Monday, 04 January 2010 00:00

Year End Note to BoomBustBlog Readers and Subscribers

Note to my subscribers and readers for the year end and the new year.

I will be the first to admit that 2009 was a disappointing year for my investment results. Although the first quarter of the year was the strongest that I ever had during the Asset Securitization Crisis, and I clearly saw the trend reversal coming at the end of the quarter (actually almost to the day since I put a comment out on BoomBustBlog that I was preparing for a very aggressive bear rally, but that granularity in timing was more luck than anything else), I significantly underestimated the length, breadth and depth of the trend reversal. I want all to be clear that I am not making excuses, but the probably reason for the lack of clarity was rampant and clandestine intervention in the equity and debt markets (moe on this later). There has been a lot of chatter in around the web about my performance, and although I am very disappointed at how the year turned out, I would like to put this into perspective. I am not a daytrader nor a swing trader and my research is not aimed in those directions. My stated investment horizon for the research on the blog is 3 to 18 months with a likely targeted range of action of 6 to 9 months. Since I rely primarily on the fundamentals and can't control markets and stock prices, I need to wait for my thesis to pan out.This entails taking some volatility at times. Of course I am the first to admit that the most aggressive rally in 70 years may be a bit much, but one must be able to ride the ups and downs of irrational market moves until one's thesis plays and your are proven right or wrong.This recent bear market rally was probably a once in a lifetime event, and in the case that it was not, we now have the tools to deal with it on an invested basis - even as a pure fundamental investor.

Click any graphic to enlarge.

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I need to run a delicate balance here, for I definitely don't want to understate how disappointed I am in 2009's performance, but at the same time it is pertinent that a realistic view is attained. I don't want to flagellate myself, yet don't want to be a braggart as well.

It has been 2 to 3 quarters of what I consider under-performance thus far, and I see the fundamentals coming to the fore in a very big way for the year 2010. To recap, I started the blog 9/07, and my personal account return for that quarter was about 14%, roughly annualized at 55%. The following year saw a time weighted return of about 450%, and the first quarter of 2009 saw a rise of around 50%, but I finished the year down 39%. Again, the last three quarters have been very disappointing to me as I can imagine it has been for others who are bearish, but I do want my subscribers and readers to know that this blog's (and particularly, my personal) record bests the records of the vast majority of market participants - and by a very wide margin. We are talking in the range of about 150% annual blended return for my own performance. I had 7 winning quarters out of 10, which although pales to Goldman Sachs' statistically impossible 97% win ratio (again, mine is unpowered by government hook-ups and multi-billion dollar subsidies, but I am working on that), should be commendable by most but is still quite disappointing to me. I need to hold myself to a very high bar.

The significant drawdown from the second and third quarters of this year stemmed from the fact that I waited too long to adopt a market neutral stance. This fault has been corrected and we plan to be well protected against extended movements against the fundamentals in the future through going long volatility via market neutral strategies, if the events call for it. The market neutral strategies allowed me to trade the volatility in
lieu of the fundamentals and still benefit from the potential of the fundamental research bearing fruit. See the researched strategy analysis released for subscribers at the end of this blog post that proved profitable in many of the preferred cases.

Although one could theorize that I could have knocked it out of the park this year if I went net long, I would not have done so. I am a fundamental investor and there were, literally, absolutely no fundamental nor macro reasons to be long most stocks, and the only reason to buy stocks was because the price of stocks were going up. - that in and of itself should give the fundamental investor pause. Now, this has been a glorious three quarters for the momentum investor and swing trader, both of whom relish in chasing trends, but the fundamental investor had to take a back seat as profits and losses, assets and liabilities, balance sheet strengths and insolvencies became inverse to share price performance in the investment space. The weakest companies literally gained the most while the strongest companies stood relatively motionless. I suspect the shenanigans played by the "powers that be" will wither in 2010. See the following articles for more on the possibility of significant manipulation that postponed the inevitable crash in the markets. Even for the optimistic, this must spur some thought:

If the pre-ordained crash is not the case, I have polished the market neutral strategies so as to attempt to prevent myself and my subscribers from being left out, or even worse, hurt by extreme market rallies that fly in the face of the fundamentals for an extended period of time. In essences, no more significant drawdowns unless I am literally wrong, this time around. Remember, the price of a stock's movement in the short term does nothing to dictate whether one's thesis is right or wrong. I, for one, believe that fundamental investors need to stick to their knitting and not become momentum chasers when the breeze blows in a different direction. This was painful for three quarters of this year, for the bulk of the year was a trader's market.

For the record, I would not have taken the risk of forging ahead after the 2nd quarter if I was managing outside money. The reason? I easily made my year's compensation, being up about 50% in Q1-09. Why jeopardize the 10% of that gain I would have received on a 2 and 20 basis. If I was running $100 million dollars, I would have been able to pocket a $10 million incentive fee plus the AUM fee of 2%, which would have doubled. Better to sit in cash and collect me fees. Now, since I didn't have the leverage of other's money to incentivize me to do so, I plowed forward. This was actually a time when greed would have been good.

Now, on to address some of the comments that I have received from those in the blogosphere.

Was Reggie Lucky in 2007 and 2008 or Does He Actually Have a Grasp of What is Actually Going On?

Hopefully, I have successfully communicated the disappointment in my last three quarter's performance, but I must also put those three quarters in perspective with the last 40 or so quarters.

You've just been lucky!

I have heard blogoshpere pundits quip: "You've just been lucky with calls like GGP, or Ambac, or the Doo Doo 32", etc. Well, here is a list of over 60 companies that I have been right on -Updated 2008 performance. If that is luck, I will gladly take it.

You are not willing to let go of your thesis!

A slightly more plausible criticism was, "You are not willing to refresh your historically successful investment thesis, basically you are not willing to change direction and let go of the past". This makes more sense as critique, however it is far from true. I am not only willing to alter my investment thesis, but I am willing to switch from long to short, and jump between asset classes quicker than a floozy jumps bed linen. I have no emotional attachment here, and I don't consider this a contest to determine who the smartest is.

For those who have read my bio, you know that I use to be a real estate investor. I started investing in real estate in 2000. I focused not only on high appreciation areas, but areas that also were undergoing gentrification. This gave the thesis an added boost, and I made use of the extremely high (20x+) leverage that was available at the time. The NYC areas of high gentrification saw up to 18% plus annual increases in price. You can do the math when incorporating high leverage over several years, combined with rental income. For those who do not follow me, please refer to "The Great Global Macro Experiment, Revisited" for a glimpse into my investment style. Reference the graph from this treatise below, and compare it to the actual graph of prices below that.

Understanding my proprietary investment style

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Case Shiller index has been amplified by a factor of 10x for the sake of comparison to the S&P 500.

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In the spring of 2004, I sensed the market getting much too overheated with the hurdle rate for risk adjusted returns based on rental income becoming harder and harder to attain upon property acquisition (which is where the money was made, in my opinion), hence I started putting buildings up for sale in a very heated market. I sold off the bulk of the properties between the end of 2004 and the 3rd quarter of 2005, with a final listing in the 1st quarter of 2006. As you can see from the chart above, the NY market peaked early 2006. My timing was apparently on point. To be honest, it really had nothing to do with timing, and everything to do with the fundamentals. You see, although rents and incomes in the areas that I invested in had increased dramatically due to gentrification and a bubblicious economy, they were increasing nowhere near enough to justify the price spikes that were occurring. I would have loved to have considered myself a really smart guy, which is why it appeared I was making money at a clip that easily bested the broad equity market and many other real estate investors, but the truth of the matter was the market was simply in a over-heated bubble, and I was fully aware of it. Sensing the top somewhere proximal, I decided it was time to go. I believe that all who were in the real estate game at that time and had access to a calculator or a spreadsheet knew the jig would be up relatively soon. It's just that they wanted to pick up every single dime off of the table. I am of the mindset that it is always best to leave a little money on the table. Don't be greedy. Often, that last dime costs about $1.20 to pick up!!!

I took a year off to spend time with my newborn daughter and prep for a hedgefund launch, then started shorting everything that had to with the run up in the real estate markets. I started this while most were still much too bullish on both real estate and the ecosystems in which real estate coincided. The rest of the tale is history.

This story (and accompanying chart) should also dispel the rumor that I am a permabear. I am only bearish when I see bearish signs. I was quite bullish during most of the real estate bubble, but I recognized it for what is was, a bubble - and not a reflection of my outsized investment acumen! I will be bullish on the equity markets when the time comes. Now is not that time for I do not feel that the financial assets have had the opportunity to fully correct from their bubble levels due to a constant bid and implicit put option from our government that prevents real and financial assets from correcting to a level that will bring equilibrium to the markets. Thus, another, and very significant downleg is due in the housing and commercial real estate markets, and by extension the stock markets as well. As stated above, I am prepared to profit if this thesis is incorrect, but the macro insight that allowed me to profitably navigate this entire boom/bust cycle since the year 2000 screams "this is far from over". I will gladly compare my longer term record with anybody else's. I may not be the best, but I am real and honest, and observant.

For the sake of privacy, I do not release my personal positions or statements to the public, but if you are an investor or asset manager of significant size or stature and their is a strategic reason for me to verify my personal results to support my historical success in navigating through the Asset Securitization Crisis, I am open to doing so. Simply email me here. I have nothing to hide, but since I do not run investors' money, I prefer to savor my privacy. The blog's research can be verified using the downloadable tools that I have made available via the links below. The method that I used as a proxy for the blog research (assuming a simple buy and hold) has become to cumbersome to produce and unrealistic, thus I have not continued to update it. The spreadsheets are still available for users to update on their own, though.

Hey Reggie, if you really made 500% on your portfolio in 2008 (a nice round
number), why are you peddling your research via the internet instead of just
managing your own money or running a hedge fund or living on a beach?

I have actually heard this several times, and this is a direct quote from one of those many anonymous guys in the blogoshpere. The answer is actually quite simple. The blog actually started out as an investment diary when I began the process of opening a hedge fund. I actually went through the process of creating the structures and the legal work in 2007. I then realized that I value my freedom, independence and my time far too much. I am a family man, and time with my children mean more to me than money ever, ever will. I work a lot now, but I do so on my own schedule. I have also learned that most investors are the ultimate in fair weather friends. Although I am very disappointed with the result of the two or three quarters, to be honest the losses PALE in comparison to the gains since my blog was established 10 quarters or so ago. They also pale to the average returns as well. Despite that, it appears that many only care about "what have you done for me lately" (for those that didn't get it, that's a quote from a Janet Jackson song), with lately increasing being defined in shorter and shorter time frames - time frames that don't necessarily coincide with workings of fundamental and forensic analysis.

As for why I sell the research, well I paid to develop the research, it is high quality research, and apparently there is some demand for it. Thus it would make good business sense to attempt to monetize what would normally be a sunk business costs, would it not? I actually stumbled upon the research business model by accident, totally unaware of the demand that was out there for truly unbiased, quality research.

Hopefully, I have answered most of the questions my readers and subscribers may have. I look forward to a very profitable 2010 and beyond, and while historical results will be difficult to replicate, I stand prepared to take advantage of significant moves in the market, regardless of direction for the new year. The fundamentals are speaking loudly in one direction, though.

I will be releasing a rash of new research this week, including the front portion of brand new pan-European research, and a study of those assets likely to fly in the face of the fundamentals should this bear market rally persist. I am also refreshing strategic bank research from last year.

Links of interests.

Market neutral strategy analysis

1. Recent strategy analysis sample available to the public

2. Additional bi-directional option strategy analysis

3. In this difficult to trade market, you have to be more than just right...

4. Option Strategy Analysis Comments

5. Option Strategy Analysis Update

Sample Research and Performance for 2008

We have made a downloadable sample of our research available without registration. Simply download this zip file: Research_Samples 11/17/2008, to your local machine and open to reveal the research reports in PDF format. To learn more about my proprietary investment style, see "The Great Global Macro Experiment, Revisited". The most recent annual performance numbers are available here: Updated 2008 performance. Adobe Acrobat Reader version 9.0 or higher may be needed to view the files

Last modified on Monday, 04 January 2010 00:00

10 comments

  • Comment Link fedwatcher Wednesday, 06 January 2010 03:25 posted by fedwatcher

    Since the normal "dead cat bounce" after March '09, we have seen the markets steadily rise in the face of what would be Great Depression II if not for the stimulous hosed out by the western democracies.

    We now have a false and artificial economy much like Japan after its real estate bubble popped. In such an economy fundamental values are ignored and the daily spin of the mass media lulls us into a false sence of security.

    For you to make money in this environment is extreemly dificult as you assume that "true" value will be revealed.

    But history has shown that "fiction" can be maintained for extended periods. Did not the MBS market die in March '07 only to have "us" recognize the crisis 18 months latter?

    2010 will be a dificult year. As for myself, I will concentrate on the preservation of capital rather than on mythical returns.

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  • Comment Link Reggie Middleton Wednesday, 06 January 2010 02:23 posted by Reggie Middleton

    Thanks, all. Don't get me wrong. Although I was bearish in March, I clearly saw the trend reversal coming. I closed out every profitable position that I had and just let the underwater positions run. It is just that the reversal became much more than that.

    Be aware that the printing presses theory doesn't hold water. This is NOT a liquidity run. If it was, I would have put long positions in earlier. Prices have been going up on record LOW volumes. If the stocks were being buoyed by massive liquidity, then entities and individuals would be using that liquidity to buy stocks en masse. Not only was that not the case, the were (relatively) almost no buyers. The only reason stock prices were going up was because there were less sellers. Reference the study by TrimTabs.

    Japan turned on the printing presses, and they still had asset crashes. The US turned on the printing presses and the result was the asset crash.

    The liquidity argument is being used too often without the justification to back it up. What apparently was happening was direct manipulation. With such low volume, a dedicated agent with the proper resources can place a constant bid under the market to drive prices up - particularly when there is no on on the other side to push prices down because everyone believes the market is rigged.

    As I said in the post, I don't want to make excuses, but it is useful to discover what actually happened, and not what is most convenient to theorize. I am happy to compare my record with anyone's. The reason why I am able to produce results is that I attempt to independently arrive at a conclusion versus towing the party line. As we can all see, it produces hiccups in the short term, but usually wins out in the medium to long term.

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  • Comment Link NDbadger Tuesday, 05 January 2010 21:35 posted by NDbadger

    Maybe the banks can continue to fudge the numbers for another quarter or two, but eventually, either the cash flows are there or they aren't.

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  • Comment Link NDbadger Tuesday, 05 January 2010 21:29 posted by NDbadger

    When the Fed starts printing money like it has, you can't be short anything. Even the most worthless piece of shit will increase in value. Ray Dalio said in Barron's over a year ago that the quickest way to make the market go up was for the Fed to start the printing press. But the underlying fundamentals haven't changed. There is still way too much debt, housing prices continue to decline invalue, a third of all mortgages are underwater, yada. yada. This isn't going to end with a happy face.

    As far as I know, Meredith doesn't have a buy on a single bank stock. And I believe Chris Whalen still thinks the big banks are f*cked, but just that for now they are getting tremendous subsidies from the Fed. Anyway, 2010 should be interesting.

    I still respect your work Reg, just sorry the last nine months have been so unprofitable.

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  • Comment Link jarret Tuesday, 05 January 2010 19:47 posted by jarret

    Bearish in 2008 meant to say

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  • Comment Link jarret Tuesday, 05 January 2010 19:46 posted by jarret

    I follow quite a few and Grantham was the only one I noticed as well and the fact he was bullish in March so publically (and right) is impressive. Since he nailed it twice some might find it interesting that he is currently very bearish and the last I saw he thought fair value of the S&P was 870-900.

    On a very limited scale Meridith nailed it twice as she was bearish through the worst and turned bullish on GS (though slightly later than March but still early). She is also bearish now on the few stock she discusses publically.


    I personally was bearish all last year....and fully long in March.....seems like the story should have ended very well......but I went net short in May....and I think you can all guess the rest :-)

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  • Comment Link c4com4b Tuesday, 05 January 2010 19:29 posted by c4com4b

    Reggie,

    I have been investing for over 20 years. Most investment analysts base their assessments on what benefits their portfolio's most. Goldman Sachs clearly is selling their book, when they predict a bull market. They don't make money in a severe downturn. What benefit does a mutual fund company derive from a declining market ?

    There are few analysts that can accurately predict when a market will go up AND down. The only one I can think of in recent history is Jeremy Grantham. Every other analyst that called the March lows, who I investigated, missed the drop in 2008. Jeffrey Saut touts that he called the March lows, yet when the DOW was at 12,000 called for his readership to put their money back into equities. There are many other "professionals", who committed the same crime.

    Looking at performance on an annual basis is a loser's game. Growth of one's portfolio over time is what everyone wants. So, using your approach, an investor would have grown their portfolio above the 2008 highs and missed the runup in March. Given the choice, I think anyone in their right mind would have chosen your strategy.

    Stick to your guns. Fundamental analysis is the only way for an investor to take risks.

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  • Comment Link jarret Tuesday, 05 January 2010 17:07 posted by jarret

    I respect the fact you were open to discussing the past year as well as answering some tough questions that came your way. As someone who stumbled upon Reggie very early on I can tell you that he produces some very high quality research that is well worth the subscription.

    Good luck in 2010 Reggie.

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  • Comment Link shaunsnoll Tuesday, 05 January 2010 16:42 posted by shaunsnoll

    this has been a pretty crazy year for sure. Correlation among assets in 2009 hit ALL TIME HIGHS (aka: company fundamentals meant less than EVER).

    The best way to get revenge on the market is to kick its butt in 2010 and I'm sure you will do that. The more people take a short term mindset the more opportunity will be available for long term minded investors.

    cheers to stacking cash (or gold) in 2010!

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  • Comment Link Lowcarb Tuesday, 05 January 2010 14:09 posted by Lowcarb

    These days I'm not expecting much from financial people -

    How can anybody predict government intervention in the Markets on the scale we have seen?

    How can anybody make an intelligent trade with that going on?

    And Programmed Trading - who can predict any-which-way with ~that~?!?

    And the Fed buying U.S. debt?

    Reggie - there is so much manipulation going on I really don't know why anybody would take the risks they do in the Markets right now or for the foreseeable future.

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