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What the hedge fund manager who played the mortgage mess better than anyone thinks about where we're headed

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October 15, 2009 – Comments (4)

Even though I do not have a Bloomberg terminal, I subscribe to Bloomberg Magazine.  It's very well done.  While perusing the new issue at lunch today I came across a fascinating article about Paolo Pellegrini.  A native Italian who attended Harvard business school, Pellegrini was one of the key people at John Paulson's hedge fund when it made its staggeringly successful bet against sub-prime mortgages that propelled Paulson's Credit Opportunities fund to a 589.6% gain in 2007.

Mr. Pellegrini has since left Paulson's fund to work on his own hedge fund, PSQR.  It's always difficult to tell if someone is a one-hit wonder as many of the perma-bears who had been calling for the demise of the markets for decades were...even a stopped clock is right twice per day, but the PSQR macro fund has produced extremely strong returns thus far (2008 and 2009 YTD) so that lends even more credibility to Pellegrini.

Here's what he has to say about where he thinks things are headed:

Today, Pellegrini’s economic outlook for the next 5 to 10 years is a sobering one. He says the U.S. economy will groan under the weight of budget deficits, increased regulation and household debt. Europe will perform only slightly better, and Asian economic growth will outstrip that of the developed world. “There are going to be huge shifts in wealth around the globe,” he says. “I want to invest in that.”

Pellegrini says the U.S. stock market is likely to generate negative returns when adjusted for inflation. And the U.S. dollar will flag as an unrestrained Federal Reserve dispenses more money.

“In the U.S., there is limited interest among those in power in the stability of the dollar,” he says...

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Meanwhile, the price of scarce commodities such as oil will surge as global competition for them heats up, Pellegrini says. Accordingly, he expects U.S. Treasuries to fall in price in the long term, and he’s buying oil futures. In September, he owned Norwegian kroner and said he believed the Australian dollar would benefit from that resource-rich country’s geographic proximity to Asia...

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“People were pretending they were earning a living, and they were not,” he says. “Banks lent them the money so they could live beyond their means.”

There is a corollary to that imbalance in the global economy, Pellegrini says. Massive consumption has turned the U.S. into a debtor nation, which will ultimately lead to the devaluation of the dollar, a scenario PSQR is betting on through its long-term short position on Treasury futures and its long position on commodities.

The massive stimulus programs and the resulting deficits will only make matters worse, Pellegrini says.

The article is definitely worth a read.  At the very least it is an interesting tale about how Paulson and Co came to make a fortune by betting against mortgages and it may even be a solid prediction of what's to come. 

I have been a firm believer that the U.S. dollar will lose value in an orderly fashion as time progresses.  This belief caused me to hang on to a large portion of my stock in foreign, dividend paying oil companies even at the apex of the financial crisis.

If the dollar does continue to fall, it doesn't necessarily spell doom for America...much to many posters' chagrin.  A weaker dollar will ease the U.S. debt burden and encourage an increase in domestic production, reducing the trade deficit, creating jobs, etc...

On a related side note, I heard yesterday that Bloomberg bought Business Week Magazine.  Very interesting.  As someone who has a tremendous amount of respect for the Bloomberg organization (not the individual who started the company) I will be very interested in seeing what they do with the historically popular publication.  My father's copy of Business Week was a fixture on my family's living room table during my youth, so I've always had sort of a soft spot for the magazine...despite the fact that I do not currently subscribe to it myself.

Deej

4 Comments – Post Your Own

#1) On October 15, 2009 at 2:28 PM, JakilaTheHun (99.93) wrote:

The one thing that I believe a lot of investors miss --- you don't have to invest in overseas companies to benefit from the shifting world environment.  If commodities go up, you're not going to get beaten by buying into American commodity producers.  In fact, you might even be better off because of the favorable exchange. 

Otherwise, pretty interesting analysis by Pelligrini and I agree with a good deal of it.  I believe Europe, however, is overlooked and will perform much better than most people think.  What people tend to miss --- Europe is the most efficient continent.  Rising commodity prices don't benefit anyone other than producers and owners of commodity stocks, but they do harm Europe much less than they harm the US or Asia. 

Russia stands to benefit the most from a commodity boom, but they have some internal issues, including severe corruption.  However, if they can (choose to) manage to deal with some of that, the most phenomenonal gains could be from our old Cold War nemesis. 

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#2) On October 15, 2009 at 2:32 PM, TMFDeej (99.43) wrote:

Of note, oil is currently experiencing a strong rally, up $2.68 to a fresh yearly high of over $77. 

We've definitely been down this road before, the last thing that anyone wants to do is hop on another bubble too close to the top.  However, I think that it is important for everyone to have at least some exposure to commodities in their portfolio. 

Despite the certainty with which many express their predictions, no one knows for certain what the future holds.  That's why I'm playing both sides of the fence with some attractive bonds that I purchased at the height of the credit crisis on one end and exposure to oil through foreign, dividend-paying stocks on the other.  In the middle I have shares of strong dividend paying companies that have significant overseas business.  They will be fine, conservative investments without a drop in the value of the dollar but a drop in the USD would light a real fire under their results.

Deej

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#3) On October 15, 2009 at 4:15 PM, Rehydrogenated (32.38) wrote:

This article made me look up autralian stocks. Boy i wish i had thought of australia months ago. Everything is at its 52 week high.

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#4) On October 16, 2009 at 8:22 AM, Counterparty (< 20) wrote:

Very good blog..

The analysis for the US economy going forward seems spot on. The situation for Western Europe should be similar, although to a lesser extend as there is less of a debt problem on a consumer, municipal and state level. Eastern European nations are still developing and should still produce above-average growth compared to Western Europe and the US.

The economic balance of power that is now slowly moving towards the East (Russia, China, India)  is something which was expected for a long time, but it will be interesting to see how long it will take for China to actually become the biggest economy and how this will affect politics and overseas investment opportunies. Africa's development should pick up as well, as especially China and India will continue to need massive amounts of commodities for those 2.5+ billion people. 

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