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Fellow Investor,
With global stock markets rallying sharply since early
March, the mood on Wall Street has shifted remarkably
quickly. Recognizing the importance of
"Animal Spirits" to
the global economy, the U.S. government seems now engaged in
a full court press to increase confidence in the financial
markets. Investors who bought Citigroup (NYSE: C) and Bank
of America (NYSE: BAC) a couple of weeks ago have seen the
price of their investments double. Greed has overtaken fear
in the markets virtually overnight. The question on
everyone's lips is: "Can it last?"
This past weekend, I had the opportunity to spend some
time with a few of the biggest names in the hedge fund
world. One made more money in 2005 than many small
investment management companies have under management.
Equally importantly, at one point in his career, he had
almost lost it all. So he has the invaluable perspective of
someone who has both won and lost big -- and of someone who
had invested in countries where he learned how governments
and individuals behaved in times of crisis.
The Predictions of a Hedge Fund Manager: Yet Another
Cassandra
He made a handful of predictions, most of which put him
squarely in the Cassandra camp.
1. All large European banks will go bankrupt. Their
"Tier 1" capital levels simply aren't high enough to absorb
all of the bad loans they had made to overheated European
economies like the "PIGS" (Portugal, Ireland, Greece and
Spain) and profligate new EU members like Hungary and
Latvia. The price at which the debt of these banks is
trading already confirms that their equity capital is wiped
out. As a result, European banks will "gate" their deposits
by limiting depositors from withdrawing their money from
banks to say, 1,000 euros a week.
2. At least one European country would go bankrupt over
the next 12 months. Individual countries simply do not have
the reserves to deal with a run on the banks. And unlike the
United States or the United Kingdom, eurozone countries
can't print money at will. And if the French wake up Monday
morning and see that the Irish are unable to withdraw their
money from their banks, it won't be long before the French
are queuing up for their money. The panic will spread like
wildfire.
3. The enormous borrowing required to finance the Obama
administration's deficit means that interest rates on U.S.
Treasuries are set to soar. All the government efforts are
in vain anyway. And anyone who is in political office now
will be out soon -- whether by coup in the third world or by
elections in the developed world.
4. The Chinese economy is toast. With 45% of its
economy relying on exports, China has never been much more
than a workshop to Wal-Mart. With U.S. consumers
re-trenching -- traffic to ports in Southern California is
down 35% -- the Chinese have little to offer to the world.
Even Russia is better off. At least it has natural resources
-- money it can suck out of the ground.
5. The recent market action is a sucker's rally. Gold
is the only safe haven. The price of gold is set to soar.
Call the Union Bank of Switzerland (UBS), buy physical gold
and store it in a safe. (One caveat: UBS is one of the
European banks that he argues will go bust.)
The Predictions of a Hedge Fund Manager: Do as I Do,
Not As I Say
Yogi Berra famously opined that "predictions are hard,
especially about the future." But Berra was wrong. Making
predictions is easy. It's making money from those
predictions that is hard.
Consider the case of our hedge fund manager. You'd
think that if he were so convinced of his opinions, he'd put
his money where his mouth is. He would short European banks,
short the euro, short U.S. Treasuries, short China and be
long on gold. Perhaps he has done all those things. But he
is also 90% in cash.
But don't hold it against him. Unlike most people who
make predictions for a living, he has been through the
experience of losing 98% of his money. When he is offering
his opinions, he knows that he is playing a different game.
He knows that his punchy views will get him attention. But
when it comes to managing $4 billion of other people's money
in highly uncertain times, he knows it's best to sit on the
sidelines.
The Predictions of a Hedge Fund Manager: Do As I
Say, Not As I Do
Pundits with strong opinions attract attention. After
all, when a boring corporate type speaks, most people can
barely stay awake. And as any on-air financial commentator
will tell you, the biggest sin isn't to draw the ire of
critics. The biggest sin is to be ignored.
Contrast our hedge fund manager's investment strategy
with that of New York University's Nouriel Roubini, aka "Dr.
Doom." Roubini agrees that the recent rally is a "dead cat
bounce or bear market sucker's rally." Yet, as reported in
the Financial Times, Roubini's own investment strategy has
been to be 100% long, and invested in index funds. But you
have to wonder why. If Roubini saw the global financial
system as the Titanic hitting the iceberg, why did he sit
back and watch his 100% long portfolio get cut in two? The
disconnect is almost bizarre. But it illustrates the
difference between offering predictions -- and making money.
Strong opinions are terrific. But making money is even
better. When someone whose opinion you agree with has lost
80% of your money, it can wear thin when he still insists,
"I wasn't wrong. I was early." That's why predictions are
worth taking with a grain of salt. Eighteen months ago, the
U.S. dollar, the Iranian president declared, was a
"worthless piece of paper." A year ago, Goldman Sachs' chief
economist predicted that thanks to "decoupling," China would
bail out the world economy. Nine months ago, Russian
oligarchs were predicting $250 dollar a barrel oil as they
were lighting their cigars with 500 euro notes. All those
predictions turned out to be spectacularly wrong. The
greatest speculator in the world, George Soros, has
literally written entire books that were chock full of
predictions gone awry. In fact, almost every one of his
predictions for 2008 was wrong (see my analysis
on video here). Yet Soros managed to eke out a 10% gain,
while other big name hedge funds struggled like never
before. That's the difference between managing money -- and
just talking about it.
Sincerely,
Nicholas A. Vardy
Editor, The Global Guru
P.S. Challenging markets notwithstanding, subscribers
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