I usually reserve the tongue-in-cheek blog posts for Fridays.  Most people are usually doing interesting things on Friday;  generally reducing the amount of people who read our attempts at wit.  As it is, tomorrow looks to be pretty busy here at Altair, so this week’s post arrives on a Thursday.  I apologize in advance.

Today’s theme:  Big Things that are Smaller than Apple.

Apple’s market capitalization has now surpassed 1/2 trillion USD.  Arguably, that’s pretty large.  What follows is a list we’ve compiled of things smaller than this tech juggernaut.

  • The Gross Domestic Products of: Switzerland, Poland, Sweden, Norway, Saudi Arabia, and Taiwan.  Upon hearing the news (honestly), Poland felt the need to respond by stating that GDP is only a measure of one year’s production.  That said, the country of Poland is actually worth more than Apple (I guess they used some kind of NPV calculation or discounted cash flow model).  So… “Take that” Apple.
  • Worldwide lottery sales
  • The entire US retail sector’s market cap
  • The value of all NFL franchises combined, then multiplied by 10
  • All the gold at the New York Fed (which happens to be the world’s largest holder of gold)
  • The entire US bank bailout multiplied by 1.25
  • The entire US meat industry
  • The total revenues of the global mobile phone market
  • 2010 US corporate tax receipts, multiplied by 2.5
  • The combined cost of the Space Shuttle Program plus the Apollo space program
  • Every home in Atlanta, GA…  combined

Yet, despite its size, there are still a handful of things larger than Apple:

  • Political rhetoric
  • Central bank hubris
  • Poland’s self-image
  • The monthly number of high frequency trading “orders” that are withdrawn without being executed
  • 6 months of US deficit spending
  • The number of Republican primary debates held in 2011-2012

Who knows, by next week Apple may be bigger than those.

While compiling a list like this, I can’t help but get nostalgic for the past decade.  Names like Cisco Systems and Applied Materials were the objects of similar comparison.  For the 200+ hedge funds now holding Apple, it’s been a great 2012-to-date.  Let’s hope that the story ends differently this time than it did last decade.


Leave it for the Groundhog… well, maybe not.

There’s really no point in going into deep detail about the markets’ returns in the third quarter.  Simply put, they were awful.  All indexes were down double digits while some, like the Russell 2000, were down over 20%.  Macro fears have dominated the market since early August when US debt was downgraded, and ongoing disjointed responses to the European crisis moved the markets daily.

Perhaps most troubling in the short term, are the high correlations among all stocks.  Right now, correlations are in excess of 97% (with 100% meaning all stocks move identically).  The problem with these high correlations is that there is no differentiation between good stocks and bad stocks.  In the long/short universe this makes adding alpha incredibly difficult — as great longs and weak shorts are treated nearly identically.  Such is the side-effect of macro driven markets, but it should afford some nice opportunities once the correlation breaks.  Meanwhile, it’s merely an exercise of trying to avoid “death by 1, 000 papercuts.”

It also requires locating asset classes that inherently can’t get locked up in this correlation accident.

On another thought, buying insurance against Morgan Stanley’s 5-year bonds got very interesting recently.  So interesting, in fact, the pricing would indicate that Morgan is now less creditworthy than banks in France and the UK.   At these pricing levels, the market is saying Morgan is as risky as the banks in Italy.  Take a look at the graph below for a sense of how quickly the CDS (insurance) went parabolic:

There are a few reasons Morgan may be in the cross-hairs.   First, they are rumored to have a lot of gross exposure to French banks.  Morgan, in their own defense, would tell you that exposure is hedged to nearly zero.  The problem the market has with those hedges is its inability to determine if the counter-party is solvent (ie. will the hedge ever be able to pay off?).  Second, Morgan has large exposure to China.  The slowdown in China is not good news to Morgan.  And finally (and possibly most dangerous), Morgan is a retail broker; not a bank like Goldman or Bank of America.  The difference is material.  The banks have a lot of liquidity available in the form of customer deposits.  Brokers, on the other hand, rely on short-term borrowing for liquidity.  If that market were to dry up, Morgan would become… well…  Lehman.  I’m not predicting that’s how things will come down, but these CDS are worth watching.

I’m not in the business of prognostication.  That is best left to the groundhogs.  Yet, I can’t help but think the equity markets are due for a short-term rally.  It’s nearly impossible to find any pundit talking positively about the market.  Further, October is generally not the best month for the market (he said in a massive understatement).  Finally, indicators like Morgan’s CDS are pricing in Armageddon.  The contrarian in me can’t help but look at these things and sense that the market is oversold.  Those wanting out of stocks are (or are nearly) out of stocks.  When there are no sellers left, short-term prospects are bullish.

Have a great weekend and an even better 4th quarter!

Confidence versus Consumption

As I was getting out of my car this morning and crossing the parking lot to my office, our landlord flagged me down.  Now, I’ve only seen this guy five or six times in my life, and each time the news wasn’t good.  “You’re office got flooded last night, ” “stop bringing your dog to work, ” and “don’t block the chiropractor’s reserved parking space” are the typical conversations he and I have had in the past.  Today, though, he seemed concerned about me.  Genuinely concerned.

“How are you guys holding up in the market these days?  Still making money?  I heard a lot of hedge funds are losing a lot of money this year.”  I assured him that we’re doing just fine and thanked him for asking.

As I continued across the parking lot it occurred to me that he might…  just might… not really have a humanitarian concern about our financial well-being.  Apart from our rent-paying ability, that is.

It must be tough out there.  Even tougher than I imagined.  What difficult economic times are these when landlords have to stand in the parking lot to gauge the rent-paying ability of their lessees!

About two hours later, the Michigan Sentiment of Consumer Confidence numbers were released.  Looking at the report, I better understood my landlord’s angst.  The index was expected to print at 62.5.  It came in at 54.9.  To give that number some context, the index hasn’t been that low since the third year of Jimmy Carter’s term.  With consumer confidence this low, angst is just part of the landscape.

What strikes me as odd about the Consumer Confidence number is that it came only 90 minutes after retail sales numbers were released.  Overall, retail sales were in line, and retail sales ex-autos beat expectations.  How is it that consumers feel as badly as they did way back when mortgage rates were at 12% (1980), but are spending their money faster than expected?

Maybe the answer lies in how Apple and Exxon Mobil keep trading places as the largest company in the world.  Despite high unemployment and lack of overall confidence, every consumer needs an IPhone, an IPad, and gasoline.  It seems that our economy has become bifurcated.  On one hand, high-end and fashion stores are doing quite well.  Look at Tiffany’s and Apple.  On the other hand, those selling necessities are holding there own (although I’ll concede even Wal-Mart is beginning to see declining traffic).  In the middle, the pain is being felt.  Restaurants are suffering as more people opt to eat in, for example.

Maybe it’s a reflection on how the middle class is disappearing in our country.  The rich shop at Tiffany’s and the poor eat at home.  Or, maybe it’s a reflection on shifting priorities.  “I have to have an IPad, so I’ll skip this month’s car payment.”  While we’re not in the business of making either political or sociological statements, I wonder about the investment implications.  It wouldn’t seem that these patterns could persist over long periods of time.  Can firms like Apple continue to pull discretionary income from an ever-more-cash-strapped consumer?  Can the rich continue to conspicuously consume as society becomes more polar in terms of wealth?

In addition to the usual macro factors we watch, the seemingly irrational spread forming between confidence and consumption has now been added to the mix.  The odds may be higher that consumption will come down to meet confidence rather than the other way around.


We have been openly wondering  for the past couple of weeks, how S&P would react to the new debt ceiling deal.  Well… the answer is in!  The envelope please…  And the rating for These United States of America is now AA+.  Yep, downgraded from AAA.

Hungary called and wants its rating back.

So, Moody’s and Fitch maintained our gilded rating, but S&P had the unmitigated gall to drop the credit rating of the world’s Reserve Currency.

What does this mean for stocks on Monday?  Probably very little.  Despite the downgrade, the U.S. is still the most financially stable economy on the planet Earth.  By and large, the rest of the world is worse off, and if the downgrade inflames the global crisis atmosphere, U.S. assets will become more desirable.  I would not be surprised to see Treasuries to rise on the downgrade, the dollar to rise, and gold and silver to fall.  At least in the short-term.  Once you’re through the Looking Glass, everything can be upside down.  And the “logical” trade can end up being devastating if you chose to place it.


What follows is an extract from the downgrade announcement by S&P:

“The political brinksmanship of recent months highlights what we see as America’s governance and policymaking becoming less stable, less effective,   and less predictable than what we previously believed. The statutory debt ceiling and the threat of default have become political bargaining chips in the debate over fiscal policy. Despite this year’s wide-ranging debate, in our view, the differences between political parties have proven to be extraordinarily difficult to bridge, and, as we see it, the resulting agreement fell well short of the comprehensive fiscal consolidation program that some proponents had envisaged until quite recently. Republicans and Democrats have only been able to agree to relatively modest savings on discretionary spending while delegating to the Select Committee decisions on more comprehensive measures. It appears that for now, new revenues have dropped down on the menu of policy options. In addition, the plan envisions only minor policy changes on Medicare and little change in other entitlements, the containment of which we and most other independent observers regard as key to long-term fiscal sustainability.  It is possible that interest rates could rise if investors re-price relative risks. As a result, our alternate scenario factors in a 50 basis point (bp)-75 bp rise in 10-year bond yields relative to the base and upside cases from 2013 onwards. In this scenario, we project the net public debt burden would rise from 74% of GDP in 2011 to 90% in 2015 and to 101% by 2021.”


The response from the Federal Reserve’s Board of Governors, taken directly from their website:

Joint Press Release

Board of Governors of the Federal Reserve System
Federal Deposit Insurance Corporation
National Credit Union Administration
Office of the Comptroller of the Currency
For immediate release
August 5, 2011

Agencies Issue Guidance on Federal Debt

Earlier today, Standard & Poor’s rating agency lowered the long-term rating of the U.S. government and federal agencies from AAA to AA+. With regard to this action, the federal banking agencies are providing the following guidance to banks, savings associations, credit unions, and bank and savings and loan holding companies (collectively, banking organizations).

For risk-based capital purposes, the risk weights for Treasury securities and other securities issued or guaranteed by the U.S. government, government agencies, and government-sponsored entities will not change. The treatment of Treasury securities and other securities issued or guaranteed by the U.S. government, government agencies, and government-sponsored entities under other federal banking agency regulations, including, for example, the Federal Reserve Board’s Regulation W, will also be unaffected.

Altair Monthly Commentary – July

Stock market activity for June was a tale of two markets.  The first 26 days of the month were characterized by stock prices falling 8% as the market wrestled with the crisis in Greece and the ending of the Fed’s QE2 program.  On June 21, Greek Prime Minister George Papandreou survived a no-confidence vote leading to the subsequent passage of a Greek austerity package.  Despite days of rioting in Athens, the markets viewed the austerity (more specifically the cash infusion Greece will receive because of it) as a major positive and rallied 6% in the last four trading days – ending the month with a 1.6% loss.


As investors returned to embracing risk, the expiration of QE2 put substantial pressure on the bond market.  During the last four days of the month, yields on the 5-Year Treasury rose from 1.37% to 1.76%.  Thus far, the end of QE2 has had the most impact on the short end of the yield curve, though longer-dated maturities have fallen in value as well.


From a macro perspective, the resolution of the Greece’s mid-term fiscal plan takes some pressure off European Banks and the possible spill-over into U.S. money markets.  The 12 billion Euro bailout tranche expected to be delivered in early July will cover Greece’s financing needs until mid-August.  Meanwhile, the French have floated a plan for holders of Greece bonds to roll-over 70% of their maturing bonds in exchange for receiving 30-Year paper in a special-purpose vehicle with a minimum yield of 5.5%.  This idea, while elegant, is not without its problems.  First, it is not clear that the ratings agencies would let this restructuring occur without declaring it a default.  Second, the plan would require the European Central Bank to hold its Greek debt to maturity – and it is questionable that the ECB would agree to such a restriction.  Third, the interest rate that will be required on the rolled-over debt will be a significant burden on Greece.  Considering these factors, Greece remains a point of interest from a risk-control standpoint.


As this is the end of the second quarter, we will be watching corporate earnings reports quite carefully for signs that the economy is not sliding back into recession.  The lack of negative guidance leading up to the quarter-end has been encouraging, but the expectations for strong earnings have set the bar rather high.


Altair Hedged Equity’s 10th Anniversary


June 30 marked the 10th anniversary of Altair Hedged Equity’s launch.  For me, that milestone brought two things to mind:  First, it warrants a sincere “thank you” to the clients who have trusted us over the past decade with stewardship of their wealth.  We are fortunate to have a great client-base that has stood with us through what can only be characterized as an “interesting” decade.  Second, it seemed like a good time to reflect on where the Fund has been over those years.  Viewed from the tree-top level, we’ve been through two bear markets and two bull markets – all of which tended to be fairly dramatic.


The Fund’s focus on delivering consistent returns was tested immediately upon its launch.  From July 1, 2001 to October 9, 2002 the stock market dropped by 37% as the tech bubble burst.  Hedged Equity made it through that stretch with a total loss of 6.8% and was back to break even eight months later.


From those October 2002 lows, the stock market went on a four year bull market run – gaining over 101% before reaching its apex October 9, 2007.  During that same timeframe, Hedged Equity posted gains of 73%.


Next in line were the financial crisis and the associated bear market in stocks.  From its peak to its nadir on March 9, 2009 the stock market shed nearly 57% of its value.  Hedged Equity traversed this bear market with a 9.3% decline in value.  That 9.3% decline proved to be the largest drawdown Hedged Equity would have experienced in its history, and was recovered in 14 months.


Finally, we had QE2 and the stock market’s melt-up.  With remarkable persistence against major macro-economic headwinds, the market nearly doubled – adding 95%.  This period, from March 2009 through June 2011, represented Hedged Equity’s most difficult time-frame from a relative performance perspective – as the Fund increased by just over 15%.


Taking these four cycles together, the stock market is up 31% since our launch, while Altair Hedged Equity has gained 69%.


And while we take a modest amount of pride in the totality of our work over these past 10 years, we continually apply a critical eye to our performance; both in relative and absolute terms.  The basis of this critique is always in the context of our stated objective:  To deliver consistent of returns over a full market cycle.


During the past few quarters, I have had some enlightening conversations with our clients.  Some shared our cautious macro view; others became increasingly uncomfortable with the disparity between our Fund’s returns and those of the stock market.  One such conversation involved a gentleman I’ve known for the past 28 years and who has been a client for the past 10.  He was the boss at my first job out of college, became a business associate in later years, and ultimately a client.  Because of our history, we speak quite candidly.  The crux of the conversation came down to this:  his overall target rate of return when we began working together was 8%.  With the losses incurred during the financial crisis, his annualized return was closer to 6%.  He viewed the past 27 months as an opportunity for his portfolio to “catch up, ” and we failed to keep pace with the market.


As is often the case in relationships that began in a mentor/student environment, the client took the time and effort to help me dissect the Fund.  We discussed our macro view in great detail.  We went down the list of our sub-advisors one-by-one, covering their strategies, their performance, and their outlook.  We shared our thoughts about the future of interest rates, equity valuations, commodities, and the regulatory environment.  In the end, we agreed on nearly every philosophical and mechanical point – we just could not reconcile the disconnect in relative performance.  Ultimately, we decided to part ways, remain friends, and I worked closely with his new advisor to insure a smooth transition.  The client did reserve the right to come back to Altair at a later date if he had a change of heart!


I share this story because I think it is important to provide some insight into what we have been thinking lately.  That includes our self-analysis as well as the acknowledgement that some of our clients have sincere questions about our relative performance since March 2009.


As I mentioned earlier, consistency of returns is our primary objective.  To achieve that objective, we use the same tools in both bull and bear markets.  Those tools include diversifying to avoid unique risk, short-selling to reduce systemic risk, and sourcing returns from areas unrelated to the direction of the stock market.  Sometimes, like 2002 and 2008, the success of this approach is gratifying.  Other times, it is one of the most difficult parts of our job.  But how we feel about our strategy over different time frames is largely beside the point.  We are paid, to put it quite simply, to assess possible outcomes, assign probabilities to those outcomes, and allocate capital in a way that reflects these probability-weighted outcomes.


There is nothing emotional about that process.  Whether the feeling is fear like that after the collapse of Lehman, or joy as the stock market doubles, succumbing to the emotion would lessen the likelihood that we could continue to deliver consistent returns.  And if we fail at that, we would forfeit our reason for existing as part of someone’s portfolio.


So, as Hedged Equity starts on its second decade, I want to thank you all again.  And, as always, I invite you to call or stop in for a visit if you have any questions or comments.