Monday, December 01, 2008

The Bubba Call

“If you have a deflationary shock, the only instrument that will perform will be government debt,” said Hendry, 39, whose Eclectica Fund returned 38 percent this year, putting it in the top 1 percent of 1,817 funds tracked by Bloomberg. “Inflation is going to be back some day. But forget the next 12 years; it’s the next 12 months that matter.”

So, the Call is to keep the majority of powder dry, focusing on short term government bonds including munis, and start looking for well managed corporate bond funds. Bond prices have effectively priced in a once in a century default rate and look attractive. We have time to find the right funds. Build a position in gold, slowly, through the deflationary cycle ahead. For the same reasons TIPS are looking interesting - if we are looking for the 10yr to bottom at 2.50%, we are almost there. The amount of monetary stimulus, WW, coming over the next 12 months almost guarantees big inflation and currency stability concerns in the long run.

More bank write offs are coming from credit card, commercial RE and corporate loan defaults, a potential full nationalization of banks is ahead of us, plus we have potential sovereign defaults as well. Credit has been shut off to the US consumer; the delevering process is less than half way finished. The WW slowdown is massive and moving very quickly, and there is little central banks can do about it. We are winding down an unsustainable system based on debt (and fiat currency) that took more than 30 years to build. This will take time.

Within this backdrop of deep concern for the global economy and global markets, we are beginning to see a few positive signs - mainly that the Fed's latest moves are making a difference in market liquidity. With the return of liquidity comes the chance to avert insolvency and default for the better companies.

I am hoping this can make the case for a sizable rally. Historically, bear markets have provided some juicy 30-50% rallies amidst the destruction. I am looking for the seeds of hope that could put together a big move. So far, the flow of information continues to be overwhelmingly bad and so rallies have simply fizzled.

But if you are like me, and you can't help yourself and want a little trading action (death by a thousand cuts), then starting around this level seems like a good entry point for long positions. Stay away from banks, use broad, liquid index ETF's (DIA, SPY, etc) and I recommend stops. With daily volatility of 5-10%, expect to get taken out of positions frequently when using stops. It will be frustrating. Of course, we may look back and realize that there was a trade at this point, only it was to be short the market...


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