5.0 Pose Id on Perspective May 2010

8/9/2019 5.0 Pose Id on Perspective May 2010

1/20

THE

POSEIDON

PERSPECTIVE

soundnavigationthroughperilouscrosscurrents

29May2010

DearInvestor,

Thetimeforequivocationispastandthe

truetestofwillsbegins. Thepastfourteen

monthshave

been

aperiod

of

reflexive

response;fiscalstimulussuppliedwithout

restraint,monetaryeasingunleashed

withoutprecedent,andfinancialmarkets

embracingriskinarushofdesire.

Unconventionalandexcessivecentralbank

policiesacrosstheglobehaveunveiledan

apparitionofrecoveryshroudedinfuture

inflation. IntheUSwehavesurpassedthe

TARP,theTALF,thecashforclunkers,and

thenewhomeownerstaxrebate.Wehave

shudderedattheshenanigansoftheFASB

changestoaccountingstandards.Wehave

witnessedtheperfect(nolossesonthe

propdesk)tradingdaysofGoldmanSachs

andtheendofquantitativeeasing. Yet,we

arenotbeyondtheeconomicconsequences

ofexcessiveconsumerdebtandendless

governmentdeficits.

Theequitymarketshaveroared. The

furtherthedrop;thehigherthebounce.

Nowthesemarketsappeartohavelost

theirspringandbegintoshowsignsof

retrenchmentonaglobalbasisafteranear

verticalascentinthepast14months. A

briefscanofTableArevealsthat,except

fortheDJTransportIndex,globalequities

havenow

retreated

Year

to

Date

(YTD).

In

fact,alllistedindexesaredownoverthe

pastyear. Asweconsiderpricechangesin

threeUSequitymarketindexes,DJI,S&P

500,andNasdaq,notincludingdividends,

theyhaveproducednegativereturnsif

heldoverthepastdecade. Thisisthe

primaryreasonwhywecontinuetobe

adamantaboutdividendyieldasan

evaluationmetric.Wehaveincludedthe

ShanghaiStockExchangeComposite

(SSEC)inTableAinordertoaccentuate

theimpactofaseverebubblewhich

peakedinOctober2007.

TABLEAYTD 1Year 5Year 10Year

DJIndus (2.79)% (9.39)% (0.64)% (0.37)%

S&P500 (2.31)% (10.7)% (1.78)% (2.62)%

Nasdaq

(0.54)%

(4.66)% 1.76%

(4.02)%

DJTran 5.77% (6.43)% 3.79% 4.81%MSCIEAFE (13.7)% (15.5)% (1.32)% (1.69)%MSCIEM (6.37)% (2.99)% 11.1% 7.93%SSEC (20.9)% (14.2)% 19.6% 3.18%*Resultsarethru28May2010and5&10yearvaluesare

annualcompoundrateofreturn


2/20

THEPOSEIDONPERSPECTIVE 29May2010

Themarketsarebestviewedwithawide

anglelens. Chart1istheworkofDoug

Shortandrevealshowbadareallybad

bearmarketcanbe.WhiletheS&P500

hasperformedinlinewithotherserious

marketdownturnsthereremainsavalid

concernthatthecurrenteconomicrecovery

isveryweakandtheequitymarketis

susceptibletoareneweddownturn.

Determiningthetruebottominrealtimeis

anexerciseinfutilityandwouldbea

matterofluck.However,multiplerisk

factorsareunabatedandwedonotbelieve

thatequityreturnsgoingforwardprovide

adequatecompensation.

Some

strategists

contendthatacorrectionwasoverdue,

andmaysignalanewdeclinewhichcould

surpassthemarketlowonMarch9,2009.

Webelieve,atthistime,thatacorrectionis

bothoverdueandnecessary. Yet,adrop

belowtheMarch2009levelisbeyondour

ken. PriortoreachingthatleveltheFed,

TheTreasury,andthePresidentsPlunge

ProtectionTeamwouldstepintopropup

marketsbyanymeansnecessary. Thus,a

20%dropinequitypricesfollowedbya

lowertradingrangeis,inouropinion,a

veryrealisticmodelforequitymarket

activityoverthenext1218months. Under

suchascenariowewouldconsider

purchasingvarious

equity

securities

which

meetrigorousvaluecriteria.

CHART1 HOWTHES&P500MEASURESUPOR,PERHAPS,DOWN?

Page 2

Source:dshort.com


3/20


WepresentChart2asasurrogateforthe

YTDperformanceofUSequities.Wehave

constructedthedailypriceandvolume

numbersfortheNYSECompositeIndex

whichincorporates3,257securities. Daily

volumeispresentedasabarchartwith

LeftHandScale(LHS). Thebluelineisa

100dayMovingAverage(MA)which

neatlymimicstheapproximately100

tradingdaysthusfarinto2010.Weview

theMA(100)asarunningmeanforthis

period;itisavisualguidelinebywhichto

measurepricevolatilityoverthepast5

months. TheNYSEcomposite,visualized

below,experienced

aprice

variation

from

hightolowof20%duringAprilandMay.

Weinviteyoutocloselyexaminethe

volumemeasureswhichindicatehigher

volumesofsharestradedonand

surroundingdowndayswhicharethe

declinesindicatedinredalongtheprice

line. Thesearemandateddistribution

daysonwhichvolumeincreasescompared

tothepreviousdayandclosingpriceis

lowerorafterthereisanadvancethereis

littleornogainattheclosing.Hence,not

alldistributiondaysresultinsolidprice

declines.Mostinstitutionalsellingtakes

placeovernumerousdaysofsmall

increasesinvolumeandsmallornoprice

declines.Webelievethatinstitutional

sellinghasbeentakingplacethroughout

2010. Inbrief,webelievethatthemarketis

signalingagreat

deal

of

uncertainty

going

forward. Thethreedriversofmarket

weaknessaretheuncertainUSeconomy,

theEurosovereigncrisis,andgrowing

skepticismoftheChinesegrowthmiracle.

CHART2 ISVOLATILITYRISKOROPPORTUNITY?

Page 3

Source:PSI;StockCharts


4/20


SOUNDINGS

Wearebombardeddailywitheconomic

statisticsonhousing,employment,interest

rates,marketgyrations,etc. Thefrequency

and

load

of

this

information

has

exceeded

meaningfuldigestionandtheresultisa

constantgenerationofnoisearound

randomeventswithmomentaryimpact.

Ourpathontheinformationavenueisto

choosediscriminatelyandruminate

cogently.Maybewearenotalwayscorrect

ortimelybutwefindtheprocessmuch

morerelaxing. Thus,weattempttoapply

somemeaningfulinterpretationtocurrent

economicconditions

in

the

US

and

the

recentdiscordinEuropeansovereign

finance.

Whilethesovereigncreditconcernsand

austerityprogramsinEuropewill

challengegrowthgoingforwardthelargest

unknownistheimpactonthetwolargest

exporterstotheEurozone,theUSand

China.

We

look

at

the

US

first.

Chart

3

is

theproductoftheNewYorkFedto

explaintheirprobabilityassessmentof

economicrecessionintheUSusing

Treasuryspreads. Asthechartclearly

indicatesgiventherecentcollapsethereis

about0%chanceofanewrecession. The

recordforthisinterestspread

prognosticationlooksprettygood.

However,wefindthissimplisticmethod

aboutas

useful,

other

than

as

aPR

gimmick,astheircontinuingfixationon

ZIRP.

CHART3 DOUBLEDIP?NOWAY!

Source:newyorkfed.org

FromtheirsisterbranchinSt.Louiswe

findsomemoreusefulinformativedatato

evaluatethecurrentbusinessenvironment.

Chart4isthemostrecentgraphicofloan

reserveratio

to

total

loans

for

banks

with

assetsover$15Billion. Asaratiothis

amountwillincreaseiflossreservesare

increasedinrelationtoTotalLoans.

Increasingreservesisprudentbusiness

evenifitmeansthatthequalityofassetsis

deteriorating.

Page 4


5/20


CHART4 GROWINGLOSSRESERVES

Source:St.LouisFed

However,theratiowillalsoincreaseif

totalbankcreditisdiminishedasithas

overthepastyear.BankCreditforUS

commercialbankswasdown(6.4)%in

2009and

down

(6.7)%

in

1Q2010

according

totheFedsH.8statementdatedMay28,

2010. ThesameH.8indicatesthatTotal

Assetsweredown(15.9)%atanannual

rate.

So,ifreservesarerisingandtotalassets

(lending)aredeclining,whatdoesthissay

aboutqualityofassets? Forthiswelookto

Chart5,StLouisFedsLLRNOT5,whichis

anindication

of

allowances

for

non

performingloanswithinthesystemover

24years. Thisgraphicpresentsaratio

whichequals=[thesumofallassetsin

bankswheretheratioofallowanceforloan

andleaselossestononperformingloansis

greaterthanone]dividedby[thesumof

allassetsheldbythosebankswithTotal

Assetsinexcessof$20B]. Our

interpretationofthisdemiseisthatthe

bankingsystemintheUSiswoefully

undercapitalizedbywayofallowancesto

providethecushionnecessarygiventhe

amountofnonperformingloansinthe

assetbase. Further,weviewthisasan

indicatorthattheneedforrestructuringin

theUSbankingsystemwillcontinue

throughout2010andwellinto2011. This

isbadnews.

CHART5

ONEEXPLANATION

Source:St.LouisFed

Unfortunately,

in

an

economy

where

credit

isthelifebloodofgrowthacessationin

thegrowthoflendingresultsinworsethan

stagnation. Theresultisstrangulation.

Banksarestillintroubleandadeflationary

spiralcannotberuledout.

Page 5


6/20


Page 6

InChart6weviewthecontrasting

opinionsfromtheBureauofEconomic

AnalysisandJohnWilliamsShadow

GovernmentStatistics. Ifwechoosethe

middlewaytheUSGDPgrowthisstill

aboutnullwhiletherateofchangehas

beenimpressive. Yet,growthcomingout

ofarecessionshouldbeveryrobust.We

pointtothecontrastofourcurrent

recoverywiththe2001recoveryandwe

stillhavesomeroomtomove. The

optimistic,Officialreadingisweak;the

SGSAlternateisveritablegloom.

CHART6 EITHERWAYGDPISVERYWEAK

Source:shadowstats.com

TheEconomicCycleResearchInstitute

(ECRI)hasproducedasolidrecordfor

economicprognosticationswhichusually

contraveneconventionintheirboldness.

WelikethefactthattheirUSLongLeading

Index(USLLI)doesnotincorporatethe

equitymarkets

which

they

do

not

believe

isaleadingindicator. Theirresearch

indicatesUSGDPgrowthin2010of

around1.5%.WhilebothWeeklyLeading

Index(WLI)andFutureInflationGauge

(FIG)areupfortheyearbotharedown

overthepreviousquarter.Whilenota

portendfordisasterthisisareversalof

trendandmaysignifycontinuing

weaknessintonextyear. Informationis

availableattheirwebsite,

www.businesscycle.com.

Weprovide

amonetary

view

from

ShadowStatsbywayofChart7which

displaysthreemeasuresofthemoney

supply.M1andM2areinaccordancewith

theStLouisFedandM3isaShadowStats

compilatedestimateinaccordancewith

previousFedparameters.M3isnolonger


7/20


releasedbytheFed. Asimplelawof

bankingandfinanceisthatanexpanding

economyrequiresmoremoney,ceteris

paribus.WhiletheFedhasdoneitsbestto

growthemoneysupply,thebankshave

beenlessthanaccommodating. Obviously,

atthistimebankersprefertorebuild

shabbybalancesheetswiththeaidofrisk

free,zerorateFederalfunds.

CHART7 THISISADEFLATIONARYTREND

Source:

Shadowstats

Thesemonetaryandproductiontrends

indicatepotentialdeflation. Some

implicationsareanabovenormallevelof

unemployment,continuedstressin

consumerspending,deterioratingcredit

quality,increasingcreditcarddefault,and

continuedhouseforeclosures. Thesystem

isdeleveraging. Thisinturnwillexert

pressureon

banks

to

reduce

consumer

lendingandmorecloselyreexaminethe

assetsandsecuritiessectionsoftheir

balancesheets.Wealsobelievethat

withoutfurthergovernmentsupportthere

willbereneweddeflationinhousingsales

andprices.Whileallthisgloommaynot

produceadoublediprecession,weexpect

averystagnanteconomyasglobalevents

continuetoexacerbatetheburdenof

excessivedebt.

Therefore,webelievethatthereisvery

littlepossibilityofaninterestrateincrease

before1Q11. Thebigquestionregarding

theFeds

FOMC

is

whether

there

will

be

a

returntoquantitativeeasingbeforetheend

of2010orshortlythereafter.

Page 7

WhiletheUSisstruggling,theEuropean

Unionisimploding. Traderscontendby

measureofcreditdefaultswaps(CDS)that


8/20


Greeceisonlythetipoftheiceberg.We

concur.Mostmeasuresofliquidityand

creditqualityareunderduress. Chart8

detailsthefallandriseofEuroratesover

therecent16months. Inthepast10weeks

theTEDspreadand3MonthLiborhave

tripled. Thissurgeinthecostofshortterm

moneyisdisconcertingamidthecredit

marketsrevaluationofsovereignrisk.

TheTEDspreadisthedifferencebetween

3monthTreasuriesand3montheuro

dollarLiborrates. Assuch,thisrateisthe

differencebetweentheriskfreerateand

moneycenter

bank

creditworthiness.

Therefore,itproducesaclearreflectionof

liquidityandwillingnesstolend.

However,wemustnotethatrisingLibor

ratesorrisingTEDspreadsaremuchmore

importantthancommercialcreditanalysis;

interbankloansareclubtradingamong

usuallyhighratedcreditors.Whenthese

closelylinkedpartiesstepbackfromeach

other

the

system

is

staggering.

CHART8 TEDSPREADLEAPS


Chart9revealsthegrowingdemandfor

longtermUSTreasuriesinrelationtothe

crestingofLibor. ThepriceoftheUSBond

30yearisrisingasindicatedbythedropin

yieldto4.22%overthepasteightweeks.

OnceagainTreasuriessuccumbtomoneys

demandforasafehaveninthefaceof

thunderheads. Reducedliquidityflows

amongbanksreflectaturntofundingfrom

centralbanks. Thisinturnleadstogreater

reserves.AshashappenedintheUS

interestratearbitragegreatlyreduces

lendingandmonetarygrowth. Charts8&

9areindicativeofseverecredit

contraction.

CHART9 TREASURIESBLINK


Page 8

Yet,somefixedincometradersand

strategistscontendthatthismeasureand

otherLibor

based

metrics

are

useless

as

theydonotaccuratelyreflectthemarket

forbankfundsintheLondonmarket.

Interbanklendinghasbeenreplacedby

cheapcentralbankandIMFfunding.

TherearealsoinsinuationsthattheFed

attemptstomanageUS$Liborthru


9/20


Page 9

currencyswaplineswhichhavebeen

reopenedwithBoE,ECB,andothercentral

banks.Webelievethisviewhassome

credibilityduetothefactthatanycredit

worthybankisborrowingfromthecentral

banksofEurope,England,andtheUS.

However,Liborisstillthebenchmarkfor

trillionsofUS$interestratebased

derivatives,primarilyinterestrateswaps.

AnysuddenchangeinLiborhasan

inordinateimpactonthestabilityof

financialmarkets.

IthasbeenhistoricallydetailedbyCarmen

Reinhartand

Kenneth

Rogoff

in

their

book,

ThisTimeItsDifferent:EightCenturiesof

FinancialFollyandothersthatoverthe

past100+yearsmanybankingcrisisare

followedbysovereigndebtdefaults.

Theseconsequencesmaynotoccurinthe

samecountrywherethebankingcrisis

occurred. Aprimeexamplewouldbe

Mexicoin1985whenthebankingcrisis

wasintheUSbuttherealpressurewason

theLatinAmericandebtwhichwas

denominatedinUS$s. Creditvolatility

movesquicklyintocurrencyinstability

whichbringsadversitytotradeand

development. Otherthantradeprotection

barrierscurrencyfluctuationsarethe

greatesthindrance

to

global

growth

and

development.

CHART10 MOREVOLATILITYISCOSTLYTOMANAGE


Chart10depictstheexchangeratesforthe

EuroandYeninrelationtoUS$. This

triageofeconomicpowerwiththe

inclusionofChinarequiresgreater

currencyequilibriuminordertomaintain

thefragiletradebalanceswhicharethe


10/20


economiclifelineglobalmarket. Therise

oftheJapaneseyen(FXY),anappreciation

of32%overa3yearperiod,hasthe

potentialtocrushJapaneseexportsand

tradebalance. Ontheotherhand,the

depreciationoftheeurooverthepast6

monthsshouldbringpressureonChinese

imports.

WEATHERWATCH

FromtheOccidenttotheOrientwemove

fromtheEuroWorldtothemanufacturing

andexportconflationoftheEast,China.

Wehavepreviouslycommenteduponthe

boomin

China

and

those

who

are

betting

onthedeleteriousrepercussionsuponits

inevitableslowdown.

ThoseconcernswerevoicedbyJames

Chanos,EdwardChancellor,andKenneth

Rogoff.WenowlookcloselyintotheMay

2010letterfromEclecticaAsset

ManagementsHughHendry.Heisan

outspokenhedge

fund

manager

who

has

shownveryastutemaneuveringinthe

volatileglobalmarketsofthepastdecade.

Thefirstbasicquestionthatheposesis

whetherweareinthemidstofavigorous

yettypicaleconomicrecovery,ornearthe

endofaninventoryledandrathershort

businesscyclebearingtestimonytoan

ongoingdebtdeflation.Weagreewith

thequestionbutareprejudicedinthe

answer. Hendryskirtsthisissuebyintroducingastrongcaseforaflawed

businessmodelinAsia,previouslyin

JapanandnowinChina.Hecontendsthat

Chinaseconomictransformation

springsfromJapaneseheritageof

exportingpoweratanycost.Hendry

detailstheriseofJapanpostWWIand

muchofhisargumentcouldalsobe

appliedJapanspostWWIIgrowth.

Beyondeconomicsisthepoliticalflawthat

maybecommontobotheconomic

flagships. Thisisthehubriswhich

preventedbureaucratsfromseeingthe

obviousandimmediatedangersarising

fromthefalloffindemand. Instead,

theypressedon,raisingthestakes

further,bydirectingtheprivatesectorto

borrowandinvestinyetmoreexcess

productioncapacityandtobuildandstore

moreinventories.

The

undoing

was

that

theexcesscapacityneverproducedthe

cashflowsnecessarytoserviceorretirethe

debtandwithunsoldinventorypilingup,

thecompaniesbegantodefaultontheir

loans. ThecurrentcaseinChinareflects

aneconomywhichrepresents7%of

globalGDPisnowresponsiblefor30%of

globalaluminumconsumption,47%of

global

steel

consumption

and

40%

of

globalcopperconsumption. Chinamay

haveexceededitsfundamentalstrengthin

thefrenzieddoublingindomesticbank

lendinglastyear. Thisexuberantcredit

creationandhardtomanagehotmoney

havestrengthenedthetwinproblemsof

commodityhoardingandproperty

speculation.Hendrygoesontodetaila

validargumentforaslowdowninChina.

Healso

notes

amajor

stumbling

block

in

Chinasdevelopment,itsnonconvertible

currency.

Page 10

HebelievesintwoAsiangamechangers:

aslumpinChinasrateofeconomic

growthandasuddenanddramatic


11/20


Page 11

appreciationintheyenthatwould

bankruptits[Japan]domesticexportbase.

AsHendryadmitsopinionsarecheap

andhebackshisupwithaninvestment

thesisandprogram. EclecticaAsset

Managementhasannouncedamajor

shortcreditportfoliotoexploitthese

majoreconomictransitions.His

investmentteamhasdevelopedalistof

over20singlenameindustrial,cyclical

businessesthathavethedubious

distinctionofsufferingfromgigantic

financialleverageandAsian/commodity

overdependence. Obviously,thetremors

fromaslowdownofanysubstantial

magnitudewouldbefeltacrosstheglobe.

AfundamentalplankforHendrys

strategyfocusesoncommodities.We

surmisethatthetypeofbusinessesthathe

maybeconsideringaregiantcommodity

andmaterialsproviderssuchasBH

Billiton,RioTinto,Vale,andsimilar

suppliersofmajorrawmaterialstoChina.

Hendryisalsocreatinganewfundto

focusexclusivelyonthisopportunity.

CHART11ESTABLISHINGNEWMEANS?

Source:

PSI;

StockCharts

Chart11revealsthepastdecadeofpricing

fortheUS$exchangeandtheReutersCRB

Index(CCI). TheCCIcontainsamajor

energycomponentwhichisreflectedinits

2008eruptionandcollapse.However,

commoditieshavebeeninabullmarket

since2001. SincemostarepricedinUS$s

thedeclineintheexchangeratehas

supportedthisappreciationinprices. As

theUS$hasshownrecentvigorin


12/20


conjunctionwiththeEurodemise

commoditypricesarevulnerabletothis

currencyrevaluationandtheanydecline

indemandfromChina.Wemustcogitate

ontimingandmagnitudeforany

commoditiesbreakdownastheUS$rises

invaluetomeetthedemandofglobal

liquidity. Therearemanyfactorsatplay;

trueinventoriesareunknown,China

seemsdeterminedtomaintainitsgrowth,

hedgefundsgathertoexploitstress,and

investorsseekoutahedgeagainst

inflation.

Theleadership

role

of

the

US$

in

world

financialmarketsisundisputed. However,

stabilityoftheUS$acrossmarketsismore

importantthananyspecificexchangerate.

TheUSTreasuryallowedtheUS$toslide

substantiallybetween2002and2008;

commoditiesandtheS&P500benefited

fromthisdevaluation. Therecent

volatility,risedeclineresurrection,during

the

past

two

years

is

a

bane

to

US$

based

assetclasses.Marketsabhorinstability.

Thechallengeliesinanydelaytoan

appreciationoftheyuanwhichiscurrently

tiedtotheUS$. AstheUS$risesagainst

theEuro,soalsotheyuan;thismakes

ChinesegoodsmoreexpensiveintheEuro

zone. ThedepreciatingEurolowersthe

costsofexports,especiallyfromthe

Germanpowerhouse.

Additionally,

the

newausteritymeasuresintheGIIPS

economiesandpartsofEasternEurope

willexacerbatepricingpressureson

Chineseexports.

TheimplicationsforChinaoftheEuro

crisismaybeasuddendropoffindemand

inthecaseofrisingprices. Asudden

imbalanceintradebetweenEuropeand

Chinawillhavemajorramificationsfor

othertradenationswhosecurrencieshave

appreciatedagainsttheUS$.Withoutthe

expectedrevaluationoftheyuanthese

nationsexportsareatapricing

disadvantage.However,thecheaper

eurowillsupportatradeadvantageto

Europeanexports;perhaps,greatly

improvingthebalanceoftradeforEurope

andproducingasubstantialtradesurplus.

Thisleaves

the

US

with

the

increased

value

ofitscurrencyastheconsumeroflast,last

resort. Thiswillnotbeapleasant

experienceforanationwhichalready

sportsthelargesttradedeficit,around$380

billion,intheworld. Theonlycertaintyat

thisjunctureisthatthehardnegotiations

willbedelayed,tradetensionswillflare,

andaviablesolutionwillgrowmore

complex.

Page 12

Asstatedabovenumerousfundmanagers

areseekingtoexploitanyslowdownin

China. Theyaredoingsobyshorting

thosesupplierswhomtheydeemmost

vulnerabletoacrashintheproperty

bubbleandinfrastructureboom. Those

suppliersareprimarilyworldcommodity

andmaterialsproducers. Chart12reveals

the5year

track

of

Chinese

equity

markets,

asviewedthruSSEC,andtheGoldman

SachsIndustrialMetalsIndex(GYX). In

theUSafterinvestorswerescorchedinthe

techmeltdownmoneyrapidlygravitated

torealestate. Thesamemovementhas

occurredinChina.Moneyflowsrapidly


13/20


Page 13

towardthegreatestachievablereturn.We

believethatacorrectionincommodity

pricesintheshorttermwillbefollowedby

theresumptionofarisingtrendintheface

offutureinflationexpectations. Thelong

termpathforcommoditiesisthesameas

inflation.Whenthedeflationaryspiralhas

subsidedforwhateverreasonsinflation

willreturnwithavengeance;commodities

willfollowcourse.

CHART12 CHINAANDTHEINORDINATEVOLATILITY OFMETALS


Chart13exhibitstwomajorimplications

fromtherisingvalueoftheUS$. Thefirst

isthedeclineininterestratesasglobal

moneyflowsseekthestrengthand

liquidityofTreasuries. The10yearrate

hasdeclined15%sinceMarch2010. The

second

is

commodity

prices,

especially

oil

whichdrivescontinuingUStradedeficits.

Asasidenotebothoftheseeffectscanbe

readastraditionalsignalsofadeflationary

trendintheeconomy.However,these

potentialbenefitsareoffsetbythe

contractionofUSexportswhichbecome

moreexpensivetoglobalcustomersasthe

US$appreciates.Modelingforthese

impactsisbeyondourcapability,however,

asMr.Hendry,notedabove,pointsout

Fromitsnadirin1987,theUStradedeficit

contractedfrom$151bntojustunder$31

bn

four

years

later

as

exports

jumped

65%.Theobversemayalsobetrue.We

wouldneverunderestimatethe

exponentialpowerofanundervalued

currencyandverylowinterestrates. This

isChinascurrenthand.


14/20


Mr.Hendrysmissivereferencesthe

wsjonline.comreportonMarch18,2010

thatmanyChineseexportersareina

fragilesituationandmaybe

approachingatippingpointdueto

razorthinmarginsonexports.Mr.Zhong

Shan,ViceCommerceMinister,explained

Waterdoesntboilifitisheatedto99

degreesCelsius. Butitwillboilifitis

heatedbyonemoredegree. Thus,a

furtherriseintheyuanbyaverysmall

magnitudemightcausefundamental

changes. Unfortunately,toprecludea

tradewarandprotectionisttacticsfrom

importersChinamaybeforcedtobegin

buyingtheEurosincewefindithighly

unlikelythatitwilldevaluetheyuaninthe

midstofthecurrentcurrencymarket

pandemonium.

CHART13 CONTRACTINGTRENDS


Page 14

Themostimposingresultofthecontinuing

stagnation

in

the

US

economy,

the

increasingcreditandbankingturmoilin

Europe,andanarrestoftheChina

propertybubbleistheuncertaintywithin

therealmofunintendedconsequences.

Theglobalmarketplaceisnowintimately

connectedthroughcommunicationsand

financialnetworks. Yet,sincethis

relatively

new

amalgam

of

conflicting

relationshipshasnotbeenstressed,tested,

andreconfiguredthetrulyweaklinksare

unknown. Everypotentialsoftspotwillbe

probedaspressuresgrowandnew

constructsmustbecreatedtochannel

increasedmoneyflowsthroughoutthe


15/20


system.Money,likewaterseekingitslevel

orelectricityracingtoground,willfindits

adequatereturnorstrongholdofsafety.

Eighteenyearsago,September1992,

GeorgeSorossQuantumFundbrokethe

BankofEngland. ThecosttotheUK

TreasurywasestimatedataboutUS$5

billionattodaysrates. Thestakesare

muchhighernow.

PROVISIONING

Thechallengeofassetallocationhasgrown

incomplexityoverthepastdecade. The

USfinancialmarketshavebeenrockedby

twoasset

bubbles

and

traders

are

able

to

movecapitalinandoutofglobalmarkets

24/7.ThetraditionalmooringsofUSstocks

andbonds,expectedreturns,andsimple

assetclasscorrelationsarenolonger

sufficientshelterfromthestorm. The

evolvinggrowthofalternativestrategies

andincessantuseofleveragehave

diminishedthepreviouslysimplemetrics

of

investing

for

retirement.

As

we

work

to

developastrategyandtacticsforthenext

twoyears,fiveyears,andtenyearsthe

researchavailablehasbeenenlightening.

However,whatwehavefoundmost

alarmingistheparochialsimplicitythat

majorassetmanagementfirmsproselytize.

Stocksforthelongrun,simplisticsector

plays,generallongtermindexing,60/40

USstock/bondallocation,munisfortax

purposes,and

TIPS

for

inflation,

are

afew

oftheplebiandictatesfrommainstream

advisersandmanagers.Thesestratagems

maysufficeforshortperiodsatendoflife

buttoprotectandbuildcapitalsomething

moreisrequired.Wehaveentereda

periodofextendedlowgrowth,a

deflationarytrendwithrisinginflation

expectations,andunconventional

monetarypolicies. Thisisnotyourfathers

investingenvironment.

Page 15

WewereamazedatarecentarticleinCFA

Magazine,AssetAllocationinCrisisby

BrianJacobson,CFA,chiefportfolio

strategist,WellsFargoFundsManagement.

Heassertsthreemainlessonsfromthe

creditcrisis(1)Strategicassetallocationis

notstaticallocation. (2)Anawarenessof

economicandmarketconditionsshould

informportfolio

allocations.

(3)

Risk

managementgoesbeyondcheckingthe

boxofsizeandstyleexposure. Thisis

scarybecauseifthesearethelessons

learnedfromthecurrentcreditupheaval;

whatwerepeoplethinkingprevioustothe

crisis.Manyinvestmentprofessionals

musthavebeenreallyoperatinginthe

dark. Thearticlegoesontodiscussthe

importance

of

qualitative

factors,

human

capitalwhichistheindividualsearning

power,theoptionofusingriskreturn

optimizationprograms,etal.Mr.Jacobson

makesagoodpointformoreactive

management:Ifmarketsarenotstatic,

thenallocationshouldnotbestatic. This

fineuseofunderstatementisfollowed

withmandatessuchasshortterm

deviationscreatetacticalopportunitiesto

reducerisk

and

add

value

to

aportfolio

andAnimportantconsiderationinany

assetallocationdecisionistheinvestors

investmenttimehorizon. Yes,andthen

what? Ourpointisthatitappearsthatnot

muchhasbeenlearnedbylarge

institutionalmanagerswhoadvise


16/20


Page 16

individuals. Thisissadgiventhe

tumultuousmarketgyrationsandmassive

investorlossesoverthepastdecade.

Rapidgrowth,moralhazard,andgreed

haveinfectedtheindustrywithconflicted

interests,biasedincentives,excessive

compensation,andsevereethicallapses.

Themeaculpafromthecentralbank,

moneycenterbanks,investmentmanagers,

andwealthadvisersiswelldobetternext

time.Wellformany,theremaynotbea

nexttime. Thelossofsubstantialcapitalis

crippling.Hedgefundsknowthiswell.

TableB

lays

out

the

asset

allocation

schedulesforfivelargeinvestmentfunds.

Thepurposeistogleanamoreintrinsic

understandingofcurrentpracticeamong

thosewhohaveafiduciarydutyonbehalf

oflargegroupsofsavers.Webeginour

examinationwithavanillamutualfund

whichattemptstomatchatimedliability

horizon. FidelityFreedom2020(FFFDX)is

focusedoninvestorswhoexpecttoretire

aroundtheyear2020. Thefundinvestsin

acombinationofunderlyingFidelity

equity,fixedincome,andshortterm

funds. Thefundbecomesincreasingly

conservativeafterreaching2020andis

ultimatelyexpectedtomergewiththe

FreedomIncomeFund.Wefindthisan

interestingmarketingconceptpremised

uponalongtimePimcostrategy. The

surpriseisFidelitysniftyuseofForeign

EquityandHighYield,inanotherwise

traditionalsandwichoftwoassetclasses.

Thismayaccountforthefunds10year

averageannual

return

of

1.8%.

The

expenseratiois0.74%;however,eachof

thefundsinwhichthisfundinvestshasits

ownselectedmanager(s)andexpensesand

fees. Fundamentally,thisfundwith62%

equitydoesnotvaryfromtheold60/40

model. Thisreflectsthepaceof

institutionalprogressonbehalfofthe

individualinvestor.

TABLEB ASSETALLOCATIONINACROSSSEVERALPORTFOLIOS

ASSETCLASS

Fidelity

Freedom1

NewYork

State2 CalPERS3 YaleUniv4 GMO5

DomesticEquity 47.9% 31.5% 66.8% 7.5% 29.9%

InternationalEquity 14.1% 12.4% 9.8% 23.6%

EmergingEquity 8.9%

PrivateEquity 9.7% 24.3%

AbsoluteReturn 2.2% 24.3%

FixedIncome 24.8% 26.3% 22.9% 4.0% 34.1%

HighYieldIncome 7.4%

InflationLink

Bonds

3.0%

11.4%

2.3%

RealEstate/RealAssets 6.5% 7.0% 32.0%

ShortTerm&Cash 2.8% 0.9% 1.9% 3.6%Source:IndividualInstitutionwebsite

1. FidelityInvestments,April30,20102. CommonRetirementFund;March31,2009ActualAllocationvsPolicy;CashandmortgagesareincludedinFixed

Incomefigure

3. ActualAllocationvsTarget;March31,2010;EquityisGlobalandincludesAlternativeInvestmentManagementwhichisprivateequity;FixedIncomeisGlobal;


17/20


4. EffectiveJune30,2009;RealAssetsincluderealestate,oil&gas,andtimberland.5. GMOsGlobalBalancedStrategyatMarch31,2010

TheNewYorkStateRetirementFundand

theCaliforniaPublicEmployees

RetirementSystem

are

funds

for

large

numbersofstateemployees. Asone

wouldexpectbothfundshavelargeboards

(councils),actuarialadvisors,advisory

commissions(panels),andconsultants.

Thesepensionplansexemplifythe

allocationoffundsintolessefficient

markets,realestateandprivateequity,

whichoffertheopportunitywithsuperior

management

for

greater

returns.

Demographicsandsizeallowthefundto

tradeliquidityandcashcommitmentsfor

greaterassetperformance.Whilethefund

providessomestrongdiversityattheedge,

atheartthesefundsareverytraditional.

WenotethatCALPERswhichhadafund

valueof$198Bin2010recordedatotal

exposuretoprivateequityof$47.9Bon

Dec.31,2009. At24.2%oftotalfundsthis

allocationlooks

exactly

like

Yale!

OntotheinfamousYaleendowment

whichledtoDavidSwensensbook,

UnconventionalSuccess. Inrelationto

manyfundsYaleisunconventional,the

allocationtodomesticequityisverylow

andoverallequityis17.3%. Thereare

outsizedallocationstoprivateequityand

absolute

return.

The

absolute

return

strategyisdesignedtoprovidesignificant

diversification. Itseekstogeneratelong

termrealreturnsbyexploitingmarket

inefficiencies50%toeventdriven

strategieswhichrelyonaveryspecific

corporateevent,suchasamerger,spinoff,

orbankruptcyrestructuringtoachievea

targetprice. Theotherhalfisvaluedriven

strategieswhich

involve

hedged

positions

inassetsorsecuritiesthatdivergefrom

underlyingeconomicvalue. The

diversificationfactorinthisstrategyisthat

historicallyabsolutereturnstrategiesare

independentofthemarketmovesin

traditionalmarketablesecurities. Finally,

Yaledirectsahefty32%toRealEstate/Real

Assetswhichistheendowmentsinflation

hedge.

No

TIPS

here.

WeconcludewithGMOs,formerly

Grantham,Mayo,VanOterloo,Global

BalancedStrategy. Asexpectedthereis

nothingreallyexotichere. However,we

pointouttheequityallocationallowsa

strongweightingtoInternationaland

EmergingMarkets. Likewise,theFixed

IncomeincludesfocusonInflation

Indexed,Emerging

Country

Debt,

Alpha

Only,SpecialSituations,andStrategic.

Whiletheportfoliois97%GMOFunds

assetsdoincludeCMBS,CDO,equipment

leases,andstudentloans. Thereismuch

morediversificationthatatfirstsight. The

portfoliomaintainsalowdurationstrategy

infixedincomeinspiteofcurrent

steepnessintheyieldcurve.Wereadthis

as

an

expectation

of

future

inflation.

Page 17

Webelievethispanelprovidessome

industryvernacularforassetclasses,

styles,andstrategiesutilizedbyastute

fundmanagemententities. Inpursuitof

slightlymoreesotericthoughtwealsolook


18/20


attheallocationundertakenbyportfolio

managerRobertArnottforthePimcosAll

AssetFund.Mr.Arnottutilizes

proprietaryanalyticstoachievea

maximumrealreturn. SincetheAllAsset

portfolioisanamalgamofotherPimco

fundsArnottbreakshisallocationinto

strategies. Asofyearend2009theywere:

LongEquityRelatedStrategies 5.0%

USBondStrategies 27.4%

AlternativeBondStrategies 13.7%

InflationRelatedStrategies 36.8%

AlternativeEquityRelatedStrategies 11.2%

ShortTermStrategies 6.0%

Arnott,bymeansofthemyriad

possibilitiesinthePimcostableisableto

produceauniquelycomplexinvestment

vehicle.Wenotethatwithaverysmall

allocationtolongequityArnottisableto

wagerheavilyoninflation(realestateand

commodities)andalternativestrategies

(developingmarkets,emergingmarkets,

high

yield,

convertibles,

etc.

We

happen

to

likeamanagerwhowillgostrongerShort

TermthanLongEquity.WhatisBob

thinking? Fulldetailsareavailableatthe

pimco.comwebsite.

Finally,wewouldliketoincludea

straightaheadhedgefundwithan

AbsoluteMacrostrategy. Thiswellrun

fundwiththefounderscapitalsideby

sidewith

investors

reveals

the

distinctive

competitiveadvantageoftheinvestment

team. Additionally,thisistheallocation

foraLondonbasedfund.

NetEquityStrategy 26.5%

FixedIncomeStrategy 28.5%

Commodities 1.8%

Currencies 29.0%

Cash 14.2%

Herewewouldpointoutthreeaspectsof

thefund. First,thenetequityposition

whichreflectsthelongbalanceofalong

shortequitybarbellissubstantially

underweightedinequity. Secondly,

introductionofcurrenciesasamajor

allocationinthefundindicatesatruly

macrofocusplayingtofund

managementstrength.Wereadthis

substantialweighting

to

the

expectation

of

volatilecurrencymarketsgoingforward.

Finally,thelargeallocationtocashmaybe

partiallyduetopotentialredemptionsbut,

inouropinion,themanagementgoesto

cashwhenlackingasolidinvestment

thesis. Thisallowsfirepowerfortheirnext

majormove. Thisresolvedemandsa

trenchantdisciplineinordertoaccept

negativereturns

in

the

current

cash

markets.

Allowustonotethatnoneoftheportfolios

wehaveaddressedmentionsprecious

metals. Exceptforthehedgefundwitha

commoditiesallocationwhichmayinclude

preciousmetalsthisassetclassisbeyond

thepurviewoftraditionaland

unconventionalinvestmentmanagement.

Page 18

Muchofinvestmentmanagementis

dealingwithexpectations,themarkets,

themanagersandtheclients. Going

forwardweenvisionavengefulreversion

tomorenormalcreditandbusinesscycles.


19/20


Page 19

Ifthepast25yearbullmarketinequities

from1982until2007wasboonfor

investors;the5yearstretchfrom20022007

wasarareeventduringwhicheverything

wentup. Inthatperiodofabundant

liquidityandgeometricleverageevery

assetclassprospered. Asweentera

periodofeconomicretrenchmentand

creditcontractionwebelievethatthemost

importantaspectsofmoneymanagement

willbeastuteactivemanagementinglobal

markets,carefultiming,inflation

protection,andtacticalallocations. In

ordertoavoidthechangingtidesand

aberrantcurrentsinvestorsmuststeerclear

ofthecrowdsandsettledowntothehard

workofresearchandduediligence.

WeremembermanyyearsagoourfirstsightingoftheGulfofMexico.Wewereonalate

winterroadtriptoNewOrleans.WerolledsouththruthenightalongInterstate85.Notime

forthe

BarB

Q

hospitality

of

Raleigh

Durham,

the

bright

lights

of

Atlanta,

or

the

genteel

invitationofMontgomery.WecruisedonwardmergingintoInterstate65.Wewerefocused;

wewereheadedfortheMardiGrascelebration. ItwasearlymorningwhenwehitMobile,

Alabama;werolledwestontoInterstate10. Therewaslittletrafficandwewereimmersedin

thesoftsaltyaircominginfromtheMississippiSound.WewheeledacrossBiloxiwiththe

risingsunatourback. TheroadflowsneatlyintotheoldRoute90,BeachBoulevard,onward

toGulfport. Thequietavenuegivesforththebeachandoldsturdypalmsgrowingsideways

intothesky.Whilenotcompletelyuprootedtheyneverreallyrecoveredfromthehurricane

windsthreeyearsbefore,buttheyweretostrong,tograndtodie.Wewerethereinatime

long

before

the

casinos

and

the

condos,

and

well

ahead

of

the

noise

and

and

non

stop

neon.

WestoppedataroadsideDairyQueen.Wewalkedacrossthehighwayslurpingcoffee. At

thebeachwepausedlookingoutacrossthegentleseaintoasouthernhorizonaskancetoa

risingsun,quiet,comforting,andveryold. Thelightlylappingwaveswashedacrossthe

beigesands. Timestoodstill,waveringgullsweremuted. Thefarwatertouchedthesky.

Wenowmustponderthedesecrationofthelandandseawithafoulandtoxicneed. The

resultwillbealocaltragedyandecologicalnightmare. Therearenoeasychoices.Whats

doneisdone. Theworldhaschangedagain.Yet,theflowofoilcontinues. Themassive

plumeswallowbelowthesurfaceinthecurrentsandtidalflows,spreadingamoebalikein

manydirections.

However,

the

gentle

breezes

of

atorpid

summer

will

change

and

the

rain

willcome.Whenthewindshiftsandthetemperaturesrise,astheydoeveryyear,the

complacentGulfwillbecomeacauldronoffrothandchop. Theoil,thechemicaldispersants,

anddefiledwaterswilllashoutagainstthesky,ontotheshore,andbackagain,overand

over. Atthattimetherealtestwillbegin.


20/20


Sincereregards,

BrianE.Shean,CFAPRINCIPAL

POSEIDON

STRATEGIC

INVESTMENTS

_________________________________________________________________________________

P 20

Theviewsexpressedinthiscommentaryarethoseoftheauthoratthetimeofcomposition. Theassumptions,analysis,and

conclusionsaresubjecttochangeinconjunctionwithchangesinthesecuritiesmarketsordiscoveryofadditionalor

conflictinginformation. Allinformationconveyedhereinhasbeendeduced,compiledorquantifiedfromsourcesthoughtto

beconsistentlyreliable. Thisinformationalreportisproducedforgeneralcirculationandisnottobeconstruedasa

solicitationtobuyorsellsecurities,financialinstruments,orinvestmentproducts. Priortoenteringanytransactionsfor

investmentproductspleaseconsultacompetentfinancialadviserandundertakeproperduediligence. AMDG

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5.0 Pose Id on Perspective May 2010