T H E
M K C
G L O B A L
R E P O R T Q2 2009 Edition May 15, 2009
__________________________________________ “For a nation to try and tax itself into prosperity is like a man standing in a bucket trying to pick himself up by the handle.” - Winston Churchill __________________________________________ Why Managed Futures? The managed futures industry includes Commodity Pool Operators (CPOs) and Commodity Trading Advisors (CTAs). Managed futures falls under the category of “alternative investments” and is considered a sub category under hedge funds. The managed futures industry has grown dramatically over the past 20 years from under $1 billion under management to over $219.7 billion at the end of the first quarter 2008.*This growth has come in part from investors discovering value in an investment that correlates very little to others. CTAs and CPOs offer investors a mechanism to truly diversify in a way that a typical portfolio of stocks, bonds and even other hedge funds cannot. In other words, managed futures performance tends to be uncorrelated and unrelated to factors that influence the performance of stocks and bonds. *”According to Barclay Hedge, ltd.”
__________________________________________ Equities We have all witnessed a historic time in the asset markets over the past two years. Some of the events like what we saw unfold were once-in-a-lifetime moves. Industry professionals threw around terms like “six sigma event” in the summer of ’07 (this refers to movements in the credit market being six standard deviations away from normal; theoretically impossible). Commodities and currencies have moved massively, up and down. The stock market declined in a way many analysts, money managers, and advisors forgot was possible. As of this writing, U.S. stock markets have moved higher from the March lows by about 43%. The NASDAQ rallied higher than other U.S. indices and some Asian markets have more than doubled. People being interviewed on television as well as some financial writers are suggesting that this is the bottom and the beginning of a new bull market. I disagree. Although, on a positive note, I do think that U.S. stocks can go higher over the next year or so, but foreign stocks
(excluding Europe) will perform the best. There aren’t many reasons why stocks will begin a new multi-year bull market. Stocks saw a truly historic run from 1982 until 2000. Simply buying a broad index fund during that period would have multiplied your original investments by a factor of almost 13. At the present time, nothing material has changed in our economy to
ignite a new cyclical bull market at this time. The “bank stress tests” have shown nothing but the fact that our largest banks still need capital (and I’m quite sure they need much more than the government is admitting). Unemployment continues to rise in a brutally consistent manner. The commercial real estate market has recently begun to suffer. GDP has dropped by the largest amount in almost 50 years and we have a
government that doesn’t foster innovation, entrepreneurship or a friendly corporate tax environment. I think it’s safe to say that typically the stock market doesn’t like any policy that takes money away from corporations. Lastly, no substantial new technology (equal in importance to the railroad, automobile or PC) is on the horizon to ignite a brand new industry and turn around the economy single handedly. I came to the previous realizations in a roundabout manner; through trying to determine when the stock market would decline. In working on a market timing model for equities I spent time going through 100 years of stock market prices. Last year I observed a significant correlation between the NASDAQ over the last 9 years and the Dow Jones Average from 1929 to 1938. (See chart on page 3). What I saw was the classic price action of a bursting asset bubble. I believe that a strong awareness of historic markets (the more obscure and overlooked the better) is helpful in developing market timing models. It was in that spirit that in August of 2008 I proposed important parallels in the stock market to that of the 1974 period. A close friend and fellow fund manger Edward Kim (2gtt, LLC) contributed insight to what I playfully called the “1974 Analog Model” (named after Paul Tudor Jones’ 1929 Analog Model that helped him anticipate the ’87 crash). My model overlaid the 2007-08 stock market with the 1973-74 market. It enabled me to get completely short stock and stock indexes before the downward move in the fall of ‘08 (in fact I put my accounts net short in mid-summer 2008). Historically, recoveries from cyclical bear markets take many years. On the short side, they can take only 1215 years in nominal terms, but upwards of 25 years in real terms. Adjusted for inflation the stock market didn’t make new highs after the Great Depression or the 1970s for 25 years. Japan still hasn’t come close to hitting its old high from 1989, some 20 years ago. These facts
This chart only includes prices of the Dow Jones until 2006. The lows of March 2009 would be comparable in level to the lows made on this chart in 2003.
do not help the case for a new cyclical bull market in the near future. In reality, I don’t think the U.S. markets will hit all time highs and begin a new cyclical bull market for more than a decade. I think it is possible we hit new highs and then break down again, but hit new highs and never look back? Not for a while. I dislike repeating investing truisms, but I do agree that emotion is detrimental to investing success. (This is one of the reasons following a defined trading system is so valuable, following a strict set of rules disallows trading on emotion). I say this because, although I started last fall with my 1974 Analog Model, the media coverage and emotion of the market fall began to influence me. I started to wonder if we would be facing a period for stocks like 1929-1932. I am again still in agreement with my first model and increasingly confident the stock market has sidestepped following the ‘29 path where the Dow Jones dropped 89% in a very consistent and destructive way. That fate may have been a reality had the Federal Reserve not stimulated in the early 2000s and “rescued” us by slashing rates and creating the housing bubble. Due to their actions the markets will probably be quite choppy instead, with periodic yet steep price declines (more like what we saw in the 1970s or late 1930s). If you look at the chart
above, the 1970s were as severe as the great depression on an adjusted basis. When the government intervened in the early 2000s, they may have halted an asset market crash, despite their efforts then and now, they cannot stop our society and economy from paying dues resulting for many years of inflated markets and lifestyles. We will merely pay the piper in another way, like the current “financial crisis” and/or possibly inflation down the road. As a result of the stimulus and bailouts of 2008-2009, it makes sense that our economy will see some combination of inflation and either a flat or declining stock market for a long time. I believe it will ultimately decline (in real terms) close to the lower channel drawn in on the chart above. We are in the middle of a long period of wealth destruction. Our nation’s two most difficult financial periods began in ’29 and ’68. A few people managed to make fortunes during these times, but most were not able to keep their powder dry for the next liquidity boom. Those that did prospered tremendously. In the 1930s the people who survived and prospered shorted stocks in general or owned gold stocks. In the 1970s those who thrived invested in commodities personally or allocated capital towards professionally managed futures.
Managed futures tend to focus on commodities and currencies, but there are many ways to gain exposure to stocks. Globally there are quite a few stock indexes that have associated futures contracts. For the accounts I manage, choosing which one is quite simple. I have spent thousands of hours on research and the data shows unequivocally that when managing an aggressive portfolio for the long run, relative strength is of utmost importance. If somebody wants to buy stocks, why buy anything but the strongest stocks or the strongest indexes? If any market is significantly outperforming its peers, there are clearly reasons for that. I am referring to sustained strength, not merely a one week thrust in price. MKC Global Investments manages accounts in a manner that follows the long-term trend and therefore watches for longterm sustained strength and outperformance. For example, in the global stock markets I currently like China, Taiwan and South Korea. This translates to the Hang Seng, MSCI Taiwan, and KOSPI 200 indexes. With U.S. stocks rallying 30% the Asian ones have rallied about 45%. It is my belief that China and Taiwan will be some of the first countries to emerge from the global financial situation.
received an additional boost from the inflationary effects of the Federal Reserve’s dramatic lowering of interest rates in the early 2000s. Last year commodities peaked and corrected with the rest of the global markets. A large correction after an 8 year run-up is to be expected, although this one was scary. There was a forced liquidation in all markets. Commodities were ripe for a correction and the forced liquidation from the “credit crisis” merely accentuated the decline. Investors, forced to withdraw assets from well
moves in the commodity and currency markets were so large. For example, my accounts had long positions in gold, corn, sugar and natural gas in the first half of ‘09 and my short positions in copper, soybean oil and crude oil in the second half of ’08 worked quite well. The currency markets also contributed to our performance as the British Pound suffered and the Euro and Japanese Yen gained. Consequently, early 2009 saw these markets consolidate and slow down, this is expected after highly volatile periods.
performing funds merely to cover losses from poorly performing ones, further depressed markets across the board. At present, the supply and demand picture is still quite promising for higher prices over the next several years. This fact coupled with government induced inflation will create exciting moves in the near future. The wildcard at present is when inflation will begin, currently it is unclear if it has reemerged or if the true upward swing in inflation is a year or more down the road.
Precious metals have been a good example of an opportunity presented to us in the markets recently. The stars seemed to be aligning for an upward move in precious metals, these include: gold, silver, platinum and palladium. When equity prices were still breaking down, investors were looking for a safe haven for their money. Since gold has long been a store of value (or at least perceived that way), it seemed like a logical place for scared investors. Also, the fear of a drop in the U.S. Dollar and the threat of inflation from the U.S. government bailouts provided another fundamental driver. From a technical standpoint, gold kept its strength over the last year compared to most other
Commodities: Commodity and currency markets are two markets that will offer the largest opportunities over the next decade. Unfortunately these markets are the least understood by most investors. I say unfortunately because these markets genuinely offer diversification to one’s portfolio, the way that simply buying stocks in different sectors cannot. Commodities suffered a massive bear market from 1982 to 1999 which resulted from huge supplies created from the historic prices of the 1970s. The current bull market began from an imbalance in supply and demand (think China’s demand coupled with low supply from almost 20 years of depressed prices). This new bull market
2008 was a strong year for Managed Futures funds. This would still be true even without the opportunity to short stock indices because the price
markets. This suggested that a strong supply of buyers and/or a lack of sellers were keeping a bid underneath the market. Silver and platinum were the first assets to breakout higher after the massive liquidations of late 2008. As it turned out, silver outperformed the others, rallying 60% from its bottom, driving the sector higher. The others have kept their strength, but to a lesser extent. I have little doubt in my mind that silver and the other metals will continue to be strong in the coming years. Lastly, I would all but insist that every investor gain some sort of exposure to precious metals over the course of 2009. Caveat emptor: Before the price of gold quadrupled in 1979 it did correct by about 50% first. This is the type of volatility that we could see over the next few years; unfortunately investors will need to accept this. On the bright side, this type of volatility is ideal for managed futures funds and investors looking to diversify out of stocks and bonds.
Currencies: At some point I believe the U.S. Dollar will fall in value drastically. The total decline may take many years but ultimately I think the drop will be significant. Currently it is unclear whether the dollar has begun its decline or not, but I would guess that it has. Due to the synchronized global stimulus and money printing over the last 6 months it is difficult to find a fundamentally sound currency. In times of war and uncertainty the Swiss Franc has kept its strength due to the country’s safety, neutrality and sound financial practices. Unfortunately the Swiss have been at the root of the financial problems in Eastern Europe. They have succumbed to pressures to prop up some domestic banks, this is not good for the Franc. The British Pound may be worse off than the U.S. Dollar and I don’t particularly like the Euro over the long run. Where does that leave somebody simply looking for a
currency that will retain its value? The Japanese Yen, Australian Dollar, Canadian Dollar and South African Rand have been strong. The latter three are currencies of major commodity producing countries. Although they have the strongest currencies assuming they will remain strong may not be wise. This can be seen in the 1970s when commodities were raging; the currencies of their producing countries had some severe drops. In sum, simply because commodities are in a bull market doesn’t necessarily mean their currencies are as well. I would suggest the Chinese Yuan, but typical investor will have difficulty gaining access to it. There simply isn’t an easy answer.
__________________________________________________
About MKC Global Investments: MKC Global Investments, LLC, run by Andrew McCormick, is the management company for the MKC Global Fund LP. As an alternative investment management firm specializing in managed futures, its primary objective is providing investors significant long-term capital appreciation with very low correlation to traditional investments. This is achieved by following the trend of a market. MKC Global Investments is a research driven firm, deriving its strategies from the historical observation of markets as well as investment psychology. Since the strategy relies solely on historical data and not on gut feel or intuition, the strategy is robust and objective. MKC’s positions in the currency or global futures markets can be long or short and the system makes no market or sector bias aside from keeping the current portfolio diversified. The average holding period for the strategy ranges from four to twelve weeks. Lastly, the strategy is implemented 24 hours a day around the globe and across multiple asset classes, including equity, fixed-income, currency and commodity markets.
The Company’s Strategy: MKC Global Investments follows a mechanical trading system that has predetermined actions for any market movement. We designed the system to signal when to enter or exit a market and how much of the fund’s capital to allocate to each trade. Some investors and traders believe fundamental analysis (analyzing supply, demand, interest rates, GDP, etc.) to be the best way to determine future market movements. We disagree. In our view the price of a market alone tells us everything we want to know. Our view holds that the current price of any market is correct at that moment and that all factors have been “priced in” to the current value. The fund chooses not to catch market turning points, rather ride the price trend between them. We choose to be buyers of a market when it rises and sellers when it declines. MKC Global Investments utilizes a systematic approach to following the long term price trends.
__________________________________________________