? Certainly possible. But my sense is that we could be witnessing a 'failing rally' here. Short covering, relief that the EU is still together (for at least a few more days), and a little 'Hawthorne effect' as QE2 comes to an end.

Nothing substantial has occured to lift the macro concerns. In fact, the forces behind those macro concerns continue to intensify. Moreover, sentiment, which was getting a tad too bearish in the near term, has dramatically shifted toward the giddy end of the spectrum in just a few days.

Risk management seems to have joined the crowd headed to the Hamptons on holiday.

As such, I want to use prices to my advantage on any continuation of this rally. This means letting go of more long exposure and looking for nice entries for additional short exposure.

position in SPX

Personal Asset Allocation Update

Current personal liquid financial asset allocation as we head into the second half of the year. (Haile Fund AA can be found here)

cash 60%

equities 21%

alternative assets 15%

fixed income 4%

Alternative assets include short equity 11% and commodities 4%. Fixed income is short duration.

21% equities + 4% commodities - 11% short equities = 14% net long risky assets