Meetings are indispensable when you don't want to do anything.

Meetings are indispensable when you don't want to do anything.
John Kenneth Galbraith (1908 - 2006)

This week has the G-20 meeting in Washington as the big highlight - even President George W. Bush will leave his ranch in Texas to attend!

We had our Weekly Investment Meeting this morning and unlike last few meetings we had some "clarity" in our assessment;

1. Financial Solvency is yet again an issue - AIG, Fannie Mae et al all were "maybe" solvent for about two month but with stock markets down 25% plus in September and as credit spreads continues to be elevated they now need further capital.
2. Private consumer solvency is now main issue - yes, interest rates have come down, taking off pressure momentarily, but now the private sector is starting to pay the price: net net we are now worse of than when it was merely a financial sector insolvency. Basically we now got both major parts of the financial sector and the private consumer being insolvent at the same time
3. ==> We are entering final leg of the deleveraging proces

The political reaction to the above will be what we call the "50/50" solution:

50% of the insolvency will be solved through additional capital injection

50% through easier accounting rules, solvency calculations, tax deferences et al.

Problem with this being it as per usual does nothing to the real issue: the solvency - the model used right now is one based on "hope".

Hope the markets will correct and then improve market valuations through better asset prices - good thing religion is so popular these days!

The G-20 meeting does seem to have some "real soluations" on the table - the latest one which Wall Street Journal picked up yesterday does make some sense to me: Spain's Bank Capital Cushion Offer a Model to Policy Makers: http://tinyurl.com/6x6lms

The argument being that the accounting rule change in 2004, which made the companies only take loss' when incurred made sure the leverage increased dramatically, without making provisions for future loss' - should be unwinded.

The Spanish model will give some "cushions" against loss - the issue with this being it INCREASES THE LACK OF TRANSPERENCY - actually almost everthing policy makers does from TARP to accounting changes works the same way: Adding layers of non-transperency!

Back to our Investment meeting:

The investment meeting had following conclusion:

The three driving premises for our research remains:

1. Cost of funding drives market and valuations
2. Price of liquidity new unknown (tax on money)
3. No prior analogy historically will work (because this is different, very different)

The market has re-entered negative bias - we still look for minimum 765.00 in S&P.

We remain at 75% cash but now we use the 25% for downside plays in markets

We favor being short stock markets, long US dollar (US Dollar balance sheet issue is back with year-end), short commodities and long fixed income.

Our asset allocation model (100% mechanical expects 1 month return of:)

MSCI World: -0.77%,MSCI EMG: -0.84%, Commodities: -1.22%, and Bonds: +0.87%

The model allocates as follows: Short 10% MSCI, Short 34% MSCI EMG, short 7% commodities and long 47% bonds - this is our WORST Scenario: OUTRGIHT bearish. The model is based on our leading Global Indicator Model - and regression analysis of expected return. It is not an exact science, but its a mechanical way of getting expected returns from one consistent source. The expected return from this allocation is: +1.75%

Economics

Incoming data continues to accelerate negatively - our model and forecast does not see any improvement in the next month.

The political landscape is getting more complicated. Treasury only got 40 bln. US Dollar left on the initial 150 bln. USD - and Paulson will soon be back in Congress asking for more, and the Democrats wants him to "fix" the auto-industry - making the bill bigger and bigger.

The fastest deaccelerating economies remains Sweden & Australia (hence best government bond buys).

Fixed Income

Credit remain scarce - credit spreads are not really moving - market starting to look at year-end balance sheet, and we expect serious deteriation of credit facilities and more and more corporate blow-ups like Circuit City yesterday.

We like Bunds over Treasuries. We like TIPS still.

Equity

Earnings forecast still too high - market looking for +15% 2008/2009 earnings. Per share it is at least 35-40% too high - I remain extremely sceptical on all earning forcasts with a positive sign on them - the insolvent private consumer is going to hurt EVERYONE in the business cycle, seems the analyst' have not been in out shopping recently.

I have to warn you - this is only the beginning - the next few month will be the worst part of this cycle - as several forces works against the markets:

• Bankrupt consumers
• Insolvent banks
• No credit creation
• Policy solutions based on hope
• The "everything is "really"cheap "relatively" clowns
• High expectations to G-20 meeting & incoming President Obama

We are short Stoxx50 & S&P. No longs at all.

Commodities:

Crude should hit 50.00$ - Gold below 680.00 - There is no value in commodities in this part of the cycle.

Conclusion

The meeting had higher conviction rate - we are now yet again outright short the markets - break of 895.00 on the close will confirm intermediate top in place - in STOXX50 this translates to 2540.00. Watch VIX above 63.00/64.00 will confirm next bearish leg has started.

We are: Short Stoxx50, long EURHUF, short EURCHF, short EURUSD, long Bunds - looking to sell crude, to buy some Private Equity & TIPS.

This is extremely important week.

Finally,

I am just back from Dubai - I had the pleasure of spending the Sunday in the Desert - you must try it - makes you realise how insignificant ones life is in the grand scheme of things - but what a place, the quietness and light... amazing.

Safe trading,

Steen

Too many people are thinking of security instead of opportunity. They seem more afraid of life than death.

Too many people are thinking of security instead of opportunity. They seem more afraid of life than death.
James F. Byrnes (1879 - 1972)


Dear Investors,

S&P from here 800 or 1200? (click chart to get larger version)

We are in period which mildy could be said to be "volatile", but we are getting towards the total panic needed in every crisis. I will not try to be brave or give any advice but I will give you my scenario for this tumultous time.

1. To stop this crisis the Government & Central Banks needs to get ahead of the curve not behind. This entails giving LARGER THAN exepected rate cuts, bigger than expected capital injections into banks - and redoing their communication policy - broadbased comments are not appreciate in a market market looking for laser-precise answers to the enigmas of the financial markets


2. Adding stocks to my personal account going from 99.5% cash to 50% cash-I have been - remains 85% in cash in my funds- and in the PA account I have been 99.5% long cash - I have this morning added a number of stocks onto the PA account -( pardon this being danish stocks but my private bank does not seem to have noticed there is equity markets outside Denmark) - but I added: Danske @ 88.00, Novo @ 263, Maersk B @ 34.500. I have NO PREDICTIVE POWERS - but really - if you like me, have been 100% cash for the last year you need to start allocating somewhere... I am starting now (For disclaiming purposes I also added Danske & Barclays to my hedge fund accounts...)


3. The outlook from here is a bifurcation: Either bounce to 1200-1300 or direct to sub-800......(check the chart)


4. Carnage is fully pricing collapse now - remember a while back I wrote about this mechanical fund who in their September newsletter proclaimed: "It is dangerous to be in the market, it is even more dangerous to not be in the market!" - I kid you not that fund is now down 70% for the year - so my point is: The last of the "remain invested jerks" are disappearing - the financials market equivalent of a clown sorry joke: Jim Cramer wants to sell all my stocks and go to cash! (He is ALWAYS wrong - only beaten by Greenspan, who is the best inverse indicator ever)


5. The policy reaction function is different in the US and Europe. One must acknowledge that Europe have greater power to do "UK like" baning bail-outs than the US - All options are open to Europe but due to the idiotic EMU construction it does lack European Treasury to co-ordinate anything - meaning it look and feels like piece-meal solutions, but at least they are not bounded by Congress. In the US Bernanke & Paulson are limited by needing broadbased political support - and we know how that works in the US --- or rather how that DOES NOT work - the US election cycle could... and I mean could mean we need to BUY EUROPE vs US - the trigger would be full fletched banking support in Europe which US can't copy ==> outflow from investors -- I am getting closer and closer to triggering UPSIDE EURUSD based on this.

Strategy

Despite being almost the parma bear on this- I simply can not be NET SHORT stocks any longer , so... I remain 85% long cash, but I am now using the 15% to buy UPSIDE STRATEGIES... on S&P, USDJPY and banking shares........

In our Weekly Investment meeting we came up with three "premises" which one needs to learn, respect and understand:

1. Cost of funding drives market & valuations (old fixed income theorem now moved into fx, equity and commodity)


2. Price of liquidity essential and REAL PRICE (tax on money)


3. No prior analogy historically will work (This is different, very different)

I will let Mark Twain end this blog: "I am more concerned with the return of my money than the return on my money".

Good luck,

Steen

Where is the Market Going ?

(click on chart to enlarge!)

Monday, Monday, .......Midday update

Classic fund manager dilemma - although this is not like anything I have seen before in my career, I feel tempted to go square from short everything more on a gut feeling than anything else - and trust me gut feelings are overrated so I will stick to our key targets (see below)

Massive rate cuts are coming - maybe even before the open today or tomorrow open - The authorities thinks in steps:

1. Bail-out

2. Rate cuts

3. Direct intervention (in bonds and stocks)....

We did step 1.) now and step 2.) is coming if not working either - we will move to step 3.) which will be unprecedented in Europe & North America but not in Asia....

The reaction off rate cuts could be: 2 min.'s rally or a longer bounce based on cheaper funding - there may still be pockets of desperation but it will be cheaper.....

I maintain as per my blog Friday - merely refinancing/bailing-out mortgage portion of risk will only help temporarily - We know the banks are "misrepresenting" the trust, this morning papers full of how Lehman told the less than honest truth about their true need of capital.

Direction key determinator will be bond market, and probably Bunds... if we are going to see action 2.) and 3.) we need furhter flight to quality.

Statewide banking guarantees - well ,well, it will not work - when everybody does the "arbitrage" goes away, its against EU regulation, it increases financial long-term burden(more debt), Widens funding rates for governments(through higher bonds premium) and it floats capital market with bonds..... Ergo: back to square one... but it does mean banks can keep their depositors, it also ironically means there is LESS CHANCE of bail-out for next bank in trouble - as the customers are already safed, why safe the bank frame-work?

Short-selling ban will by "law" disappear three days after President sign bail-out into law - Will be interesting - my estimate it will increase liquidity and get volatility back down, plus obvisously take CDS spreads down, as they have been the short financial proxy of choice.

Strategy:

Cash 90% - now, +5%
Small long US dollars versus EUR
Was small short european stocks - but awaiting resolution on rates...
Long Dec - EDZ
Long CHF vs GBP options
Small, small upside option on stocks...

We are entering the acceleration part of this market, one which creates more losers than winners...........I am keeping my powder dry - awaiting better risk/reward.

Our KEY targets remains:

S&P 867-00 (Was 1100 untill early August)
EUR 1.3500 - almost reached, we move it down to 1.30000
Yield 10 yr - when the US dollar hoarding done we expect the final bubble of this cycle: low interest rates to start playing for real. We see LT rates in the US in 8-10% in 2009....
GOLD --- 1000 US Dollars
Crude- 80-100 for balance of this crisis, then 200 US Dollars next year.

Trade smaller size, be active, be prudent, listen not to what they say, but observe what they do....

Steen

A little learning is a dangerous thing but a lot of ignorance is just as bad.

A little learning is a dangerous thing but a lot of ignorance is just as bad.
Bob Edwards

I have decided to explain the crisis and why the plan is useless once and for all to myself - it is really an economy of scale issue as it is the question I get the most (Yes, I know you are wondering why people even bother to ask me anything being an European Elitist Arrogant High-horse something as a "friendly anonymous visitor to my site called me!)....these days....but let me try:

The background is this:

Imagine you have a bank - for arguments sake let us call it : Banque Paulson & Bernanke - their corporate motto's is: "We create moral hazards better than anyone else -faster".....

This bank BP&P got an asset side which really mimics a traditonal portfolio:

A little stock, a little government bonds(10%), a little (sorry a lot) of mortgages(30%), a little lending(40%), a little Real Estate(20%) and other on-and-off balancesheet vehicles...

- It is - obviously- all funded day by day in the money market.

The portfolio is leveraged 10 times - which happens to be the average leverage in commercial banks.

Now - the market (portfolio) is down 15% - meaning you are insolvent by 50% -- i.e 10 x 15% = 150% minus your capital = -50% - but your "bank" --- allows you to keep the portfolio because tomorrow they "hope" the market will be better.....(The Church going traders I call them..)

Then one day the Congress and its two parties called We-got-zero-clue and We-got-even-less-clue gets call from The White House - some geezer who doesn't know what an CDO is shouts: "Fire, Fire - pants on fire ......." Please send in the Mortgage Firebrigade..... fast!

Congress goes into panic and decides they will buy ALL MORTGAGES and ALL MORTGAGE INSTITUTIONS in the country.

Fine.....but hang on... lets go through this...

If the GOVERNMENT buys only the mortgage loss from my portfolio what happens next?

Well if we deal a market-prices the mortgage portfolio is off my book @ 20 cents in the dollar... so my cash goes up but the loss remains in place plus taking 30% of loss off still leaves me short a few bucks...but even if they bail-out out without loss' on my mortgages I am still short: (100 USD - 30% in mortgages equals 30 USD x 10 leverage = 300 USD x 15% loss = equals 45 USD loss....so I am getting 45 USD back - but I am down 50 USD net - leaving me 5 US dollars short (Yes, this is constructed portfolio but.. point is still the same....)

- and IF... the others parts of the portfolio continues to fall --- BP&B is still even more insolvent.

Why?

Because you are NOT dealing with the real issues:

1. Funding is done day by day - with massive mismatch in time - Bad business model is environment of scarce credit creation.
2. Leverage - in a perfect storm EVERYTHING becomes correlated. .meaning falling...
3. Mortgages - there are 4.5 mio. unsold homes, so whether government or private sector owns them does not matter - its all math.....
4. Solvency - portfolio of BP&B still insolvent - why should anyone deal with them?
5. Transperency - how do I know BP&B is honest?

The right solution would be to let everyone go bankrupt - but if you want to spend the tax payers money the government needs to think like a Private Equity Fund - buy on the bid, restructure balance sheet,give new management upside in equity, sack the old management, and buy equity upside leverage.

There was God forbid an excellent Swedish model for this before - Imagine that recommending anything Swedish is a first for me......but DO realise this is PURE SOCIALDEMOCRATIC policy and hence I can not support it, but it did work before....

So......if the deal adresss real issues it will work, but I doubt BP&B will survive longer than a few quarters more, and neither should they....

Strategy:

Calling it a strategy is an insult to the word itself, but.....

85% cash
Long USD vs EUR as we broke uptrend since 2000 - meaning lower EURUSD
Small short T-bonds
Small long upside stocks...

Nice week-end

Steen Jakobsen

The morally bankrupt US Government

I have short comments on the weekends bail-out; Now we got:

• Higher energy prices
• Higher food prices
• No credit creation in private sector...

and courtesy of US Government

• Much higher yields! T-bonds down close to two full points in Asia.

The US Government must clearly think we are idiots - the above cocktial should mean higher stock prices for sure - if you live in Fantasy-land!

I am only involved through options but this could be case of 3% up but week down 10%

Excellent link here: http://abnormalreturns.com/ (weekend link fest)

Good luck - the only guarantee for now is: Higher volatility.

Will give full report Tuesday - in transit back to office.

Steen