2009 Paper

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Introduction Investment theories operate in a double bind: Ones heuristic view is consistently caught between the Scylla of a lens which focuses the field of vision on a few variables, hopefully capturing mimicry and the Charybdis of a blinder that narrows the field of vision, causing one to miss many important clues if the underlying theory turns out to be flawed. It is with the above caveat in mind that I attempt to navigate the uncharted waters of what investments will prove expedient in 2009. The Nobel Prize winner James Tobin succinctly stated “The terms in which a problem is stated and in which the relevant information is organized can have a great influence on the solution” This is not an academic paper but rather an Investment outlook with its Prima facie being one of making money. Its intent is not to be academically acceptable but rather to elucidate my investment outlook for 2009 and mutatis mutandis increase expediency in my investments. The hypothesis put forward is crude, general and built on empiricism with the overall objective being “How much money can be made with limited value at risk?”

The Meta Pattern in recent Financial Crisis: Folklore of financial markets has it that while history doesn’t repeat itself, certainly it rhymes. The year 2008 presented the financial world with another financial crisis. However, regardless of what the mass media hysteria has made it out to be, it does not surpass the credit crunch of 1974-75. Chronologically analyze the past major and mini financial crises since the great depression: 1966, 1969-70, 1974-75, 1982-83, 1987, 1991, 1994, 1997, 1998, 2000 and a familiar macro pattern emerges. The absence of a depression has been a major achievement for our capitalist economy but is not tantamount to saying the authorities have discovered the magic formula to deliver of an epicurean lifestyle devoid of recessions. Rather we traded in depression for bouts of massive inflation, bail outs and a consistent crisis prone financial system. The instruments that caused the credit crunches in each époque evolve from one set to another: 1966 - Municipal Bonds, 1970 – Commercial paper, 1974-75 – REITS, e.t.c. What is interesting however was the pattern of actions the authorities took that alleviated the credit crunch and the unintended consequences those actions created that provided fertile ground for incredible profits. In each instance the Federal Reserve actions of lender-of-last-resort, accepting unorthodox financial instruments as collateral and lending en masse, stabilized the distressed financial sector. Such actions coupled with Big Government running budget deficits, massive fiscal spending, helped avoid a debt deflation, by providing pent up demand (Transfer payments e.t.c). Contrary to the pundits of each financial crisis (Paul Krugman et al, who foresaw 10 of the last zero depressions) these actions of Big Government and Fed as lender-of-last-resort each time produced short term relief and a financial market recovery, which only later evolved into chronic inflation and a sell off of the US Dollar. The Profit equation of companies can be succinctly summed up as: P↑ = i↑ + Df↑ - π↓+ T↑ P = Company Profits | I = Sum of Private Investments | Df = Government Budget Deficit T= Government Tax on Profits | π = Profits earned in producing for the Government.

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The Authorities Intervention of 1974 -75 and the unintended fertile consequences Following massive Government Budget Deficits and the Federal Reserve acting as Lender-of-Last-Resort, failures of large banks such as Franklin National Bank never caused the feared depression. Rather late in 1974 we witnessed a nascent equity market rally. To form a meaningful analogy and by abduction an expedient heuristic investment in 2009, I analyze in a little more depth the movement and form of the following variables: -

The US Equity Markets The US Dollar Against world currencies Short term Interest Rates

For clients not interested in the heuristic and only concerned in what I am buying and selling, you can skip to page 6. (i) US Equity Market Index – Dow Industrials 1973 - 1975

The market bottomed with a double bottom fractal formation on the week of 12/13/1974 and proceeded to trace a mirror image rally. Reflexivity Capital Group Europe Tel: +41 22 510 2158 Fax: +49 30 916 875 87 North America Tel: +1 702 992 0389 Fax: +1 425 671 1963 Internet: www.RefCapGroup.com E-mail: [email protected]

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Zoomed Daily Chart of Fractal bottom formation right before the New Year in 1975! Fractal shows the New Year rally was the start of a secondary recovery

A major characteristic of the rally was that the Dow Industrials for the next 10 years never crossed previous highs set before the credit crunch of 1974-75. The Dow remained in a trading range between the highs of 1973 and the lows set in late December 1974 until late 1982.

Chart on the left shows Dow Industrials Between 1973 (Peak of market rally) to late 1982 when market finally broke out of trading range to new highs. During that 10 year span great profits would be Made trading against the support and resistant Levels!

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(ii) US Dollar Index (against European Currencies)

As indicated by the above chart, the dramatic surge in Equities at the end of 1974 caused the US Dollar Index to create a temporary bottom and produce a mini rally. This lasted almost a year before the dollar began its travail on a main vicious downward cycle. The drastic drop of the US Dollar is more pronounced with the Asian currencies as shown in graph below. Left: US Dollar Index (Against Asian Currencies)

Graph to the left shows the more dramatic effect of the US dollar sell off with a much shorter J-Curve once the US Dollar vicious sell off began.

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(iii)

Interest rates (Eurodollar)

Euro dollar interest rates continued dropping and remained low through 1975 touching new lows in December 1976 of 5.01. It can be posited that inflation had reared its ugly head but the authorities were more concerned in maintaining the markets rallying mode. Euro dollar (Short Term rates) began a drastic surge, three years hence

Highlights:

1976 [5.01]

1977 [7.12]

1978 [11.62]

1979 [15.00]

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1980 [18.71]

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Conclusion: 2009 INVESTMENTS Revisiting the equation expanded on earlier:

P↑ = i↑ + Df↑ - π↓+ T↑ The authorities in 2008 have gone to great length to run the largest Budget deficit on record (Df). It is set to hit 2 trillion US Dollars by the end of this year. This huge Budget deficit (Df), will more than offset any fall in Private and corporate investment (Indicated by “I” in above equation). The authorities have followed the past Meta pattern in clock work fashion. Big-Government (Large Budget Deficits through massive fiscal spending, Transfer payments, Tax cuts)! If Obama has his way this number might even surpass the 2 trillion dollars. To quote his speech “We need a massive stimulus to jolt the system.” The Federal Reserve helicopter is in the air, acting as the Lender-of-Last-Resort in ways that dwarf any prior movement. Interest rates have been cut to near Zero and unorthodox instruments are being accepted by the Federal Reserve as collateral in exchange for freshly minted US Treasuries. A case in point is the dosage of red herring the financial authorities dish to the politicians, media and general public. This is what Gregory Bateson referred to as “the fallacy of misplaced concreteness” While they argue about the TARP Funds of 700 Billion and how this money should be used, scrutinizing every little detail, the Federal Reserve in all ease and comfort already spent over 2.5 Trillion US Dollars within two months, lending to undisclosed Financial and commercial companies. When Bloomberg news tried to sue under the Freedom of Information Act, they were politely informed, that such information if made public would be of grave risk to the stability of the Country. Needless to say as Lender-of-Last-Resort, the Feds have responded with unbridled enthusiasm. Only the foolhardy with such ontological settings would bet against the market. The medicine has been applied and by abduction I am betting on the following phases occurring:

1.) The massive amounts of dollars flooding the world have a high probability of causing a surge in the Equities Market. December 1974 fractal and current Dow shape have a very uncanny similarity. The US Equity Markets may surge to the 14,000 level before settling in a trading range between 7,500 and 14,000 for the next couple of years. Asian Markets (Nikkei, MSCI Taiwan, and Kospi 200 should outperform the rest of global equities).

2.) An initial surge in equities, I contend will cause the US Dollar to have a knee jerk reaction, first rallying (US Dollar Index might touch the 85,000 level) before turning into a vicious downward trend later in the year. Bulk of the profits may be made shorting the US Dollar against Asian currencies (Primarily Aussie)

3.) The effects of the applied medicine will cause the recovering economy to evolve into the mother of all chronic inflations as the sea of paper dollars chase too few hard commodities. The CRB index should thus be an incredible investment and may surge to new highs. This makes buys in commodities from concentrated orange juice, Corn, Rough Rice Futures, metals (Gold, Silver) to energy (Crude oil Futures) excellent investments. 4.) A second Paul Volcker époque shows up to tame the inflationary beast and stabilize the US dollar by pushing up short term interest rates to high double digits. I will continue looking at taking on a large short position the Eurodollar interest rate futures once turn becomes discernable. 5.) On the Private Equity side Agricultural farmland overseas investments will become ubiquitous as Western world countries struggle to hedge against surging food prices. South Korea’s Daewoo Logistics 99 year lease on 3.2 million acres of land in Madagascar which it will use to produce corn and palm oil for shipment back home is just the tip of the iceberg. China, which already farms more than 100,000 acres of land in Australia, is buying or leasing huge swaths of farmland in the Philippines, Laos, Kazakhstan, Myanmar, Cameroon, Uganda, according to Grain, a sustainable agriculture group based in Spain. Do not forget Gulf States as well. Reflexivity Capital Group Europe Tel: +41 22 510 2158 Fax: +49 30 916 875 87 North America Tel: +1 702 992 0389 Fax: +1 425 671 1963 Internet: www.RefCapGroup.com E-mail: [email protected]

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Paradoxes occur when one ignores time. However initial reactions have been very expedient for my Net Asset Values (NAV). CRB (Commodity Weekly Chart):

Extrapolated Wave Formation of CRB

Completion of wavelet H-I and nascent I-J channel has a high probably of starting this month (Corn, OJ, Gold, Silver, oil) US D Dollar Index (Daily Chart)

US Dollar Index Futures (USDX) Expect US Dollar Index to rally to either 84.650 before major selloff. Should US Dollar Index cross the 84,650 level then next stop would be 88.500 where again I would test its strength by selling short. However based on a priori there is a higher likelihood of Dollar giving up the ghost after touching the 84,500 level

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