Role of Macro Trends to Investing and Current Biggies

In the last post we mentioned that we are not 'macro' fund managers, but that we do not believe in simply 'bottom-up' either. Here is how it works: we think macro-trends helps you find or avoid. For example, knowing and understanding the housing bubble and its link to the debt bubble, to the trade deficit/capital account, and to the level of leverage that different types of entities were using (relative especially to levels that history has shown to be prudent) was essential if you were to avoid losing money in the last year.

On the other hand, bottom-up analysis is also important. It is what helped us differentiate Lehman Brothers and Goldman Sachs from Bear Stearns on the day that Bear collapsed, and the other broker-dealers fell in sympathy. If you had sold near-month just out of the money puts struck at $25 (why selling puts was the best strategy is for another post) on lehman when it fell in sympathy, for a few more days of risk, you could have earned about 2900 dollars for each 10,000 risked. That is right, that day (March 17th) we saw an opportunity to make 29% between March 17th and the day March options expired (March 22nd) WITH NO CASH OUTLAY but requiring sufficient capital to back up the puts. The only way we would have lost money was if Lehman was indeed going to go the way of Bear. We were pretty sure this was not going to happen because (1)the Fed had just opened the discount window to all broker dealers and (2)Lehman had the best liquidity ratio of the lot.

What, precisely, are our big macro views?

1. The hibernation of the US Consumer for the next 2 years or so with slow revival thereafter (so don't rely on the next 3-4 yrs of cash flows if your company only sells to US individual consumers).

2. Temporary slow down globally, with outright recession probable in Japan, somewhat probable in the EU area, and a virtual certainty in the US. This should make emerging markets slow a lot, but different countries will have vastly different experiences depending on their exposure to exports vs domestic demand resilience.

3. Recovery will begin first (and potentially even a slow-down may be avoided) by companies who sell primarily into emerging markets, to governments or to other companies that are positioned to make large capital outlays. Companies that rely on the US consumer should be avoided unless (a)the valuation is extremely compelling (b)their plans include international growth and (c)their moat is pretty damn wide.

This view has led us to short financials and housing while being long cash, only certain segments of health care and a certain very large and well-managed diversified insurance/ manufacturing/ energy conglomerate based out of Omaha, Nebraska. We have largely held these views and positions since the middle of 2006, with some rebalancing mostly on the shorts as some of our best-chosen shorts went bankrupt or the stock fell so much that it was just as good to get out before bankrupcy (ie New Century, which actually did go bankrupt, vs CFC/MBI/ABK which eventually got into low single-digits from mid double digits) to re-use that capital on shorts with a better risk-return profile.