Saturday, December 9, 2006

November 2006 Review and a Volatile World


Our eleventh month of trading ended up strongly with a positive return of 1.77%, our best monthly number since inception as a result of some well-timed trades in the currencies. We like to think this bodes well for the holiday season and hopefully none of our clients’ children will be left without presents due to poor performance!

Jokes aside, market conditions and perceptions continue to diverge from the reality embedded in the economic data that is doled out each week. At the very least the data picture is mixed with the ISM Manufacturing number, released on December 1st, unexpectedly shrinking for the first time in more than three years, while the ISM Non-Manufacturing report, released December 5th and which reflects activity in the service sector, showing evidence that US economic growth was not slowing.

The various business news outlets are also emitting conflicting interpretations on economic data. Take a look at on November 29th and the spin is decidedly favorable. In an article entitled “Better Than It Seemed,” the author writes positively “Fed Chairman Ben Bernanke may be on to something. A day after he indicated the U.S. economy was stronger than investors appeared to think, government data arrived to support his argument.” This is posited on the same day Bloomberg reports that “The U.S. economy may head into 2007 in weaker-than-expected shape after reports showed October new-home sales fell for the first time in three months and stockpiles at companies jumped last quarter.”

Who is right? I guess it depends if you are looking at the stock market or the bond market, or how deep you want to dive below the headline numbers to get at the economic undercurrent. Either way, in our opinion more and more evidence seems to validate our long held idea of a substantial slowdown (that is, recession) in 2007. At the very least it would seem to indicate a cyclical peak in corporate earnings. Not only are economic statistics pointing in that direction but it would seem that even the inside corporate players, the ones supposedly with the best knowledge of future profitability of their corporations, are also beginning to be heavy sellers.

In the meantime, world headlines are filled with negative stories: a civil war brewing in Iraq (at least according to one channel I watch), ever growing current account deficit financed by China and oil exporters, and continued rumblings about the supply of energy from Russia. Yet in this volatile and risky world investors in the equity markets will point to soaring oil prices and a nuclear test by North Korea as “exogenous events” which the markets have barely responded, and then blithely focus their attention on mega mergers and private equity acquisitions that are taking place.

The result is that S&P 500 options have only priced in a 1% move up or down over the next month. Yet, markets have never been good at spotting and pricing political risks and at some point expectations of low volatility will turn out to be wrong.

I would argue that the massive complacency of market players, measured by one of the lowest level of volatility (VIX) in more than 10 years, is certainly misplaced. The bond market seems a bit more worried about future growth and so are forex players who have pushed the dollars to new lows for the year. Gold is following a proven inverse correlation to the greenback as it becomes more apparent that no matter who is going to be right, the bullish pro-growth camp or the bearish recessionary club, that should be negative for the currency of the world (USD) and a solid, yellow hedge (gold) may be in order. Certainly the Chinese, the Arabs and the Russians (when they are not too busy poisoning or shooting anyone who doesn’t see it their way) have all indicated a desire to diversify their foreign reserves away from the dollar.

Should a recession indeed occur next year and possibly weaken crude oil and other energy sources, I would view such a price break as a great opportunity to accumulate serious positions. After all, over the long term the world demand of more and more of a commodity of which there is less and less of is normally a characteristic of a buyer’s market… at least until we find out how to use anti-matter like they do on Star Trek.

Overall my investment tactics don’t change: look for cracks in the thesis of the majority, use common sense, diversify your plays.


-Davide Accomazzo, Managing Director

Thursday, December 7, 2006

The Lore and Legend of the Bulls and Bears

“Nothing is more admirable than the fortitude with which millionaires tolerate the disadvantages of their wealth.”
— Rex Stout, Mystery Novelist (1886-1975)

After gold was discovered at Sutter’s Mill in California, instant wealth was for the taking and all across America men made the decision to go west. Many sought and some found fortune in a camp called Hangtown, which at that time rivaled San Francisco.

Among the diversions sought by the miners on a Sunday afternoon was the bullfight that had long been a part of California’s development under Mexican rule. The bullfight, which had been introduced to Spain by the Moors in the 11th century, was brought to Mexico by the Spanish and was part of the fiesta held regularly at the mission-presidio complexes established between 1536 and 1832. The Mexicans added a wrinkle of their own by arranging fights between Spanish bulls, first brought to the new world by Columbus, and the native grizzly bear that roamed the California coast.

The Spanish longhorn cattle were brought to Mexico in quantity in 1521 and virtually ran wild until Texas became a state in 1845. The longhorn had a keenly developed sense of survival and often encountered the grizzly in the wild.

The game that entertained the miners in Hangtown was to chain a 1,000-pound grizzly to a huge stake in the middle of an arena and then turn the bull into the same arena. The fights were short and violent with the bull sometimes winning by impaling the bear, but mostly the bear won by meeting the charge between the horns and using his enormous paws to wrestle the 1,500-pound bull down to the ground, often breaking its neck in the process.

Since the gold discoveries created a flood of trading in mining shares, both in San Francisco and New York the terms “bull” and “bear” were introduced in the investment jargon to describe opponents in setting market direction. The analogy had been used before by the Spanish writer Don José de la Vega in 1688, but the active Civil War markets established the terms for all time.

The first person to be called a bear or bull was Jacob Little, who made his mark by introducing short selling in the panic of 1837. He made and lost four fortunes in the years that preceded the Civil War and was dubbed “The Little Bear” by fellow traders. One time he escaped a corner in Erie Railroad by buying convertible bonds that had been sold in England, unbeknown to the bulls, and he converted the bonds to cover his short position.

The two combatants that focused the terms for all time were the bear, Daniel Drew, and the bull, Cornelius Vanderbilt. The analogy fit perfectly the gigantic struggles between these two titans that went on for 30 years over steamboats and railroads.

Vanderbilt was as straightforward and optimistic as a bull, while Drew was devious, without scruples, and always trying to wrestle the market lower. These two bumped heads continually with a fight over Harlem Railroad during the Civil War producing a typical encounter.

Vanderbilt had been accumulating shares of the road for a number of years and introduced improvements to the line. Uncle Daniel was attracted when the stock started to move and joined in the buying to give the price an artificial boost from $8 to $100. He then cooperated with the politician “Boss” Tweed to mount a massive bear attack on the road. They went heavily short the stock, and Tweed used his influence to get Harlem’s right-of-way rescinded.

Vanderbilt let them “operate” until the stock dropped to $72. They had sold 137,000 shares, even though only 110,000 shares were outstanding. Vanderbilt then began soaking up the shares held by others and advanced the price to $179, forcing the bears to terms with the Commodore.

But then Drew attacked again, selling the stock down to $100 before Vanderbilt began to squeeze again. He raised the price to $285 and offered to settle again. Drew, hat in hand, pleaded with the Commodore and was finally excused with a $500,000 loss.

Vanderbilt advised Drew, “After this, never sell what you haven’t got, Dannie.” Which prompted Dan’l to compose his famous couplet, “He who sells what isn’t his’n, must buy it back or go to prison.”

In the gold camps, the bear defeated the bull in most fair fights. On Wall Street, the smart money follows the bull. Daniel Drew died broke, unable even to fulfill pledges to his church (he was short there too!), while Commodore Vanderbilt left his son William a fortune of $80 million——the only son he didn't disowned because he was as ruthless in business as his father and the one Cornelius believed capable of maintaining the business empire.

- Mack Frankfurter, Managing Director