Performance Aug 2008

Performance in August was good. It was my third consecutive month of positive returns. I am trying to improve the consistency of my performance instead of always shooting for the moon. Moon shooting is great when it works out, but it can be nasty if you are wrong. My little bit of risk management earlier in the month helped out, as the TSX and gold both rose after that point. I am looking to off-load the gold on any strength. I was going to do it mid-week but, alas, I was not able to trade so missed the opportunity. So far the bounce has been tepid, but I expect at least a minor surge before it turns lower again.

As for the broader markets, they have been pretty directionless, as any look at a chart shows. The conditions seem to be building for another leg downwards. Sentiment had a boost with the revised US Q2 GDP numbers on Thursday. There seems to be a growing sense that the US may have dodged the recession bullet. Meanwhile, European and Asian data has been pretty bad, threatening the exports that have kept the US afloat. Mortgage rates are still high due to the problems at FNM and FRE, which should prevent the housing market from recovering quickly.

Some of my favourite indicators are starting to suggest an increase in financial stress. EUR/JPY is below 160, US 2 year treasury yields have fallen by 23 bps in the past month, and the CP discount rate has ticket up a bit. VIX is still low at about 20, however, indicating that the pressure has yet to have too much impact on equity markets (although european and asian indices were weakish this week).

From a psychological standpoint, the market may need to move sharply higher in the near term in order to increase the bulls confidence and shake out the weak bears. This would set-up a sharp decline over a few week period to much lower lows. This is a low conviction prediction, but if the market DOES move much higher over the near term I may increase short positions.

MARKET POSITION: EQUITIES - short SPX (5 units); short S&P/TSX (3 units); short EAFE (3.5 units); short energy (2 units); short real estate (2 units) ; long gold (2 units)

Hedging some bets

Last week was a good one. Despite the fact that SPX rose fairly strongly, and I have a strong bearish bias in my positions, my portfolio rose in value, reaching its highest point since early March. With this in mind, and with SPX moving higher again in early trading today, I thought it might be a good idea to hedge some bets. The primary reason for my good performance the past few weeks has been the fall in energy and commodity stocks (I am short both the S&P/TSX index, which is heavily weighted towards commodity plays, and the S&P/TSX energy index).

Looking around for a cheap hedge, gold stocks seemed like a good candidate. The price of gold has fallen by about $150 over the past month or so, and gold stocks have been crushed. HGU, the Canadian ETF that tracks gold stocks, has declined by almost 50% since July 14. I previously owned HGU earlier this year, but sold my positions at levels about 50% higher than here (which was tough at the time, as it then went up about 25%, but I feel vindicated now). Although I am usually wary of trying to "catch a falling knife", a small gold position seems like a good way to offset some of the risk that my short S&P/TSX and energy positions might turn around after strong runs. Enhanced risk management is also part of my new strategy. I reduced S&P/TSX to partially fund the purchase, raising a bit of cash in the process.

MARKET POSITION: EQUITIES - short SPX (5 units); short S&P/TSX (3 units); short EAFE (3.5 units); short energy (2 units); short real estate (2 units) ; long gold (2 units)

Summer Doldrums

After my best month yet (June), I managed to follow-up with second positive month, making 2 consecutive positive months for the first time. This fact, plus that my portfolio is barely even 12 months after starting this journal may indicate that risk management has not played as strong a role as it should have (although many have done much worse, I suppose). So I plan to try to have a greater emphasis on risk management this year. This will mean more stop losses to ditch losing trades, more closing out of positions when the risk-adjusted return wanes, a greater attempt to find trades where some of the risk is offset, and higher cash holdings in times of uncertainty.

Economic news last week continued to be poor, though not terrible. Internationally, there is growing fear of recession in the UK, some smaller eurozone countries and Japan, and the economies of Germany, Canada, Australia and India appear to be slowing. Even the Chinese are now more worried about growth than inflation. In the US, the initial unemployment claims hit almost 450k, a level consistent with a recession. Q2 GDP numbers were lower than expected and Q4-07 was revised to negative. ISM came in at 50, though the forward-looking components were weak. The employment report was viewed as positive because jobs declined by 'only' 50k or so. The Baltic Dry index is down.

On to the markets: bond yields are rangebound, though down from their peak several weeks ago. Nothing really interesting in the FX markets. Commercial paper spreads remain wide, as is LIBOR. Mortgage rates are about the same as they were 12 months ago before the credit crisis even started and the Fed funds rate was much higher (not good for the housing market). Commodities prices are weak. Oil is $20 off its highs, as are many industrial metals.

The rally in equities may have petered out. There was a failed attempt by SPX to break above the 1290ish mark set 2 weeks ago. This is negative as bear market rallies need to maintain momentum, otherwise they die. I took a quick look at most of the rallies following sharp declines over the past 5 years or so (using SPX). I did not see one where the rally stalled for longer than 5-6 days. Pull-backs were always very short. There is nothing scientific in this, but it suggests that we may not be seeing 1325 anytime soon as many pundits are suggesting. Many people see April-May as the model for the current rally -- a gradual move higher over 2 months or so. The market rarely repeats itself so cleanly.

I continue to believe that we will see a major market bottom in the near future, either this month or early next. This may be followed by a brief rally and a re-test of the lows, and then a sustainable rally for a considerable period. One can then assess whether the global economy is out of the woods, or if their is scope for further declines. As there have not been any changes in my strategy, there have been no changes to my portfolio.

MARKET POSITION: EQUITIES - short SPX (5 units); short S&P/TSX (5 units); short EAFE (3.5 units); short energy (2 units); short real estate (2 units)