1H09 OUTLOOK: BE TRIGGER HAPPY

"It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of Light, it was the season of Darkness, it was the spring of hope, it was the winter of despair, we had everything before us, we had nothing before us, we were all going direct to Heaven, we were all going direct the other way--in short, the period was so far like the present period, that some of its noisiest authorities insisted on its being received, for good or for evil, in the superlative degree of comparison only."  -Charles Dickens, A Tale of Two Cities

When one pauses and considers that the novel was published in 1859 and takes place in 1775 on the eve of the French Revolution, it serves as an eloquent reminder that crisis is an integral part of the human condition.  The good news is that we’re all clearly better off living today, than anytime in the past Technology, hardly a stifling Big Brother, has served as an agent that both enables competition and innovation, and facilitates checks and balances.  Ultimately, I interpret the election of Barack Obama as a referendum on the perception that President George W. Bush didn’t respect these norms. 

[History will probably at least credit Bush for achieving his primary objective of preventing another domestic 9/11-style attack; it’s still way too early to keep score on the can of worms he opened in Iraq/Afghanistan]. 

Personally, I voted for Obama not because I believed what he said to egg on Liberals or naïve and relatively youthful base on the campaign trail, but what his non-political leadership track record indicated: he is driven by a sense of pragmatism first and compassion second.  The miracle was not that a bi-racial man was elected, but someone of Obama’s intellect and character, having had to sully himself, albeit briefly, in the highest (and lowest) levels of politics could flourish in such a cynical ecosystem.  This development surely is not a prelude to the disintegration of the United States of America vis-à-vis Emperor Caligula’s Rome.  Not even close.  So as everybody braces themselves for the first full week of trading in 2009, the contrarian perspective is to embrace the (relatively) positive developments that helped avert a total collapse of global capitalism.

The Great Recession.  This is not to say that my current outlook isn’t grim.  A Great Depression II scenario (e.g. peak unemployment of 25%) may be improbable, but still can’t be entirely dismissed as impossible.  If the main source of global growth, China, suffers a hard landing the subsequent takedown of commodity-based economies like Australia and Brazil (Czar Putin's empire is already gasping for air) will be problematic. Dire outlooks are the norm globally with the possible exception of under-banked Africa. Although the consensus expects the U.S. economy bottoming around September, the odds are that this credit-led recession will last longer than the standard consumer-led variant as it normally does.  The biggest problem is we’re probably in the early innings in a multi-year (decade?) credit deflationary cycle.  Lower mortgage rates in the absence of demand by a credit-strapped, job-loss fearing consumer are no panacea for the oversupply of housing stock.  FED Chairman Bernanke and Treasury Secretary Paulson were hardly prophetic handling the market meltdown, but reversing the commitment to a TARP-heavy strategy to one that emphasized shoring up the capital reserves of our major banks (and bank-like entities) and guaranteeing time deposits definitely qualifies as better late than never.  There are times to police against the risks of moral hazard and now is not the time.

Sell in May and Go Away.  Although the triage process appears to be making some progress as Libor spreads are at less than insane levels, there is only so much (inefficient) government stimulus can be expected to deliver while simultaneously crowding out private capital. Our economy is like Tiger Woods intensively rehabilitating his ACL: when healthy its capable of doing amazing things, but is just as feeble as the weekend duffer when seriously wounded.  Hence, I believe sentiment will shift from relief back to a sense of prudent fear in anticipation of a brutal 1Q earnings season. The script of grim reality already seems clear; consumer discretionary spending is stalled as thrift is already being seen as “cool” while cautious CEOs dramatically scale back 2009 capital expenditure plans.  In this environment there is no such thing as conviction and the market eventually revisiting last November’s lows seem inevitable.  There may be brief stock specific short covering rallies during earnings season where strong managers will be able to distinguish themselves.

Bernie Madoff is Going to Hell.  The sheer audacity of the Madoff Ponzi scheme should earn him the re-naming of the crime.  After all, his last name is pronounced “Made-off.”  Even if by some miracle the markets recover to pre-Lehman bankruptcy levels the painful reminder why Cash is King means one suspects the backlog of hedge fund redemption requests won’t abate soon.  Unfortunately, the equivalent to a run on the bank is so destructive because of the negative self-fulfilling prophecy dynamic.  This significant overhang of selling pressure cannot be ignored, and may last a long time if the net outflows during the mid-1970’s are instructive.  Then again things seem to develop in a much more compressed time frame these days.  And to the credit of the hedge fund industry, still did outperform the main indexes by a gigantic margin.

Why Bother?  If you can adopt a bias that the U.S. equity markets will be bound by a wide-range for a multitude of years, not unlike Japan since 1990, there is still a massive opportunity to make good risk/reward decisions. If “investing” means you’re agnostic about going long or short that’s even better for the time being.  If we’re lucky, our chosen leaders will apply the lessons of history and at least avoid repeating critical mistakes; I think we’re doing that.  And lastly, the U.S. still has the trump card: we operate the world’s reserve currency, and nobody else has the stature to seize that from us. See how the vicissitudes of crude oil affects the arrogance and reach of hostile nations (e.g. Russia, Iran, & Venezuela).  The audacity of hope at least makes it easier to get up every morning.