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Hedging Risk: 5 Years Ago

It’s hard to believe it has been 5 years since the shotgun wedding era of Bear Sterns to JP Morgan. The market was imploding already with NASDAQ down 14% in the first two months of the year of 2008 with the S&P down 9%.

We were a roller coaster with a huge loss in January of around 13% but then we returned with an up 20% in February. We had been up in January until the Gerbil in Paris was caught with a massive position and ShockGen as we called them, unwound the position dropping European markets by 10% while the US markets were closed for a Holiday.

The Fed cut rates by 75 bps hours before we opened, and I watched a green month go red in hours. We scrambled to unwind our pain, and then boom February hit as I unwound the fund.

We are enjoying the market swings now that we have deleveraged our fund so that it‘s able to take advantage of dislocations as they appear. We believe an equity dislocation in the US markets is a given at this point. We are prepared for it, and waiting for the opportunity to buy some excellent companies at fire sale prices.

While it‘s very rare for the S&P 500 to be down for 4 straight months as it has recently (the record being 9 straight months in the 1974 bear market) we do not expect anything more than a very brief trend reversal in the near-term. The markets might put in a short-term bottom in the coming weeks. However, the overall leverage in the US financial system took many years to build up and will take more time to unwind.

The financial write downs necessary to remove the bad mortgage exposure at the major credit banks has not yet run its course. The estimates for the total amounts necessary to be written down has risen to over 400 billion, with only about 160 billion of it declared, as of yet.

It is our expectation that the Federal Reserve will experience its biggest stress test since it was founded. The majority of leverage that has been built up in the market has yet to be written down and absorbed back into the economy.

The process of editing my old partner letters into Hedging Risk: The Altissimo Letters, has been a walk down memory lane. Bear Stearns was about to be sold to JPM in a rushed shotgun wedding. The great blow up of banks was proceeding, and liquidity was drying faster than paint. Preferred shares in CEF invested in auction rates were toast. Fun times.

It has been interesting, remembering the era now that history has had a chance to bury it. In the coming days, I will be sharing additional comments from my upcoming book.

Best Wishes,