Buy And Hold What?

June 24, 2009


More Bubble Trouble

At this time, I am ignoring short-term bullish trends in the equity markets in favor of long-term fundamentals.

The markets are at risk of exploding to higher prices that are even more detached from reality than they are now. Our portfolio, the Arrow Insights 75/50, has reduced its gross holdings by 21% after selling 26% of long and 2% of short Treasuries (TSY) positions over the past four weeks.

Asset Inflation Coming Into Play

Our biggest asset management problem is asset inflation. There is too much money chasing too few assets issued by entities with insufficient income to pay their debts and still offer high earnings growth.

Currently we are seeing a replay of the 2007-2008 easy money-driven commodity and resource inflation stemming from the unintended consequences of the Fed's attempts at bailing out financial and industrial firms. Speculation, driven by easy money, is also divorcing asset prices from fundamentals.

Two negative unintended consequences are high gasoline prices and mortgage rates. Gasoline was at $1.62 in December 2008. It is now at $2.70 a gallon, while mortgage rates are approaching 5.4%. Higher gasoline and higher mortgage payments will strain consumer spending and dampen a home price recovery.

Our current crisis has had four waves: the collapse of a debt bubble; the bursting of a housing bubble; systemic financial system risk; and an economic recession.

The fifth and final wave will be a three- to five-year period of high corporate credit defaults with the risk of a U.S. currency and a government debt crisis.

Our position is that Treasury bonds are in a sort of “make believe” state and that corporate bonds have gotten ahead of themselves—as have domestic and foreign securities.

Emerging market investors are ignoring post-financial crisis lags more so than other indices, while the U.S. technology and health care sectors via the Nasdaq 100 are favored, given the index’s current value and long-term fundamentals.

Gold and gold stocks are no longer undervalued but they continue to hedge inflation risk and U.S. dollar risk better than other asset classes, which is why they comprise a large portion of our asset base.

Our ultra-short and outright short tactical hedges are traded over a short time horizon. They are positioned for expected declines of 10%–25% in our beta holdings and gold stocks.



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