Juggling Dynamite

Valuable investment management is simple but not easy. The investment world is full of hares that seem at times, to be sprinting ahead at breakneck speed. And in a world of short attention spans and systemic impatience, hares often attract great interest.
But the thing is this. In the long and medium run, it is humble turtles that win the money race. Turtles win by collecting steady, low risk gains, not losing capital and sticking to their buy and sell discipline in good markets and in bad.
Like the Tech funds managers before them, from 2003-2007, hedge fund managers attracted enormous capital and adoration. As commodity markets went parabolic, those “genius” enough to keep playing them were proclaimed prolific. And now we come full circle.
In the down cycle that began last October, high risk managers have been falling on their swords. Hedge funds that once sprinted on ahead are now trying to quietly close their doors. This is a very old story. The managers are sorry and bow their heads. The leverage that was a wonder drug in the bull market becomes a lethal potion in bears.
This week the next “surprising” casualty is the demise of the once exalted Ospraie Fund, the flagship fund of Ospraie Management, the commodities-focused money manager. Having lost nearly 39% of its value this year — or almost $1.3 billion, with more than half of that in August alone — the fund is being wound down. No longer pushing for returns on their money, investors are now hoping for just the return of some of their money. For several years Ospraie enjoyed a solid reputation. It appears they have been hurt by the rapid fall in resource companies, particularly in energy and mining. Apparently they have been taken unaware.
“That such a large, experienced fund manager was tripped up doesn't bode well for many others who have crowded into the commodities bull market.”
See WSJ: What Ospraie taught us.
Meanwhile in the category of “I wouldn’t be surprised” comes this story today in the WSJ: Oil supply data probed for manipulation. Park prediction: next will come a wave of managers and investors who will claim that they are not responsible for big losses to capital, because they relied on other people’s data to make their bullish bets. Cue the lawyers.
Away from the thunder and the fray, we turtles will methodically and humbly continue to advance.

For the year to date through August, equity markets worldwide fell an average of 23%, with U.S. markets down an average of 10% (Standard & Poor’s). All 26 markets in developed countries were down an average of 23%, and markets in 24 of the 26 emerging countries fell an average of 18%. The Canadian Venture Composite was down 30%. Jordan (+11%) and Morocco (+10%) were the exceptions.
The entire S&P 500 dropped 13% for 2008 through the end of August, with 343 stocks declining and 153 gaining. All 10 sectors in the S&P 500 were down, with
financials (-27%) falling the most, followed by telecommunications (-22%). Consumer staples did the best, (-3.2%), followed by materials (-6.7%), consumer discretionary
(-7.4%), health care (-7.6%) and energy (-7.8%).
These results refute once again, the myth that there is safety in spreading equity capital around the world in a bear market. It also demonstrates why buying “defensive stocks” in a bear market is also a fool's play. All boats fall in bear markets. Saying you lost less of your savings than others, should be poor comfort.
But here is the next big issue that markets will have to face going forward: according to data compiled by S&P, analysts are predicting 2.4% y/y earnings growth for Q3, then a surge to a record 62% in Q4 and 27% for 2009. The probability of getting this type of record earnings growth over the next couple of quarters is low to nil in my humble view.
I accept that I don't know much about the future. All we have is common sense and rational probabilities to calculate. But with the present Price to Earnings ratio of the S&P 500 already at an extremely lofty 26 times reported profits, (highest in 5 years, third highest in history) and the “E” in that equation risking more compression over the coming months, stock prices here must be clinging to a very rickety rung of hope.
Buyers and holders beware. You buy the “long always” party line from your broker/dealer/mut fund companies at great personal risk.

US$ bears can wring their hands and forecast doom all they like, but the chart of the US $ over the past 6 months should silence its critics:

Meanwhile in the mirror opposite direction, commodities of all stripes and the Canadian dollar are tumbling as they must, down, down, down.
Much hope has been laid at the feet of China and India over the past five years; hope was that their enormous populations would fuel enough demand to abolish the business cycle and carry the global economy indefinitely. In Canada this hope became widely held optimism that our economy would continue to expand by selling our exports to Asia notwithstanding the contraction in western world demand. Central to this thesis, was the argument that the centre of the demand boom, over the past few years, has been Asia.
But the centre of the 2002-2007 boom never was Asia. With a national savings rate at 35% of its GDP, Chinese domestic consumption is the lowest of any economy in modern times. In fact, per capita, western consumers in Europe and North America have historically been 10 times better at consuming than China and India. At best, China is a country of consumers in training. So far most are still concerned with basic necessities like food, shelter and personal security.
Asia merely aided and abetted this late-great-boom, giving the world tons of cheap finished products. The epicentre of the super-demand was western consumption fuelled by 50-year-lows in interest rates, insane lending and mindless spending. Now that all the major western economies are slumping, consumers are putting on much needed brakes.
As I have said for the past couple of years, a major support to commodities and the Canadian dollar has been the falling U$ over the past 7 years. Commodity bulls that insisted parabolic price spikes were justified by demand from Asia are finding out the hard way that “hope” is a four letter word.
The rest of the world is now realizing that they too have been mesmerised by the consumption dance. All over consumers are faltering, economies are weakening and de-levering is quickening the pace of decline.
Since few countries are fiscally solid, or prepared for this slow-down, realization dawns that if the US is in trouble, the rest of the world’s smaller economies will likely suffer even more.
Whether the US dollar will enter another weakening cycle in the time ahead is a point open for debate. In the meantime though, its trend is decidedly up. Bears beware.