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Miscellaneous Notes

 October 02, 2007 10:06 AM
 


Well, look at the DJIA and Nasdaq Composite.  New 52-week highs.  I am still bearish on our credit markets, tepidly bullish on equities, particularly inflation-sensitive sectors (and insurance), and bearish on Real Estate and Real Estate finance.  This is a hard combo to hold together, but in some ways, I suspect that surplus capital that was making its way to the credit markets is now making its way to the equity markets.

I'm eclectic, what can I say?  I'm always trying to blend signals from the long-, intermediate-, and short-term, with greater emphasis to the longer cycle elements.  I'm not a trader.

Now, just a few notes to catch up on reader questions:

Why FSR and not VR or IPCR then?

[Related -What To Do When Things Are Nuts?]

I forgot about VR, and will have to consider it in the future.  I like IPCR, but it has run some recently, and their aggregate maximum loss discipline will limit their returns vs those companies that use probable maximum loss.

I think your post is very useful but that it raises some critical issues about successfully forecasting future inflation/real rates. Your study period includes a period where 3 major versions of CPI existing. There is the pre-Reagan CPI, the pre-Boskin CPI and the current. John Williams at shadow statistics calculates all three. The curren pre-Reagan CPI is running over 10% so "real rates" based on that would be negative 6-7%! The pre-Boskin is I think 5-6% which would still produce negative real rates….and the Fed is cutting rates!

I wish anyone luck trying to forecast 10 year hence real rates or inflation given this mix. My personal opinion is that due to fiat currencies they are likely to be much higher unless central banks allow a deflationary credit contraction to take force without trying to inflate. History suggests that they all try to inflate!

[Related -Validus Holdings (VR) Receives Regulatory Approvals For Purchase Of Flagstone Reinsurance (FSR)]

One thing that is different about my blog is that I will do different sorts of posts.  I'm hard to categorize.   This comment makes some very good points, most of which I agree with.  I believe inflation is understated in the US, and I think that the idea is growing in the populace, while Ph.D. economists stay in lockstep with the guild, and deny it.  My main article on the topic, for those with access to RealMoney, can be found here.

Also, my main point was not to get people to try to forecast inflation and real interest rates.  It was to point out how changes in inflation and real interest rates disproportionately hurt equity investors compared to bond investors.  That said, it takes a large move in inflation rates to wipe out the ordinary advantage of equities.

Hi, how do you think i-bank incentive fees will effect EPS over the next year?

I worked for a technical trend following CTA in the 90's that had a severe drawdown of -55% over the course of a year. It started with one bad day and the company was never even remotly profitable again and the owners closed it down 3 years later.

I think that people don't understand that in order to make incentive fees the hedge funds have to make new highs, just being flat doesn't cut it. Unless they are constantly making new highs, the hedge fund business is the same model as the mutual fund biz but with much higher overhead.

Alternatively they shut their existing funds down and open new ones to reset the mark but its hard to replace the truely large capital pools.

Interested in your thoughts.

That's an interesting question.  With respect to compensation from internal hedge funds, there will be some loss of EPS.  That said, investment banks have more true technical information than most hedge funds, and will benefit from trading against funds that are in bad situations.

In general, most hedge funds that lose 25% of capital go out of business.  At 50%, almost all of them do.

That's all for the evening.  Let's see if the S&P 500 hits a new high on Tuesday.

Full disclosure: long FSR

Tickers mentioned: VR IPCR

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