intelledgement (95.21)

1Q09 Intelledgement Macro Strategy Investment Portfolio Report - 2

April 24, 2009 – Comments (0) | RELATED TICKERS: SLV , SCC , DBA

Analysis: As we discussed last quarter, the watchword continues to be volatility.

Our strategy is to look for long term investment opportunities congruent with macro trends, such as the rise of the Chinese, Indian, and Brazilian economies while tactically hedging against risks such as the collapse of fiat money in general and the dollar in particular with commodity plays. However, the systemic risk we have experienced over the last nine months has engendered extraordinary volatility—both down and up—as the market has struggled to process and integrate extreme eventualities into valuations. The intrusion of politics into economic decision-making has exacerbated this volatility. Consider: under normal circumstances—let’s say, from March 1950 through June 2007—the average daily change in the value of the S&P 500 index is 0.57% (up or down)…but since then, here are the number of days in each quarter categorized by the daily move up or down rounded to the nearest percentage, and the overall average:

Year	0% Days	1% Days	2% Days	3% Days	4% Days	5% Days	6% Days	7-9% Days	10%+ Days	Average Daily Change
3Q07	27	23	10	3	0	0	0	0	0	0.83%
4Q07	23	27	8	6	0	0	0	0	0	0.97%
1Q08	10	33	13	4	2	0	0	0	0	1.27%
2Q08	33	18	10	2	1	0	0	0	0	0.75%
3Q08	17	21	15	4	3	3	0	1	0	1.53%
4Q08	4	19	6	9	9	5	5	5	2	3.27%
1Q09	11	17	14	9	4	4	1	1	0	2.00%

Thankfully, in 1Q09 we backed off of the surreal level of volatility experienced in 4Q08…which is to say, instead of nearly 6x normal volatility, we “only” had 3.5x normal. But the point is, when we are experiencing single days when the market moves as much as it normally moves in an entire year, one’s perspective as to what constitutes a “long term investment” is subject to being telescoped.

There’s trouble, right here in River City. In living beyond our means, we’ve been digging our own grave for years, and the new U.S. administration’s main plan to fix the problem seems to be borrowing (more) money to afford everyone the latest and greatest new shovels. As we have said before, we got into this mess by overspending, borrowing beyond our means, and speculating on bubble-valued assets. Any “solution” that involves lowering interest rates, increasing our debt levels, and easing credit/issuing more money is, essentially, attempting to put out a fire by dousing it with gasoline. The government does not have the resources to “rescue” all the zombie banks whose obligations exceed their assets, not to mention all the homeowners whose mortgage obligations now exceed the value of their properties, not to mention all the industrial companies whose profligate and short-sighted management have left them vulnerable to the economic tsunami we are experiencing…etcetera, etcetera. Yet it appears this is to be our plan of action…along with providing universal health care, switching to more expensive energy, building highspeed rail systems…etcetera, etcetera…all with (more) borrowed funds.

And we don’t believe the economy has bottomed out. The negative feedback loop of less demand-more unemployment-less demand is still intact. There are many more residential foreclosures looming, which will continue to devalue housing prices, which also inhibits demand (as consumers are less wealthy). And more credit card defaults, which dry up credit, which also inhibits demand. We’ve barely begun to scratch the surface of commercial real estate foreclosures, and the concomitant bad loans, and the ramifications for the lenders.

So we believe things are headed south. And yet, in March we sold half our short ETFs (that go up when the market declines). Why? Because this market is so volatile, that we felt it was risky to stay short in the face of “obtimism” that the new administration would somehow work a miracle. We held our short positions last November in the teeth of a post-election rally…and saw the value of the portfolio decline 29% in six weeks. Once burned, twice cautious. But, unfortunately, we do expect to be going short again, this quarter or next.

Conclusion: Things will almost certainly get worse; the real question is, how much worse? As of 1 April, we retained three inverse ETFs in the portfolio…covering the consumer goods (SZK) and services (SCC) sectors as well as long-term Treasury bonds (TBT), which we expect to decline in value as interest rates inevitably rise in order to entice buyers of the copious outpourings of US debt. We still expect the cumulative effect of the liquidity injections and increased need for borrowing by the USA to eventually degrade the dollar’s value, and consequently remain long our commodity plays (GLD, SLV, and DBA). And finally as a hedge against a quicker-than-anticipated recovery, we still retain our China and India emerging market funds (FXI and IFN)—as we expect those economies to lead the recovery. If the rally that ensued in March persists, we may further lighten up on the shorts and temporarily go long energy or Brazil.

But batten down the hatches. Upgrade your vegetable patch, make sure your emergency supplies of batteries, dried food, and water are current, check the ammo for your shotgun, and touch base with the neighbors to encourage them to be prepared, too. The odds still favor things not getting that bad…but those odds are not as good as they were three months ago.