Bread Vs. Cake Part II

October 22, 2009

John Serrapere of Arrow Insights adjusts his portfolio for the troubles to come. M&A funds, VIX ETNs and commodities are attractive.


Investors eat more bread. Speculators eat more cake.

Speculation improves the health of free markets if it is the province of the skillful and the few who let their gains and losses improve economic efficiency. In pure capitalism, we all sink or swim. Anything else is something else. Globalization has benefits, but it also risks empowering nation-states that seek greater autocratic rule. Capitalism thrives on freedom.

Throughout history, privileged classes seeking the rewards of their political economy have ruined nations. They direct commerce while seeking exemption from fiscal responsibility. Many historic superpowers spent their end-days with their economies dominated by the financial sector, which has been the sector most prone to political influence and government favor.[1]

Since the mid-1980s, our national policies and the global economic system have become dependent upon excessive risk taking with huge rewards going to the few and losses allocated to the many. Archived in the research section is Issue 6 (July 2009), Deflating Fears & Inflating Hopes. This issue focused on a dysfunctional system run by gamblers who got their chips funded through nonpartisan and global economic policies.

In our September issue, we showed that the great economic moderation of the 1990s heralded as a New Era was actually a central-bank-managed economy. Bankers and regulators got out of the way of free markets while they applied increasingly asymmetrical remedies for the few.

Too much cake (debt accumulation) weakened the financial system because central banks and their political economies implemented planned economies designed to recover from the 1997-1998 and 2000-2002 financial crisis. Their plans rode the back of highly indebted

Consumers were fed primarily Asian-made products. Our energy policy also became very dependent upon oil-rich dictatorships in which freedom is a crime. These central imbalances between our domestic and global economies are currently receiving much attention. We are attempting to implement Plan #3, designed as a re-recovery from past plans!

Prior plans culminated in The Panic of 2008. Central planning has been the cause of three 100-year floods since 1997, namely an emerging markets/sovereign debt default crisis, the collapse of the technology/telecom bubble in 2000 and the pricking of the grand credit bubble in 2007. The first flood was fed by storms brewed from China-led competitive currency devaluations during the 1990s; the second monsoon rode a wave cresting from hundreds of global central bank rate cuts and overly accommodative emerging market export as well as
consumption policies initiated in 1998-1999. “Made in the U.S.A” was stamped all over the clouds that rained on our globe from 2007 to 2009. From 2005 to 2007, a debt typhoon was our largest export.

Why History (Research) Matters

Part II expands on these themes because secular alpha (long-term investment reward) is dependent upon positioning core asset allocations to advance and defend against economic fundamentals influenced by structural factors that can be imbalanced. In 2003 and 2006, we recognized conditions conducive to bull markets in the energy sectors and commodities market and a bear market initiated by an implosion in the credit markets precipitated by declining home values.

In 2003, core positions were overly weighted to energy stocks. In 2006, core positions were put on credit-watch, and during the first week of August 2007, all asset-backed credit instruments were sold along with exposures to the financial sector.[2] Tactical hedges were also traded within the context of the outliner risks resulting from energy/commodities and credit factors that impact security price trends. Energy exposures were then brought to a neutral weight in 2007-2008.[3] Currently, our portfolio is positioned to weather social/political turmoil accompanied with a
U.S. sovereign debt crisis. It is not easy to research and implement investment policies for these risks.

Wealth/income inequality is not a pleasant topic. It is emotionally charged. However, we are not at a family picnic, where it is wise to avoid political/religious talk. This is no picnic! We are at a stage of this crisis where there is an extreme risk of a long-term inflation accompanied with acute bouts of deflation.

Events may soon unfold that spill forth social unrest ignited from a powder keg of polarized political views and a sense of futility from an ongoing crisis. If so, investing will be treacherous due to exploding uncertainty premiums. Investors will demand these premiums.

Higher consumer price volatility (severe inflation-deflation) and currency volatility has been the post hoc of most global financial crises. Our Price Index Score (PIS) attempts to measure this uncertainty. We have covered PIS extensively in past issues. PIS remains in a high-risk zone.

At this time, The Arrow Insights (AI) 75/50 Portfolio favors commodities, commodity-based equities, developing market stocks, foreign bonds, inflation-indexed bonds and gold bullion. Our tactical hedges are to be short long-term Treasury bonds, short real estate stocks and long stock market volatility. Beginning with this issue, we are reporting gross returns, which produce a simulated year-to-date (YTD) return of 18.8 percent.


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