Mr. P is sophisticated, relentless and cunning, part of that cabal you always suspected controlled the markets. Here's what he thinks will happen this year -- and how you might make money from it.
Late last winter, Mr. P was in a world of hurt.
Responsible for research at one of the world's top hedge-fund complexes, he had urged his firm to make a large bet against the
amid the swiftest advance in the index's history. The position had gone "terribly wrong," he said, and as slap-happy tech investors around the world euphorically celebrated Nasdaq 5000 with high-fives, he was grimly setting about the task of deep-sixing his shorts.
Performance of funds under his control fell sharply because of what he termed a "mistake on the timing, not the extent, of the Nasdaq plunge." And yet, by the time the year was done, he had righted the ledger by cutting losses, regrouping and then forcefully recommending a one-two global counterpunch that worked like a charm over the rest of the year: New bets against U.S. stocks, the dollar and the yen, plus bets in favor of U.S. bonds and the euro.
Sound scary? Welcome to the high-stakes and highly volatile world of "macro" hedge funds. A world of futures and options trades made with as much as 3-to-1 leverage on the basis of deep fundamental and quantitative research straight out of the halls of the nation's finest graduate schools. A world of nerves and high turnover. And a world of secrecy and deception.
Mr. P agreed to speak broadly with me about his world last week on the condition that he and his company would remain anonymous. Not normally inclined to cloak sources, I made an exception in this case because I thought his views reflected the "smart money" that private investors believe is in a vast, evil conspiracy to steal their retirement savings.
Indeed, the smart money was absolutely delighted to profit from your pain of the past few months, he said. But for the record, he thinks of every other hedge fund manager as his mortal enemy, not a co-conspirator. Investing on this level -- he trades as many as 93 markets around the world, around the clock -- is a zero-sum game where one manager prospers at the expense of others. There are no friends, only prey. Experience and cunning rule. To make the point plainer, he said he holds three advanced degrees, but "my most valuable Ph.D. is in losses."
So how is this guy gaming 2001? The short answer is that he believes the
has embarked on a path to cut the discount rate by as much as 300 basis points, and thus he generally likes the prospects for U.S. stocks over the next 18 months.
Primed for a Recovery
Let's start with the big picture. Mr. P contends that "macro is back" -- by which he means that the most successful traders will be ones that put in the time to understand and accurately forecast global macroeconomic trends. He claims to read 200 newspapers a day, largely from 4 p.m. to 2 a.m. -- a task that makes him much like a military intelligence officer searching for details his enemies might inadvertently leave in plain sight. For instance, one recent nugget gleaned from the flagship publication of the
business and economic information network, the
Nihon Kezai Shimbun
plans not to repatriate dollars to Japan in 2001 helped him make a successful trade against the yen.
More broadly, he believes the world entered a global recession in early 2000 that picked up momentum in September. While many observers have ballyhooed the great gains in productivity that technology has brought to the world economy, he believes that it is less well understood that technology can now also cripple the economy much faster than in the past -- pushing the "angle of attack" of a slowdown to a nosedive of 45 degrees to 75 degrees. An example: Supply-chain and customer-management software has made it easy for
executives to comprehend quickly that sales of power tools declined sharply in the past month -- and also to "push a button that leads to 700 people getting fired at
the next day."
Mr. P furthermore believes that smart investors last year sensed that the economy was in much worse shape than government statistics led Americans to believe. He thinks, for instance, that U.S. employment figures have been "politically corrupted" over the past two years at the
Department of Labor
and will be "corrected" much lower by the incoming
administration. He doesn't care if you or I believe this is true; he is paid to make these kinds of assessments and act on them with clients' money.
What happens next? He contends to have accurately predicted that rising energy prices, rising interest rates, a declining euro and colder-than-usual temperatures would lead to a "perfect economic storm" this winter that would destroy stock prices. But he believes that just as most private investors have reached a peak of bearishness, the storm is actually ready to lift -- producing the most favorable climate for investing in years.
He believes this improved climate will last until the midterm
elections in November 2002, but stock prices will actually peak a short while before that, in July 2002. The scenario in a nutshell: President-elect George W. Bush needs to have the economy reasonably strong by then or face the loss of the
House of Representatives
. To make the timeline work, Mr. P believes that Bush needs to move up his timetable for a giant tax cut to the coming fiscal year, which starts in July, so that the economy looks as if it is on the mend, statistically speaking, by the fall.
Mr. P believes that Federal Reserve Chairman
purposefully helped the new president in this respect by stonewalling on rate cuts in December. "If he had dropped rates in December, as most investors and businesses believed prudent, the public would have been inclined to buy more at Christmas -- and the economic statistics for January and February wouldn't be as weak as they're going to be," he said. "Now Bush can take three months of bad numbers to Congress to get a tax cut of immense proportions. And, in addition, it gives Greenspan cover to cut interest rates equally dramatically -- possibly by as much as 200 or 300 basis points."
Surveying the Scene
I'll sum up the rest of Mr. P's comments by subject. Take them all with the understanding that he's very often talking up his own positions.
Natural gas stocks:
"I'm shorting, and re-shorting them. It's a weather game. Spring is now in sight. Natural gas is in a world of its own because there is so much supply in the United States, despite what you might have heard. We only have the incredibly high prices now because of government intervention, but the demand is artificial and at some point it will be resolved and prices will come down, and the stocks will crash."
Market price inefficiency:
"Indexing and modern portfolio theory have destroyed the efficiency of stock pricing, if it ever did exist. The reason is that stocks are now bought as parts of indexes regardless of their fundamental value vis-a-vis other stocks. And modern portfolio theory requires managers not to pick one great energy stock for their portfolio, for instance, but a basket of them. So you have five mediocre stocks go up, when only one should have. Everyone keeps doing this, because they all go to the same schools and believe what they're told."
"Only two things are true: physical science and mathematics. Everything else is a belief. So when everyone comes to think that something is true, the opposite will almost always happen. That is a real truism that permeates the market. ... I'm not normally in the business of helping people with false beliefs know that they are false, by the way. I take advantage of those false beliefs."
Strategy for stock investing through July 2002:
"Buy stocks into every dip until the Fed stops easing. The rebound will pick up speed when other central banks around the world start easing as well. But when the Fed stops easing, flip back to the other side and return to currencies, commodities and bonds. ... Why buy now? ... I believe the stock market has already adjusted to the weakness expected for the next six months, and possibly the year. ... Furthermore, we are at levels where the world's smartest investors buy. At the end of the day, the most important thing for the average investor to know is how long to hold a security. I believe it is five years.
"Now, once you have that long-time horizon in mind, and you know it's the right time to buy, you actually want the market to go lower because you want to buy cheaper. You see, you shouldn't care at this point what happens this quarter or next quarter; don't get mesmerized by the present. You want to look out farther, and start building long-term positions in beaten-down companies that have outperformed as businesses for the past 10 years. Of course, I have the experience to see patterns in the tape that suggest to me that the smart investors are buying, and that gives me confidence to do this after being short the entire year. But I can tell you right now, without hesitation, that I will personally be out of my long positions by the middle of 2002, because that is when economic confidence will have peaked."
The SEC's new Regulation FD:
"The worst thing that happened to U.S. markets this year was
, because its editors persuaded the
Securities and Exchange Commission
to prohibit all private conversations between analysts and companies. This has made it impossible for multiples to expand. Why would I pay 75 times earnings for a company when I can't ask the chief executive any questions? The notion that they would abruptly change our culture makes it one of the most insane rules ever. My hope is that a new SEC guy comes in and reverses it. It'll make liquidity for the market much better. In fact, one of the reasons I was so bearish for this half of the year was that I felt that no rational person would pay 100x earnings if they couldn't talk to the CEO. ... This is how I make money. I study things like this, and place my bets."
Turnarounds to Get in On
To leverage some of Mr. P's contrarian ideas into some stock picking, I took his advice to look for companies that had excelled in their business for the past 10 years, but had taken it on the chin in the past year. Because the
Stock Screener doesn't contain information stretching back 10 years, I used the Market Guide Screener at
instead. My criteria: I sought companies that had grown earnings and revenue at a 15% annualized clip over the past 10 years; had improved cash flow sequentially over the past three years; and were trading at least 30% down over the past 12 months. I've made a recommendations list out of the top-10 names. (
At the time of publication, Jon Markman owned or controlled shares in the following equities named in this column or listed in the SuperModels portfolios: Microsoft and Cisco Systems.
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